Tax reprieve for investment bond holders

Holders of investment bonds who have overpaid tax on withdrawals could be able to reclaim thousands from the tax authority, which lost a court ruling last month.

The upper tax tribunal upheld the appeal of a taxpayer who chose to access his money in a way that incurred much higher tax liabilities than would ordinarily have arisen.

The judge ruled that the financial impact on the taxpayer was great enough that HM Revenue & Customs, which had refused to recalculate his chargeable gains, should amend his liabilities.

Investment bonds are widely used among wealthy investors as a tax-efficient wrapper for holding assets.

While they are technically life insurance policies, onshore and offshore investment bonds are typically used to generate long-term capital growth, with the flexibility for bond holders to withdraw capital when needed.

Withdrawals in any given tax year of up to 5 per cent of capital invested do not incur an immediate tax charge, but one that can be deferred until the bond is fully cashed in - usually when the holder is paying income tax at a lower rate, or dies.

Rachael Griffin, a technical expert at Old Mutual Wealth, says that taxpayers looking to take a lump sum out of their investment bonds face a choice that can have important tax implications.

Investors can choose either to cash in whole units of their investment bonds - which are typically comprised of a large number of identical policies - or to partially surrender equally across all segments.

While the latter is usually the default option, its selection will incur larger tax liabilities for withdrawals exceeding the 5 per cent threshold.

"Clients would often have been better off in such circumstances, but unfortunately once [the election] has been done, it's done," said Ms Griffin.

Patrick Stevens, tax policy director at the Chartered Institute of Taxation, said that it is "absurd" that taxpayers can find themselves in a position where they can make negligible profits on investment bonds but face tax charges that could bankrupt them.

"Clearly the law never intended this, yet the Revenue have been intent on pursuing [this taxpayer]. I think that's a genuine black mark against HMRC."

Mr Stevens said that despite the tax authority's lack of leniency in this instance, he hopes that others who find themselves in a similar position and can prove that they made a mistake, should avoid any legal dispute.

"While this ruling doesn't set a precedent, it does offer hope that the Revenue will be more understanding in the future," said Ms Griffin.

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