A common question when discussing onshore bonds is why chargeable event gains carry a basic rate income tax credit when gains from most other investments do not. To understand why, Tom Archer – tax and trust specialist at Quilter shows that it helps to look behind the scenes at how an onshore bond is structured and taxed.
The answer starts with how the bond is structured.
A bond is a unit-linked life insurance policy. Its value is linked to the funds selected by the policyholder, but they do not own those funds directly. They own the bond; the linked funds are held by the bond provider.
That separation brings corporation tax into play.
Because the underlying funds belong to the bond provider, the income and gains within them are taxed on the provider. This is UK corporation tax, but at a special rate linked to the savings income tax rate for individuals: currently 20%, increasing to 22% from 6 April 2027.
Calculating the corporation tax liability
The bond provider is liable for corporation tax and the corporation tax charge is calculated by looking at transactions on the funds linked to the bond, including income received, taxable fund distributions, and gains or losses on deemed or actual disposals.
Income:
Corporation tax applies to interest and fund rebates received within the bond. No corporation tax is paid on dividends, though the provider must ‘lift the lid’ on dividend payments because some fund distributions include a taxable element when broken down.
Capital gains:
These arise in two ways –
- Annual deemed disposals. The funds linked to the bond are treated as sold and immediately reacquired at market value at the end of the provider’s accounting year. This rebases their acquisition costs for gain calculations for the next accounting year.
- Realised gains on actual disposals. If funds are sold during the provider’s accounting year, for example for a switch, fee or withdrawal, any gain is calculated by comparing the disposal value with the fund’s base cost. This will usually be the value at the last annual deemed disposal or, if purchased later, the purchase cost.
Capital losses:
These may arise on deemed or actual disposals and can be carried forward and offset against future gains. Limits apply to losses on equity weighted funds, meaning those with 40% underlying equity content, as these can only be offset against gains on another equity fund.
Recouping the tax from the bond
Some providers recover this cost through mirror fund pricing. These funds are created by the provider to broadly track an underlying external fund, with the mirror fund price adjusted for provider charges, including corporation tax.
Others use a separate product charge: the corporation tax liability is calculated and deducted directly from the bond.
The result is an income tax credit for the policyholder
When a chargeable event gain arises, such as following a surrender, part-surrender or death, it carries a basic rate Income Tax credit equal to 20% of the gain.
A £10,000 gain therefore comes with a £2,000 tax credit, so gains within the basic rate band have no further Income Tax to pay. Chargeable event gains arising on or after 6 April 2027 will carry a 22% credit, reflecting the increase in the basic rate for savings income.
That treatment reflects how the bond is taxed before the policyholder is assessed on the gain, and helps explain why onshore bond gains are treated differently from directly held investments.
By understanding the relationship between provider taxation and chargeable event gains, paraplanners can explain the tax treatment of onshore bonds to clients.
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