April 2008

Grave concerns on tax advice

Dear Editor,

We have grave concerns that there is a risk of inappropriate advice being given to existing bond customers and new investors following clarification of the capital gains tax changes announced in the Budget. While we understand the Chancellor's intention to simplify capital gains tax, we believe the way in which the announcement could be interpreted will be damaging to consumers, the intermediary market and the wider UK investment industry.

Life funds are taxed on the "i - e" basis which can reduce the effective rate of tax on income. Gains are taxed after allowing for indexation in a life bond, unit trusts receive franked and unfranked income and pay tax accordingly. Investors need to consider their own income and capital gains position (both now and into the future) in making product selection.

Most analysis thus far has considered each of the above components to make a simple, but individual, comparison. This runs the risk of, at best, oversimplifications potentially leading to the wrong conclusion. Further, many comparisons seem to leave out another obvious, and key, component. That is the charges the customer will pay. Ultimately, what matters to the customer is the net return after charges and tax.

Let's consider all of the factors. Assuming an equity based investment into a unit trust with a 10 year reduction in yield of 2.2% and 2.0% in a typical bond. These are fairly typical charges. A higher rate taxpayer investing £75,000 and who remains a high rate taxpayer ten years later, would expect the same net return from the unit trust and the bond, because the difference in tax treatment is offset by the difference in charges. The same investor who becomes a basic rate taxpayer seven years into the investment will, at the ten year point, see a net annual return of 0.6% higher from the bond. These calculations assume a return from equities of 7% (3.5% dividends and 3.5% gains) with inflation of 2.5% and 'canny' use of the annual CGT allowance.

It is essential that consumers seek financial advice to ensure they have the most appropriate solution to meet their investment needs and essential that advisers properly reflect customers' interests. The risks to the reputation of the industry are plain to see, as a significant number of customers may be disadvantaged if advisers fail to carefully take account of all the issues.

Paul Wright is investment management director - proposition management & development at Zurich.

Paul Wright
Investment Management Director – Proposition Management & Development
Zurich