The income received in a life fund is ‘streamed’ into its component parts, principally interest and dividends. Where a fund would otherwise only distribute interest, ie a fund where 60% or more of its assets distribute interest, the life fund will still tax each component separately, part interest part dividend.

Dividends from UK equity funds which make distributions to UK investors are received with a notional tax credit equal to one ninth of the dividend received. From 22 April 2009, this also applies to offshore funds with more than 40% in equities. This tax credit is not reclaimable and reflects corporation tax already suffered on the profits of the underlying companies whose shares are held inside the collective. There is no further tax liability. For mixed funds (a fund which invests in both equities and fixed interest) the unfranked (not taxed) element is taxed at 20% and deemed to be received net of the 20% tax.

A higher rate taxpayer (HRT) would suffer an additional 20% on the net dividend received within the life fund when the bond is encashed. From 2010/2011 on encashment an additional rate taxpayer* will pay an additional 30% on the net gain, which means the maximum effective rate will be 44% (20%/30%).

Realised gains

Indexation still applies to corporately held investments (including life companies) so any gain, after indexation, will suffer corporation tax at the life company rate of 20%. Losses will be set against current year gains or carried forward.

All interest income, realised and unrealised gains (and losses) are combined together and taxed at 20%. Any net loss can be set against other income and gains within the funds or bond.

Indexation relief is not available for fixed interest investments within the bond.

A HRT would suffer an additional 20% on the net interest received when the bond was encashed which would mean an effective tax rate of 36%. From 2010/2011 on encashment an additional rate taxpayer (50%) will pay an additional 30% on the net gain, which means the maximum effective rate will be 44% (20%/30%).

A property fund may pay rental income (known as property income distribution or ‘PID’) or dividend income depending on the nature of the fund.

Where the income is a PID it suffers 20% tax deducted at source. Where the property fund distributes a dividend, the dividend is taxed as a UK equity fund, as above. A HRT would be liable to 20% on the net income of the dividend received when the bond is encashed. From 2010/2011 on encashment an additional rate taxpayer* will pay an additional 30% on the net gain, which means the maximum effective rate will be 44% (20%/30%).

Gains would be treated as per UK equity funds above. Realised gains would benefit from indexation relief and the tax spreading over seven years.

Capital gains tax does not apply to a UK bond investor. Any chargeable event gains will be assessed for income tax on the investor.

For tax already paid within the fund there is a 20% tax credit. This tax credit cannot be reclaimed by a non-taxpayer or a taxpayer able to benefit from the 10% savings tax band. A HRT will be liable to an additional 20% on the net gains. The tax rate applicable to the life fund is likely to be lower than the 20% tax credit. From 2010/2011 on encashment an additional rate taxpayer* will pay an additional 30% on the net gain, which means the maximum effective rate will be 44% (20%/30%).

* Finance Act 2009 increased the top rate of income tax to 50% for individuals with income in excess of £150,000 from April 2010. This means an additional 30% would be due for those individuals affected.