The Chancellor announced a number of changes on investment taxation, most of which had been subject to widespread consultation.

Individual Savings Accounts (ISAs)

The most important change on the investment front was the revision of the ISA limits, which had been hinted at by the Prime Minister in March. However, the proposed revision is not as straightforward as it might be:

•  Until 5 October 2009, the 2009/10 ISA investment limit is £7,200, of which £3,600 may be invested in the cash component.

•  From 6 October 2009, the 2009/10 limit will rise to £10,200 (of which £5,100 may be in cash), but you can only take advantage of this if you are aged 50 or over by the end of the tax year (ie. born before 6 April 1960).

•  From 6 April 2010, the start of the new tax year, the age 50 restriction will disappear and the new higher limits will apply for all eligible investors.

Given that the original ISA investment ceiling was £7,000 in April 1999, the new limit is higher than it would have been if it had been adjusted each year in line with inflation (which would have made it about £9,300).

Overseas dividends

Last year's Budget made changes to the treatment of overseas dividends received by individuals. This briefly opened up a loophole which would have allowed investors to earn interest free of basic rate tax. However, the Treasury spotted their error – after the press had highlighted it – and inserted an appropriate anti-avoidance clause into the Finance Bill 2008. In 2009, the Chancellor revisited the issue.

From 22 April 2009, individual shareholders with 10% or more shareholdings in a non-UK resident company will generally receive the same treatment as investors with smaller holdings, i.e. dividends from the foreign company will be deemed to be accompanied by a non-payable 10% tax credit. The foreign company must be resident in a country which has a double taxation agreement with the UK, with a non-discrimination article

Offshore funds

This Budget has made a sensible change to the treatment of offshore fund distributions which its predecessor attempted, but failed, to do.

For income payments from offshore funds made to individuals on or after 22 April 2009:

•  If the fund is an equity fund, then the distribution will be accompanied by a 10% non-payable tax credit. If you are a basic rate taxpayer, you will therefore have no further tax liability. If you are a higher rate taxpayer, your additional tax liability will be 25% of the dividend you receive.

•  If the fund is not an equity fund, the distribution is classed as an interest payment with no attached tax credit. A fund in not an equity fund if it holds more than 60% of its assets in interest bearing securities, cash deposits and similar investments.

Before these changes, all distributions from offshore funds were treated as dividends, but with no attaching tax credit. The reforms therefore reduce the amount of tax you will have to pay on equity fund dividends, but increase tax payable on non-equity fund income. The overall effect is to bring tax on offshore fund income payment largely into line with that of their onshore counterparts. If you are looking for income, the Chancellor's reworking of the 2008 Budget reform makes high yielding offshore equity funds, including exchange traded funds, more attractive.

UK authorised funds

UK authorised investment funds will be able to opt to become tax elected funds (TEFs) from 1 September 2009, if they satisfy certain conditions. A TEF will have to divide its income distributions to investors into two parts:

•  A dividend, covering UK dividend payments received by the fund, which will be accompanied by the usual 10% non-payable tax credit; and

•  A non-dividend distribution which represents all other income and is taxable as interest. For individual investors this will be paid with 20% reclaimable tax deducted.

The reform will make little difference to taxpaying investors, but will make certain types of fund, such as funds which hold equities and bonds or funds invested in foreign equities, more attractive if you are a non-taxpayer or investing via ISAs or pension arrangements.

Venture Capital Trusts and Enterprise Investment Schemes

The 2006 and 2007 Budgets were both bad news for venture capital trusts (VCTs) and Enterprise Investment Schemes (EISs), as they placed tighter constraints on the companies eligible for investment and, for VCTs, reduced the level of tax relief. The net result has been that new VCT investments fell from £780m in 2005/06 to £230m in 2007/08 and probably to even less in 2008/09. At a time when the issue of financing business is high on the political agenda, there were hopes that the Chancellor would do something to boost the attraction of EISs and VCTs.

In the event, there were a number of minor technical changes, but no increase in the rates of tax relief. For the EIS the Budget revised the backdating rules so that it is now also possible to backdate the whole of an EIS investment into the previous tax year for income tax purposes. Previously only up to half of the investment (with a cap of £50,000) could be backdated. The requirement that any backdated investment must be made by 5 October in the tax year has also been removed.

ISAs

Since 6 April 2008 it has been possible to transfer the cash component of an ISA, including anything from a former TESSA, into the stocks and shares component. When this option was first announced, it was widely viewed as a rather pointless facility, as for most investors the value of the income tax saving from the cash component was greater than any tax savings offered by the stocks and shares component.

However, the world has changed since this switch facility first became available. Back then, base rate was 5.25%, so that interest on the cash component of an ISA could be a meaningful amount. With base rate now just 0.5%, many existing cash ISAs are paying 1% or less.

If you are looking for income from your ISA, a switch from cash to the stocks and shares component now has much more appeal. For example, an investment in a corporate bond fund could produce 6% or more tax-free income. The quid pro quo for the immediate extra income is that you lose the capital security of the cash ISA and your new higher income will not rise if base rates climb and could fall. Before making the switch – which is irreversible – you should always take independent advice.

Offshore funds

The changes to offshore fund taxation have largely removed the income tax advantage of holding offshore rather than onshore fixed interest funds, but given a new tax advantage to offshore equity funds. In some instances it may now be preferable to hold overseas equities via offshore rather than onshore funds.

If you have funds which invest in overseas equities or offshore fixed interest funds, you should review your holdings in the light of these tax changes.

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The contents of this Bulletin are based on the proposals put forward by the Chancellor in his Budget speech and explained in documents subsequently published by HMRC and the Treasury.
All Budget proposals may be subject to change before the Finance Act is passed. References to spouse, husband and wife and married couples include references to registered civil partners and civil partnerships.
This Bulletin is provided for general consideration only and no action should be taken or refrained from based on its contents alone. Accordingly, no responsibility can be accepted for any loss occasioned as a result of any such action or inaction.
Professional advice must always be taken.

This news item is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at July 2008. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.

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