UK Moves To Tackle Tax Avoidance On 'Strips' Of Government Bonds

by Robin Pilgrim, LawAndTax-News.com, London

16 January 2004

The UK government on Thursday announced that it has taken action to close a potential loophole whereby individuals and trusts can set 'strips' of government bonds against income in an attempt to avoid tax.

'Strips' are securities that confer the right to receive an amount equal to either the interest due on an individual bond (coupon strip) or the principal due on redemption of a bond (principal strip). Strips trade at a discount to their redemption price since they consist of the right to receive a certain sum at a fixed point in the future without any intervening income. Strips are therefore treated as 'relevant discounted securities' (RDS) for tax when held by individuals other than those trading in securities, and by trusts. Different rules apply for strips held by companies and for individuals trading in securities.

RDS generally are taxed on disposal, either when the RDS is sold or when they are redeemed. The profit or loss on disposal is broadly the difference between the disposal proceeds and the cost of acquisition, taxable in full in the year of disposal. The rules that apply to strips of government bonds are slightly different. At the end of each tax year, there is a deemed disposal and reacquisition, so that the discount is taxed on a yearly basis as it unwinds. The year-end disposal is deemed to take place at market value.

Previously, an individual could enter into arrangements with the intention of creating artificial losses. For example, these could involve purchasing strips of government bonds at market prices, and disposing of them shortly afterwards, by the granting of an option at a low strike price. The person disposing of the strips would not suffer an economic loss because the low price is balanced by receipt of a non-taxable premium for the option over the strips.

However, the changes announced on Thursday, and effective from then, address these schemes. The legislation will specify that, where there is a scheme or arrangement to obtain a tax advantage, market value will be substituted for the cost of acquisition and disposal proceeds. This will effectively limit the allowable loss to the loss (if any) that would arise based on market prices on the dates of purchase and sale.

Speaking following the announcement of the new rules, Paymaster General, Dawn Primarolo announced that:

"This is a highly abusive tax avoidance scheme, which we have identified quickly and acted against immediately. Schemes like this rob honest taxpayers and essential public services of revenue, and we are determined to take all appropriate action to counter them."

Recommended