Analysis & Comment:  

I generally do not worry too much about the taxation aspect of bonds. When it comes to my own investments, I drop any purchases I make into either an ISA or SIPP. These easily-accessible tax-shelter structures enable both the gross coupon and any capital gains that may be made to roll up over the years without the unwelcome attention of HMCR.

Even when bonds are not held within such a wrapper, the tax element is fairly straightforward. Income tax is payable on any income received whilst capital gains on gilts are tax-free. The situation is broadly the same for corporate bonds - "qualifying corporate bonds* ", sometimes known as QCBs, also merit the capital gains tax break. So far, so good, but there is a potential problem with the capital gains tax exemption - QCB status means that any capital losses incurred will not be offsettable.  

Thus, in the current low-yielding environment, some investors will find themselves in a tricky situation. If a 40% taxpayer buys a high coupon bond such as the British American Tobaccos 5.75% December 2013 (or many of the hundreds of other bonds issued a few years back with respectable coupons), he or she may end up paying the government more than he receives.

How could this be so? In a tax-neutral environment, the BATS 5.75% 2013 is a decent enough bond. With a maturity of three and a bit years and a market price of around 113, the bond offers a yield to redemption of just under 2% per annum. That may not seem much, but it is double the return available on gilts of an equivalent maturity.

However, for the 40% taxpayer, the situation is not so rosy. A holder of £10,000 nominal of the bond will receive £575 a year in income from the coupon - that’s roughly £1,869 between now and maturity. After applying tax, that’s just £1,121. The problem is, the investor paid a £1,130 premium for the bond. There is more money going out than in.

The situation is even worse for those unfortunate souls receiving in excess of £150,000 a year. At this point income tax jumps up to 50%.

My view: Buyers and holders of high-coupon gilts and corporate bonds should check their tax situation. Moving bond holdings into an ISA or SIPP structure should solve the problem. Alternatively, look to switch out of current high-coupon holdings into more tax-efficient low-coupon bonds. Readers can use the "sort by coupon" function (just click on the top of the coupon column) on the website to identify suitable candidates.

Mark Glowrey     

* How do investors know which bonds are "QCBs? The definition is somewhat opaque but broadly speaking, the majority of sterling bonds are QCBs. According to the HMRC website PIBS also make the grade. Bonds with convertibility features, however, may not be allowed. 

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