How does tax affect your bonds?

With forecasts that inflation this year could turn into deflation next, as commodity prices fall and the economy slows, bonds look increasingly attractive. Many offer a fixed income useful if interest rates on cash deposits are falling and all are safer than equities. Indeed, gilts are backed by the British government, while corporate bonds rank above shares for repayment if a company goes bust. But anyone investing in bonds should be aware of how the tax treatment differs from stocks.

First off, income tax. Interest received worldwide on both government bonds ("gilts") and corporate bonds is taxable if you are a UK resident someone who spends more than half of the tax year in Britain. For non-residents, only interest earned in Britain is taxed. Interest income on gilts and most corporate bonds is paid without tax deducted ("gross"), so you have to declare it on your tax return unless you have made a specific election (with gilts this involves filling out a form) to receive it net. To maximise your income tax savings, don't forget that gilts and corporate bonds can be held within an individual savings account (Isa) so that interest is earned tax-free. But be aware that individual gilts must not be redeemable within the next five years to qualify for an Isa.

On capital gains tax (CGT) there's some good news. There is no CGT liability on any profit you make on gilts. The same is true of corporate bonds, provided they are what HMRC call "qualifying". This covers many "plain vanilla" UK corporate bonds, provided they do not have exotic features, such as the ability to convert them into shares later. There's more good news when it comes to stamp duty, a tax normally levied on registered assets, such as British shares and property. Despite them being classified as registered, the government doesn't levy stamp duty on gilts, nor on corporate bonds.

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