How are payments from FDL taxed?

In 2006 a number of investors received money from a fund established to make distributions to eligible investors in relation to investments in zero dividend preference shares (Zeros). Are they taxed as income or as a capital gain?

September 2007

As the UK tax self-assessment deadlines approach and pass, there must be people who are wondering, like me, whether the two payments from Fund Distribution Ltd (FDL) in 2006 need to be declared as income, or as a capital gain.

After much searching, I think I have found the answer. I've posted it here so that I can find it again, and in the hope that this page gets indexed in time by the search engines to help somebody else who may be searching.

Paragraph 6.13 on the Fund Distribution Ltd website on the FAQ page gives the answer, and I mirror it here in case the original may be unavailable for any reason:

6.13 Will an eligible investor be taxed on a distribution received from the Fund?

The tax treatment of a distribution received by an eligible investor from the Fund will depend upon the investor's own tax position and will be different for different investors. Eligible investors will need to take their own tax advice.

The Inland Revenue has confirmed to FDL that distributions received by UK resident individuals who held Qualifying Investments as capital assets will fall to be taxed as capital receipts. To the extent that such applicants have any unutilised capital losses arising from earlier sales of their Qualifying Investments, or from negligible value claims made in respect thereof, those losses will be available to set against a chargeable gain arising on receipt of the distribution.

The Inland Revenue has also confirmed that where an applicant's Qualifying Investment was held within an investment structure permitting the tax-free realisation of capital gains (such as a PEP or an ISA) at some point between 1 July 2000 and 30 June 2002, and is still held in a PEP or ISA (although not necessarily the same one) on the date the distribution is paid, the distribution can be retained in that PEP or ISA (and can be received tax-free).

However, you are responsible for any tax that may arise as a result of receiving a distribution from and Fund and if you are in any doubt as to your tax position you should take your own advice.

So there it is - a potential Capital Gains Tax (CGT) liability, not Income Tax - and even better news for those who hold the zeros in a PEP or ISA.