How is interest on UK government gilts taxed?

Full answer

Gilts (UK government bonds) have a somewhat unusual UK tax treatment that splits differently from most other investments, making them particularly attractive for certain tax-planning purposes, especially around Capital Gains Tax. **Interest (coupon) is taxable as income** The regular interest payments a gilt pays (known as the "coupon," typically paid twice a year at a fixed rate set when the gilt was issued) are treated as savings income for UK tax purposes, taxed at the investor's marginal rate of Income Tax -- though, as with any other savings income, this can be sheltered entirely by holding the gilt within an ISA or pension wrapper, or can benefit from the Personal Savings Allowance and starting rate for savings where applicable outside a wrapper. **Capital gains on gilts are completely CGT-exempt** Unlike almost any other investment asset, a capital gain made on a UK government gilt (the difference between what you paid for it and what you receive when you sell it or it is redeemed by the government at maturity) is entirely exempt from Capital Gains Tax, no matter how large the gain, and regardless of your other income or gains in the tax year. This is a specific, long-standing exemption unique to gilts (and certain qualifying corporate bonds), and does not require using any of your annual CGT exemption at all. **Why this creates a distinctive planning opportunity** Because of this split tax treatment, some investors specifically seek out LOW-COUPON gilts trading at a discount to their face value (meaning more of the eventual total return comes from the tax-free capital gain as the price rises towards the face value at maturity, and less comes from the taxable annual coupon) as a way of maximising the proportion of their overall gilt return that is entirely tax-free, compared with a higher-coupon gilt of similar overall yield where more of the return would be taxable annual interest. **How gilts are bought and sold** Gilts can be bought directly via the Debt Management Office's approved gilt-buying service, or more commonly via a stockbroker or investment platform, and can be held to maturity (when the government repays the face value in full) or sold on the secondary market before maturity at whatever price gilts of that type are currently trading at, which fluctuates with prevailing interest rate expectations. **Gilts vs cash savings for higher-rate taxpayers** For a higher or additional-rate taxpayer who has already used their full Personal Savings Allowance, holding cash savings outside an ISA means ALL further interest is taxed at their marginal rate -- by contrast, a carefully selected low-coupon gilt held to maturity could produce a similar overall percentage return with a much smaller proportion subject to Income Tax (since most of the return comes as a tax-free capital gain), potentially making gilts tax-efficient even outside an ISA wrapper for higher-rate taxpayers in certain interest rate environments. **Worked example** An investor buys a low-coupon gilt for £92 per £100 face value, with a small annual coupon of 1%, and holds it to maturity when the government repays the full £100 face value. Over the holding period, they receive taxable coupon interest (a modest amount, taxed as savings income), but the £8 gain from buying at £92 and being repaid £100 at maturity is entirely free of Capital Gains Tax, regardless of the investor's other gains or income that year -- compared with an ordinary corporate bond or share investment of similar overall return, where a capital gain of this kind would usually be subject to CGT once the investor's annual exemption is exceeded. **Practical tip** Investors considering gilts specifically for their tax-free capital gain feature should compare the SPECIFIC gilt's coupon rate and current price relative to its face value and time to maturity, since the tax efficiency benefit is strongest for low-coupon gilts trading well below face value, rather than high-coupon gilts where most of the return comes as fully taxable annual interest instead.

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