The Chancellor has closed a tax loophole that had been quite popular with wealthy investors, by restricting the use of insurance bonds to avoid tax on income from savings.

The tax avoidance scheme was used to provide artificially high returns on cash and enhance returns.  Investors took advantage of the fact that rebates on commissions for the sale of insurance bonds were exempt from income tax.

This scheme was used by thousands of individuals and generated tax savings totalling tens of millions of pounds.  But as at 21 March 2007 (Budget day) this scheme was restricted to investments of £100,000 or less in a tax year.

Prior to Budget Day 2007, managers set up insurance bond schemes for investors with a typical minimum investment of of £1m.  The investor would pay as a one off premium payment £1m on a life insurance policy.  The payout on a death of the policy holder was not huge, but that was not the purpose of the insurance policy as it was set up for tax benefits.

The tax benefits were substantial, with a risk-free tax-free return of about 5.6 per cent in one year, which equates to a return of more than 8 per cent gross equivalent for a higher rate tax payer.

A investor who invested £1m would receive about £56,000 in rebated commission, which prior to the 07 Budget was tax free income.  A further £4,000 would go to pay for the scheme's costs.

Twelve to 15 months later the investor would receive back their initial £1m investment giving them a total of £1.056m after tax, a much better return than a top savings account.