Offshore investment bonds benefit from unique tax treatment, but are often overlooked as a tax planning tool.
An offshore bond is effectively a collection of investments held under the wrapper of a non-qualifying insurance policy, which is governed by its own tax rules. They can be highly efficient tax and investment planning wrappers.
Taxation rules
Although certain dividends may be subject to withholding tax in their country of origin, offshore insurers are not subject to UK income or capital gains tax (CGT) – so that the investor can benefit from gross investment returns.
An assignment of the bond does not give rise to a tax charge, unlike assignments of assets subject to CGT. However, an individual’s CGT exemption and taper relief is not available to reduce any amount subsequently chargeable to tax.
Investments switches within the bond are not subject to CGT and can be made without concern as to whether a tax liability will arise.
If annual withdrawals do not exceed 5% of the original investment there is no tax liability when they are made. This 5% allowance is cumulative, although it ceases once total withdrawals equal the amount originally invested. On full encashment, or if withdrawals exceed the 5% allowance, the full amount of any gain or excess is subject to savings rate tax at 20%.
Higher rate tax may also be payable, although this will depend upon the number of years the policy has been in existence and other income of the policyholder in the year of encashment. With careful planning one or both of these liabilities can be avoided.
It should be stressed that individual investment portfolios might be better suited to investments subject to CGT as both taper relief and annual CGT exemptions can be utilised. It is important therefore that financial models are built to compare these two investment wrappers and judge their appropriateness in different circumstances.
Tax considerations for trustees
Tax arising on chargeable events will be payable by the trustees at 40%. Where trustees are non-resident the tax is payable by UK resident beneficiaries of the trust. Where both the trustees and beneficiaries are not resident, no UK tax is payable.
Retirement planning
A bond may be attractive to individuals who have, for example, used their lifetime allowance for pension purposes. When they get to retirement they can defer taking their pension, thereby reducing their income to nil, at which time segments of the bonds can be encashed with a view to limiting the tax charge to no more than 20%. To help this process an assignment can be made to a spouse who would be able to make use of their own 20% band.
Administrative advantages
All administration and paperwork is handled by the offshore insurers and funds can be switched or sold within the bond via simple written instructions. As they are non-income producing assets, no trust tax returns would be required, which reduces the administrative burden on the trustees.
Trustees can also assign the bond, or individual segments of it, out to beneficiaries who would then be able to encash it, paying tax at their own marginal rate which, in some circumstances, will mean that tax on growth can be avoided altogether.
Investors should take time to understand the mechanics and tax treatment of offshore bonds, as well as their advantages and disadvantages relative to other forms of collective investments. Depending upon the circumstances of the investor, these bonds can prove to be highly tax efficient investments and, where there is uncertainty, diversifying the wrappers used is not necessarily a bad idea.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
