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Expat Offshore Investment Bonds

Expat Offshore Investment Bonds
Expat Offshore Investment Bonds

Expat Offshore investment bonds are an investment wrapper that can be used as an investment vehicle to control when you pay tax, how much you pay and whom you pay it to.  Offshore investment bonds are also referred to as portfolio bonds and tax wrappers.

An offshore investment bond is a wrapper set up by a life insurance company and domiciled in a jurisdiction with a favorable tax regime, such as the Isle of Man, Luxembourg, or Guernsey.

Increasingly, international clients are also opting to use Dublin to benefit from perceived increased regulatory protection and tax efficiency.

Internationally, offshore bonds are typically provided by global life insurance companies such as Friends Provident InternationalOld Mutual InternationalRL360Generali Worldwide and Zurich International.

Within an offshore investment bond, investments benefit from growth that is largely free of tax – often referred to as gross roll-up.

This can have a significant impact on returns, as we will show you below.

Unless the money from within the offshore bond – as either income or capital – is brought into the UK, it is not subject to UK taxes.

Investors must therefore be aware of the tax regime in which they are resident when they encash their bond.

Choosing the provider and location of your offshore bond is therefore important, as this will dictate many of the rules surrounding taxation and access.

Many of the offshore bonds available are transparent, low cost, efficient tax planning structures – although great care must be taken considering such a tax wrapper.

Why issue investment bonds offshore?

An offshore bond is a tax efficient wrapper that can hold a variety of assets, like stocks and shares or mutual funds.  One reasons bonds are issued offshore is because this adds the legal and tax shield of a life insurance policy to an investment portfolio.  The offshore investment bond can be structured to combine a life insurance policy and a portfolio to create an investment wrapper that investors can buy, manage and sell their assets through.

There can be potential tax advantages and investor protection advantages when issuing this type of bond offshore.

The closest onshore equivalent is an open-ended investment company (OEIC). Offshore investment bonds, also known as portfolio bonds or wrappers, should not be confused with traditional bonds.

Traditional bonds are fixed income investments where investors lend money to an entity (typically a company or government) which borrows the funds for a defined period of time at a variable or fixed interest rate.

One of the major differences between onshore and offshore bonds is that taxation is deferred within an offshore bond due to low (or no) tax on gains and income arising on the underlying investments during the term of the investment.

Do offshore investment bonds generally work?

Because we review a lot of offshore bonds and providers, a commonly asked question is ‘do these offshore bonds work’ particularly for international executives.  They are certainly sold prolifically to those with lump sums to invest, but they are not always sold with transparent fee structures, and that can be the undoing of an otherwise excellent solution.

Therefore, the answer to this question is – yes, offshore bonds work well for many investors for whom they are suitable, but only when they are not subject to commission charges and high ongoing costs.

Are offshore investment bonds taxable?

Your personal tax status will determine whether your investments are taxable, and at what rate.

In very general terms, offshore bonds can offer regular withdrawals that give investors access to capital in a tax-efficient way by enabling the withdrawal of up to five percent of each investment amount every year as tax-deferred income.  This five percent can be taken every year for 20 years, or built up over a number of years and withdrawn less frequently, without triggering a chargeable event for tax purposes.

A chargeable event occurs, for example, when you take out more than five percent a year, or you cash in your bond in full, or the last life assured dies, thus triggering an income tax charge.

Tax deferral is a feature of offshore bonds heavily marketed to expatriates, even when it is inappropriate or not relevant, therefore do not be over-sold on this feature until you have explored whether it is available to you, and of benefit to you.

Whats the taxation of the offshore investment bond?

Offshore bonds are taxed under the chargeable event legislation, which means gains are assessed to income tax, rather than capital gains tax (CGT).As the bond is invested with an offshore insurer, it does not suffer any income tax or CGT within the fund except for any un-reclaimable withholding tax that may have been applied. Any gains, dividends, rent or interest are taxed at 0% within the fund.

What are the UK taxation rules of the offshore investment bondholder?

For individuals any chargeable event gains will be chargeable to income tax at their appropriate rate: 20%, 40% or 45%. Trustees will pay tax at 45%.
Taxpayers can use their personal allowance and the 20%, 40% and 45% tax bands when calculating overall tax liability. For trustees, the first £1,000 worth of chargeable event gains (assuming no other income) is taxed at 20%.For highly personalized bonds it’s important to remember that for UK resident bondholders there is a deemed gain of 15% of the premium and the cumulative gains each year that is subject to income tax.

Advantages of the offshore investment bond

  • Bonds are non-income producing assets so there are no annual tax returns for individuals or trustees.
  • Funds can be switched within the bond without giving rise to a CGT or income tax liability on the bondholder and with no tax reporting requirements.
  • Switches in and out of funds are not subject to the CGT 30 day rule so will not give rise to a taxable event.
  • Income received gross within the bond will only suffer income tax on future encashment of the bond.
  • Income tax liability is reduced proportionally for time spent as non-UK resident.
  • The bond can be assigned by way of gift without giving rise to an income tax charge, although there might be inheritance tax (IHT) considerations.
  • 5% tax deferred allowances on each premium paid can be taken each policy year for 20 years without incurring an immediate income tax liability
  • For the purposes of age allowance, withdrawals within the 5% tax deferred allowance are not treated as income.
  • Realized chargeable gains may benefit from top slicing relief, which can reduce or remove any higher rate liability and for offshore bonds the number of relevant years on full surrender always refer to complete years since the bond started. The number of relevant years on excess events which occur on bonds taken out prior to 6/4/13 is the same however; bonds taken out from 6/4/13 (or bonds topped up from this date) will be the lower of years since inception or years since the previous excess event.
  • Top-ups will benefit from top-slicing from commencement of the bond (individuals only and subject to the above rules on excess events).
  • Using multiple lives assured for a life assurance contract can avoid a chargeable event on death of the policyholder.
  • Alternatively, a capital redemption contract where no lives assured are required can be used.
  • Can be gifted into trust and assigned out of trust without giving rise to an income tax or CGT charge
  • Offshore bonds are not normally included where means testing is applied by a local authority for residential care.
  • Wide investment parameters.
  • Ability to appoint third-party custodians and discretionary managers.
  • Where a bond terminates and a chargeable loss is made due to a previous excess event, deficiency relief may be available. This can reduce higher and additional rate income tax liability for the tax year that a chargeable loss occurred.
  • The remittance rules for UK resident non-UK domiciled individuals do not apply to offshore bonds. Therefore, provided the capital invested into the bond is clean (no unremitted interest or gains) then no income tax is payable until a chargeable event occurs and there is no CGT payable.

Disadvantages of the offshore bond

  • On encashment, chargeable event gains can suffer income tax up to 45%.
  • As withdrawals from a bond are assessable to income tax, it’s not possible to use personal or trustee CGT allowance to reduce gains.
  • Base cost of the investment is not re-valued on death for income tax purposes (chargeable event gains are assessable against original investment and any subsequent additional premium paid).
  • Death of last of the lives assured on life assurance contracts will create a chargeable event (even if policyholders are still alive).
  • Chargeable event gains reduce any available age allowance based on the total gain, not sliced gain.
  • May not be suitable where ‘income’ interest exists inside a trust. Investment losses cannot be offset elsewhere
  • On death of the last of the lives assured, income tax and IHT may be due.

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