An offshore investment bond is a tax wrapper that can hold different kinds of financial products including stocks, shares, mutual funds and structured notes. There are many advantages to how offshore investment bonds are taxed and various ways in which they can be used as highly effective investment vehicles to control when you pay tax, how much you pay and who you pay it to.
By deferring virtually all taxes, the investor can choose when he or she pays the tax and may be able to elect to defer the happening of a chargeable event until a more favourable time. As offshore bonds are non-income producing assets, there is nothing for investors to report on their self assessment form until a chargeable event occurs.
Offshore investment bonds are issued overseas, so unless the money, as either income or capital growth, is brought into the UK, it is not subject to UK taxes. Investors must be aware of the tax regime in which they are resident when they encash their bond.
Tax Advantages of an Offshore Investment Bond
Below are the details of key UK taxation benefits which an offshore bond can provide to a UK expatriate investor.
5% tax-deferred yearly withdrawals
Yearly withdrawals of 5% of the initial premium (and any additional premiums from the year in which they are added) are allowed without an immediate UK tax charge. The 5% is cumulative if not used. So as an example, if you don't take any money out in the first 3 years, you can take 15% out in year 3. The total allowance is limited to 100% of each premium paid, so if a policyholder withdraws less than 5% per policy year, the tax deferred withdrawals can last for longer than 20 years. he 5% tax deferred withdrawal facility can prove to be an extremely efficient way of supplementing your income in the UK to control the income tax you pay.
If a withdrawal is taken which exceeds this 5% allowance, then the amount by which the 5% allowance is exceeded is called a ‘chargeable excess’ and is subject to income tax regardless of whether or not the policy has made a gain.
It is important to note that the 5% allowance does not represent tax free income but is tax deferred, since any withdrawals will be added to the surrender value when the policy comes to an end in order to calculate whether or not the policy has made a gain. Even so there are further tax planning tools that can still help to mitigate tax even when the policy does come to an end.
Top slicing relief
Top slicing relief is generally available where the taxpayer would be liable to tax at a lower rate were it not for the inclusion of the chargeable event gain in their income for the year.
Top slicing relief is used to reduce higher rate or additional rate income tax when a chargeable event occurs.The gain on full surrender is divided by the number of completed policy years since the policyholder became UK resident. Top slicing is designed to assist policyholders who would face an increased rate of tax solely due to the chargeable gain being added to their income upon surrender.The gain is sliced by the number of complete policy years the bond has been in force minus the number of years of non UK residency. The slice is then added to the policyholder’s income to determine the split between basic and higher rate tax (or higher rate (40%) and additional rate (45%) tax).
When the chargeable event gain does not move a taxpayer into a higher tax rate, there may be still be some top slicing relief available due to the effect of the personal savings allowance nil rate and the starting rate for savings. The amount of these allowances available in the top slicing relief calculation is set by virtue of the taxpayer’s adjusted net income.
Time apportionment relief
Time apportionment relief can be claimed by investors in offshore investment bonds who have lived overseas and during this time were not resident in the UK for tax purposes. In these circumstances, gains can be reduced by the amount of time spent away from the UK. For example, if you have been resident outside of the UK for half the term your bond has been held for, the taxable gain would correspondingly be reduced by half.
Any chargeable gain is reduced proportionately by the time spent as a non-UK resident.
Additional investments are deemed to be made at the commencement of the contract (even if they are top-ups or regular premiums made when the client is UK resident again) thereby increasing any time apportionment relief given. This relief is of benefit to UK expatriates who return to live in the UK and surrender their policy. The chargeable gain will be reduced by the proportionate amount of time spent outside the UK during the life of the policy. The exact number of days is used to calculate the relief.
Offshore bonds can be assigned to other policy holders. There is no UK income or capital gains tax charge on the assignor. So future UK income tax will be charged at the new owner’s tax rate (if any).Therefore the overall UK tax payable can be reduced if the policy is assigned as a gift to a non-taxpayer, for example a child or grandchild of the assignor who is a university student or a non-working spouse/partner.
Gross roll up of funds
Generally, the funds in which clients invest are not subject to taxes in the Insurer's jurisdiction. For example, Insurers in the Isle of Man do not currently pay tax on the funds held for their policyholders.
Offshore bonds are easy to assign into a trust. Therefore it is possible to reduce or eliminate UK inheritance tax liabilities. This can help to remove requirements of probate.
Tax advantages when retiring abroad
It may be that the investor will retire abroad. If a chargeable event happens when an individual is resident in another country there is no liability to UK income tax (local tax advice needs to be sought in the new jurisdiction).
Additional points to note
You can switch funds within an offshore investment bond without creating any capital gains tax or income tax liability on the policyholder and you do not need to declare it on your tax return.Individuals who make top ups to their offshore investment bonds will benefit from top slicing relief from the date of the commencement of the bond
It is possible to set up an offshore investment bond with multiple lives assured which can avoid a chargeable event on the death of a bondholder.
Income tax is only payable on any chargeable gains if the gain takes the investor into the starting rate tax threshold. So non taxpayers pay nothing. Higher rate taxpayers pay 40% tax, additional rate taxpayers pay 45%.
You do not have to disclose details of your offshore bond on your tax return unless you withdraw more than your 5% per annum deferred allowance, surrender your bond or the bond comes to an end because the last life assured dies.
Choosing the provider and location of your offshore bond is 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.