Putting together the taxation of an investment wrapper with the right advice for clients is not always easy. Murray Drummond outlines some key facts about offshore bond taxation to help the decision making
Offshore bonds benefit from virtually tax-free growth within their funds. The only tax paid is non-reclaimable withholding tax - this can make an offshore bond an attractive option for clients who will not be paying UK tax in the future. For example, where money is earmarked for a non-taxpayer, such as a child, or where the client plans to move abroad.
Tax will not be payable on bond gains until a chargeable gain happens. For example, when the bond is fully cashed in or when the bond comes to an end on the death of the last person covered.
Offshore bonds have a tax deferred allowance of 5% of the payments made per policy year. This allowance continues until 100% of the payments made into the bond have been withdrawn. A client can potentially reduce any tax liability by waiting until they are in a lower tax bracket to realise gains, or assigning the bond to a spouse or adult child in a lower tax bracket. The original owner should not benefit from the bond proceeds once the bond has been assigned.
Individuals pay tax on the bond gain at the savings rate (10%, 20% and 40% in 2006-2007). A non-taxpayer can also set any unused personal allowance against the gain. This can offer the opportunity to drip-feed gains out annually to a non-taxpayer by cashing in segments of the bond.
Where the gain from an offshore bond takes an individual into the higher rate tax bracket, top slicing relief can be used to calculate the tax liability based on the average annual growth of the policy. The top slicing period for an offshore bond always goes back to the beginning of the policy.
It is important to take withdrawals from an offshore bond in the most tax-efficient way. If there is a gain, basic rate and higher rate taxpayers will have a liability.
This is an area where the adviser can add real value by advising on the most tax-efficient surrender method.
A client planning to spend time abroad, and then return to the UK can benefit from time apportionment relief. This relief is only available to clients holding offshore bonds.
In broad terms, the gain on the bond is reduced in proportion with the time spent as a non-UK resident. Offshore bonds also give a client who is about to move abroad permanently the opportunity to realise any gains in the country with the most beneficial tax regime.
Combining an estate planning trust where the beneficiaries are non-taxpayers with an offshore bond offers an attractive way to potentially minimise inheritance tax and income tax liabilities.
The trustee rate of tax on bond gains is 40% (2006-2007) but segments or the entire bond can be assigned to adult beneficiaries of the trust. Tax on any gains would then be paid at the beneficiaries' rates, which could be lower.
In summary, offshore bonds are not just about gross roll-up. The ability to defer tax and the tax mitigation opportunities this can bring offers the adviser a real opportunity to show the positive benefits of professional advice.
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