There's no getting away from, it the taxman wants his slice. But there are a number of options for those who get the right advice on investing offshore
It is wrong to believe that investing money offshore mitigates the tax burden for an investor. Increasingly, authorities are closing down on vehicles such as trusts and offshore bank accounts for reasons of tax avoidance, and in some instances the UK tax consequences are not always immediately obvious and can come as an unpleasant surprise.
Likewise with investments made by expatriate and non-domiciled individuals, which more often than not come into the scope of some form of tax, whether it be tax on disposal or when re-entering a country of residence. There are, however, some planning opportunities for non-domiciled individuals and expatriates if the appropriate structure is in place.
Historically the UK tax authorities have had rules in place to ensure that UK investors do not achieve a tax advantage by choosing to invest in offshore funds as opposed to UK funds (commonly known as the offshore fund rules). Furthermore, the European Union Savings Tax Directive, which has sought to tackle "non disclosure behaviour" by ensuring individuals resident in member states pay the right amount of tax, and the Gaines-Cooper case, which has reviewed the non-resident status rules, have further muddied the waters for offshore investment opportunities.
As a result, advisers need to be vigilant in regards to their clients' residence status when advising an offshore investment strategy. Bearing that in mind, there are a number of options.
OFFSHORE INVESTMENT FUNDS
Offshore investment funds are for the most part structured in much the same way as their onshore equivalent. However, the key difference is that the offshore funds are tax resident in low tax jurisdictions or tax havens and hence the funds themselves do not pay tax.
Returns can be greater because UK onshore investment is highly regulated which restricts how more volatile investment strategies may be marketed to the public and offshore investment funds are not necessarily subject to the same level of regulation. The upshot is less protection to the investor in the event of "failure" of a fund, but the possibility of greater returns.
For expatriates and non-domiciled individuals, offshore investment offers great variety. The different categories of offshore fund investment require varying levels of commitment, openness to risk, and capital, and tax treatment is usually advantageous in that non-residents are taxed only by the locality of the fund.
How the gain on disposal of an investment in an offshore fund is treated for UK tax purposes depends on whether the offshore fund is certified as having distributor status by the UK tax authorities.
If an offshore fund has distributor status (by distributing 85% of their income and meeting certain investment tests) a UK investor is liable to UK capital gains tax (CGT) on the gain realised when they dispose of the investment. Additionally, the investor will pay UK income tax annually on the dividend that they receive from the offshore fund.
Tax wise, it is less favourable for a UK investor if an offshore fund does not have distributor status as there is no CGT but instead income tax which quashes the possibility of taper relief and the annual CGT exemption. However, gains can be made because the point at which tax is payable can be deferred until the investment is sold and the investor gets the benefit of being able to reinvest the return while the investment is held.
For non-UK resident individuals, the tax liability on any income element is limited to the tax deducted at source, if any, but in practice no such liability is likely to arise. Offshore funds should be entitled to receive income from UK investments free of UK tax, provided appropriate arrangements are put in place. For taxpayers who are UK resident but not domiciled in the UK, income is taxed only to the extent that it is remitted to the UK. Some circumstances permit investors to remit tax-free to the UK, but this is complex tax planning and will not be appropriate in every case.
A distributing fund gives the UK investor the benefit of capital gains tax reliefs on disposal which is achieved by the investor paying tax annually on the dividends. In this instance the investor loses the ability to roll up the income in a tax free manner. However, individuals who are resident but not domiciled in the UK will only be taxed on this income and on any eventual gains on a remittance basis - this means they are only subject to tax when the income or gains are brought back to the UK. Furthermore, individuals who are non-resident will not be subject to tax on this income.
For non-UK domiciled individuals, there is an advantage in owning the offshore fund through a non-UK resident trust. In such cases, provided that there are no UK domiciled beneficiaries to whom gains might be attributed, capital gains arising on disposal of the offshore fund would not be subject to UK tax even if remitted. But, this too is a complex area and specialist advice is recommended.
Although similarly structured to offshore funds, hedge funds tend to be more active than traditional investment funds. A hedge fund usually invests in derivative instruments, undertakes hedging strategies and will sell stock short and generally pursue active strategies to achieve an absolute return.
Most hedge funds do not seek distributor status typically because UK tax authorities regard them as trading funds and argue that the capital gains made by the fund itself should be treated as income for UK tax purposes. Therefore, hedge funds will not get the CGT annual exemption and taper relief and will be subject to income tax.
OFFSHORE LIFE POLICIESand BONDS
Offshore life assurance bonds are popular as tax is usually only due when the funds are withdrawn. This allows assets to be reallocated between the underlying investments without incurring a potential CGT liability. To work effectively, offshore bonds must be large and must be rebalanced regularly.
It is worth noting that commissions on these investments tend to be higher than commissions on investment funds. However they have the advantage of being exempt from the European Union Savings Tax Directive and this mean investors don't have to declare their holdings to a tax authority, as the EU directive was targeted at individuals and bonds are technically held by the life companies.
For non-UK residents there is no charge to either UK income tax or CGT. For individuals UK resident but not domiciled, they will be subject to tax on the withdrawal of the funds to the extent that these funds are remitted to the UK.
Deferred interest accounts may be an attractive proposition for offshore account investment. They operate in a similar fashion to bond wrappers by paying out all accumulated interest only when the account is closed so that savings can roll up until it makes sense to declare them.
Savers will eventually need to declare interest, but they can time such a declaration at a point when they are in a lower income tax bracket, allowing an investor to cut his or her tax bill.
For the most part interest earned on bank deposits is free of UK tax for non-residents and as it is possible to ensure that interest is paid out or added to the gross balance.
It is, however, important to ensure that if non-UK residents use UK based accounts, the bank is notified of non-resident status so that tax is not deducted at source, as this could create a tax liability where one would not otherwise arise.
Some investors may have currency commitments at home, for example mortgage payments, but can maintain an account to deal with these expenses as most offshore accounts are equipped to deal with all aspects of expatriate money management - remittance included.
For individuals who are resident but not domiciled in the UK, it is possible to avoid tax on interest from offshore bank accounts by avoiding remittances to the UK. There are planning strategies in place that can allow remittances of the interest to the UK tax free and again specialist should be sought.
WHAT ELSE TO CONSIDER?
Advisers need to be wary of the variances in international tax law and tax treaties between different countries, but most of all, the correct status of their investor, as getting this wrong could completely invalidate an offshore investment strategy.
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