This year's pre-Budget report is likely to impact on offshore life assurance policies, but the outlook is not necessarily gloomy. Luanne Ahearne looks at some of the positive aspects of investing offshore
The pre-Budget report 2007 unveiled two items of proposed legislation that will have an impact on offshore life assurance policies.
The first of these relates to legislation to bring life insurance policies (excluding protection policies) and annuity contracts held by UK resident companies under the Loan Relationships legislation as from April 2008.
The second and more controversial point relates to the Government's intention to introduce a flat rate of capital gains tax (CGT) of 18% from April 2008, simultaneously abolishing indexation and taper relief. Such a proposition clearly has more far-reaching implications than just its effect on offshore bonds. At the time of writing, it is being reported that nearly 12,000 people have signed a petition asking the Chancellor to revoke the proposed changes to CGT.
Whether or not the Government will make any amendments to the proposed legislation remains to be seen. In the meantime, however, it is inevitable that much attention will be drawn to the direct comparison of a higher-rate taxpayer paying a 40% income tax charge on an offshore bond gain as opposed to an 18% CGT charge on a directly held collective investment fund.
This will not be the first time the issue of whether or not a collective should be held in a wrapper has been raised, and in the spirit of holistic financial planning, it will never be the last. The fact is that no single investment can suit all individuals and all circumstances. Each type of investment has its own unique selling point and the purpose of this article is to revisit some of the more positive selling points associated with offshore bonds.
The investment choice within offshore bonds covers all the major world regions and sectors, from low-risk capital guaranteed funds through to hedge funds and higher-risk specialist funds. These funds can also be accessed in a cost-effective way as institutional discounts are normally able to be negotiated by the offshore company.
A popular feature of offshore bonds is the fact that they offer 'gross roll-up'. The underlying funds do not suffer any income or capital gains tax apart from some withholding tax deducted at source. This feature can make an offshore policy suitable for individuals who are likely to be basic-rate or non-taxpayers at the time of encashment. Furthermore, since offshore policies are issued with a number of segments, it is possible to stagger the release of gains by surrendering just one or a couple of segments each year.
It is the individual who owns the policy immediately before the chargeable event who will bear the income tax liability. Therefore, it is possible for the policy to have been owned by a higher-rate taxpayer and to be assigned to a basic-rate or non-taxpayer before encashment. Also, a higher-rate taxpayer may intend to retire abroad and hence he would no longer be liable to UK income tax of 40% upon encashment.
Top-slicing is used to average out a gain over the number of years the policy has been in force; the resulting figure is called the 'slice'. Where the 'slice', when added to the client's other taxable income, keeps him within the basic rate of tax, this relief effectively extends the individual's basic-rate band.
Offshore bonds are also excellent vehicles for clients who work abroad for a number of years, intending to retire in the UK. This is because the bonds can benefit from a relief called time apportionment relief, which serves to reduce the taxable gain by the proportion of time the individual has spent as a non-UK resident.
Furthermore, if you had to surrender an offshore policy during a temporary period of non-UK residence, you would have no liability to UK income tax on your return to the UK within five years of leaving. This is in contrast to selling an asset subject to CGT, which would become taxable if the individual resumed their UK residence within a five-year period.
Another well-known feature of offshore bonds is the cumulative 5% rule. Even if an individual is taking their tax-deferred 5% every policy year, the payment is deemed a return of capital as opposed to income. This is excellent news for a higher-rate taxpayer or for those who are in danger of falling into the age allowance trap. There is no need to enter these capital payments on a self-assessment tax form, meaning the policy will be much easier to manage from a tax point of view. Since offshore policies are non-income-producing assets, they also make suitable assets where a trust is being considered. The trustees will not have an obligation to distribute income to the beneficiaries and thus can avoid completing annual tax returns. Trusts can also indirectly benefit advisers as they can lead to an increase in business. This is because trusts often allow advisers to speak to the client's trustees, who may then decide to use the adviser for their own financial needs.
Switching between funds within an offshore policy does not trigger CGT. Such switches within a portfolio of onshore direct equity or unit trust investments would incur a CGT charge of 18% in the tax year during which the switches were made. Offshore bonds therefore provide a more tax-efficient structure for active investment management and ensure investment decisions are not constrained by tax considerations.
Offshore bonds can often be used to supplement a client's pension provision by taking advantage of the 5% deferred tax rule. Furthermore, the investor will not be restricted in the timing of taking benefits from the bond, unlike a pension arrangement.
Offshore policies may be the preferred option where lump sum inheritance tax (IHT) planning is a consideration, enabling the settlor to carve out an 'income' or arrange repayment of his/her loan without suffering an ongoing income tax liability by virtue of the 5% rule. Furthermore, offshore bonds can be gifted via assignment either to another person or assigned into or out of a trust without triggering a disposal for CGT or an income tax charge. The gifting of a collective investment is counted as a disposal for CGT purposes.
In the pre-Budget report, it was proposed that the remittance basis of taxation will be removed for those non-UK domiciled individuals who have been UK resident for the past seven years, unless that person elects to pay an annual fee of £30,000. Although offshore bonds are not subject to the remittance basis of taxation anyway, they would avoid any income tax liability if withdrawals were kept within the cumulative 5%. Some UK-based foreign nationals may therefore be better off with an offshore bond so as not to have recurrent income and hence avoid the need to pay the £30k charge. Since the bonds are offshore, they could also be placed under an excluded property trust, thus avoiding exposure to UK inheritance tax should the investor become UK domiciled.
In summary, it is always essential for a client to receive professional advice after taking into account all of the facts and variables before making a decision as to whether or not a wrapper is required. This has always been the case. n
Luanne Ahearne is a tax and estate planning consultant for Scottish Provident International (SPILA)
SPILA is regulated by the Isle of Man Government Insurance and Pensions Authority. The information contained in this article is based on SPILA's understanding of the tax and legal position and is not intended to be relied upon as legal and/or tax advice. The impact of tax legislation depends on individual circumstances and can alter in the future. SPILA will accept no responsibility for any actions taken or not taken on the basis of this article.
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