An IFA recently had a query as to the UK tax treatment of an offshore bond held by an offshore holdin...
The following assumes that the offshore company is structured in such a way that the company is managed and controlled offshore for UK tax purposes. In such a case, the UK tax treatment of any gains firstly depends on when the bond was effected. If the bond was already held in the ownership of the company before 17 March 1998, then any benefits received from the bond by a UK-resident beneficiary are likely to be free of UK tax. This is because s553 ICTA 1988 gives a deduction on gains from offshore policies by reference to any time the policyholder spent outside the UK. In this case, the policyholder is a non-UK resident company, so 100% relief should be claimable.
This loophole in the legislation was not widely used, but sufficient cases must have been cleared by the UK Inland Revenue to force them to take steps to close it in the Finance Act 1998, although those bonds already held in an offshore company before 17 March 1998 are protected under the old rules.
For offshore bonds held by companies on or after 17 March 1998, the new tax rules are contained in s547 (11) and s553 (5A) ICTA 1988, which refers to bonds held by "foreign institutions". A foreign institution is defined broadly in the legislation as a "person which is a company or other institution resident or domiciled outside the UK".
Clearly, this definition is potentially wide enough to catch offshore shell companies created for tax planning purposes, as well as Continental-style structures such as "anstalts", "stiftungs" and foundations. The latter are normally created in Roman Law jurisdictions, such as Liechtenstein, for tax-planning purposes by individuals resident in jurisdictions where the concept of a trust is not recognised.
The new rules introduced two changes: (i) Treating offshore bond gains as income: Under the old rules, professional opinion was of the view that where an offshore bond was held in the ownership of an offshore company, an assessment under s739 ICTA 1998 may not have been possible. This is because the proceeds of a bond are not income but are, in fact, capital which happens to be liable to income tax. S739 only applies to income, so no assessment could be made on individuals in the UK when a chargeable event was created.
New s547 (11) deems gains on a bond held by a foreign institution to be income arising to the foreign institution. By treating the gains as income, it allows the Inland Revenue to tax those gains under s740 ICTA 1998. Therefore, it is not possible for UK resident individuals to avoid the tax liability on the chargeable gains by placing the bond into an offshore company. However, UK resident individuals can defer the liability until the gains are actually appointed for their benefit. Furthermore, if the beneficiaries are non-UK domiciled, such appointments would be covered by the remittance basis of taxation.
(ii) Removing time-apportionment relief: In order to apply the above anti-avoidance provisions to gains arising on a bond held by a foreign institution, s553 ICTA 1988 was amended by the Finance Act 1998 to remove the ability to reduce any chargeable gain to nil by claiming a 100% reduction under non-resident relief.
This change brings the gains made on offshore bonds held by offshore companies into line with the tax treatment of gains made on bonds held by offshore trustees; changes which were introduced in the Finance Act 1985.
Brendan Harper is technical services consultant at Royal & Sun Alliance International Financial Services, Isle of Man
This article contains general information only and is not intended to be taken as specific investment or tax advice. Further information would be required.
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