Richard Leeson goes through reasons to look at offshore options.
With the Retail Distribution Review redefining the meaning of ‘independence', it is now timely to consider which clients may be suited to offshore solutions. Here are some scenarios that might call for an offshore option.
1. Low risk clients
Clients who are primarily concerned with capital preservation tend to focus on low risk assets including cash, gilts and bonds. In recent years, bond funds of various sorts have been topping the list of most popular funds in the IMA league tables.
Low risk assets, particularly in the current low interest rate environment, are unlikely to produce any noticeable gains. The returns going forward will be income and as such these assets are taxable year on year in a collective investment at the client's highest marginal rate. By holding these funds inside an offshore bond the income tax liability can be deferred indefinitely.
2. Clients with foreign property
Thousands of clients over the years have been tempted to make investments in property abroad; in 2006, Mintel research already put the number at over 800,000 people. With lower property prices in favourite locations such as Spain and a strengthening exchange rate with Sterling up over 10% against the Euro in the last year, more people may be tempted to make the same decision.
While the purchase of a property abroad is an investment decision, it also affects the client's view of their other assets. Potentially a large number of them will look to change residence at or near retirement and become non-UK resident. That being the case, they will be subject to tax in the destination country of residence which will impact their selection of investment products. It may come as a shock to find that a person's ‘tax-free ISA' is actually fully taxable in the country they move to.
Offshore products are often taxed favourably and most providers should be able to give information on how their products are taxed in a variety of different countries.
3. Clients requiring ‘open-architecture' investment
As investing clients have become more sophisticated they have increasingly demanded ‘open-architecture' investment. For pension assets this has been seen in the growing self-invested personal pension market. For non-pension assets, advisers have turned to offshore bonds which offer thousands of mutual funds, with new funds being able to be added relatively quickly and easily. With new funds launching every week and with changes in investment fashions, offshore bonds are well placed to meet future and existing fund choices.
4. Long-term income
Where income is required at a fixed level, bonds have often been used because of the attraction of a 5% tax deferred withdrawal facility which is available on both onshore and offshore bonds. Importantly the underlying investment needs to substantiate the level of withdrawal selected to avoid capital depletion and in recent years this has proved a challenge. With onshore bonds losing tax at source at the equivalent of 20% on income, the meagre returns on corporate bond funds are further depleted. By using offshore bonds the client can benefit from gross roll-up on these same funds and have a wider range of funds to choose from, reducing the pressure on the underlying investment.
5. Discounted gift trusts
A natural follow on from the need to achieve long-term income is discounted gift trusts. Where a client establishes a trust of this sort, the trustees are required to ensure that the selected level of payments established at outset is paid throughout the client's lifetime. The payments, once selected, cannot be varied or stopped, so it is essential that there is the lowest possible pressure on the underlying investments to achieve this. As mentioned before, offshore bonds reduce the pressure on the underlying assets to perform by removing the fund tax at source.
6. Loan trusts
Continuing the theme of long-term income, loan trusts are often established with the expectation of repaying a loan at 5% per annum over 20 years. Bonds, both onshore and offshore, are used in combination with a trust and a loan document. As the offshore bond does not suffer tax at source (except withholding tax), there is less strain on the chosen investment fund to provide loan repayments.
7. Gift trusts
A popular method of estate and inheritance tax planning is the use of outright gifts into trust. Usually, these days, the trust will be discretionary with a wide choice of beneficiaries and with this comes a wide possibility of tax rates. An offshore bond assigned to an individual gratuitously is not immediately charged to tax on the chargeable gain. It is possible, with careful planning, to minimise the tax charge on the eventual gain by choosing whether to pay at the trustee's rate of tax or the beneficiary's rate of tax if lower.
With the change to non-domicile taxation in recent years, many foreign nationals are now subject to tax in the UK on their worldwide assets for income and gains each year. By using an offshore bond they can defer their liability until they return to their home country without having to pay the HM Revenue and Customs (HMRC) levy each year.
9. Corporate clients
Companies can still benefit from deferral of corporation tax. By using offshore bonds investing in fixed term deposits, they can both increase the rate of return on their cash deposits and reduce their corporation tax liability.
UK nationals moving abroad or intending to move abroad can benefit from holding offshore bonds until they return to the UK. HMRC allows them to claim ‘time apportionment relief' against gains made when they are non-resident. As a simplistic example, if a bond is held for ten years with five years of non-residence then the Revenue will ignore those five out of the ten years (therefore 5/10ths) of the gain when calculating income tax on a chargeable gain. This relief is not available on other investment products.
If you are an adviser who has discounted the use of offshore products for your clients it would be worth identifying whether any of their situations apply to one of the scenarios above and if so, reinvestigating whether it is time to look at the market again.
Richard Leeson is sales and marketing director at AXA Wealth International
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