Offshore Bond

UK tax breaks on holding offshore funds in an offshore bond

Typical Client Profile: UK expatriate planning his return to the UK.

Reproduced from an article by Brendan Harper, Technical Services Consultant for Royal & Sun Alliance International Financial Services Limited:

An adviser recently inquired as to the main tax differences between an offshore roll – up fund, and an offshore bond as investments held by a UK national resident abroad, who planned to return to the UK in eight years time.

Both offshore bonds and offshore roll - up funds are tax efficient investment structures that allow the investor to roll up income and gains generated by the underlying assets without ongoing tax liabilities. Both are attractive, therefore, to those individuals who are looking for long term capital growth and who do not want the headaches associated with running a direct portfolio. For example, no income or gains need to be accounted for in the investor’s tax return until benefits are actually taken from the plan. Another attraction of either structure to expatriates and the international investor is that either investment is usually available in a wide range of currency links, unlike their onshore counterparts which are invariably sterling denominated.

When benefits are taken, and providing the investor is UK resident at this time, both investments create a capital gain which is subject to income tax rather than to capital gains tax. It is on encashment that the differences between roll - up funds and offshore bonds really begin to show.

The first major difference is in the treatment of partial encashment. Offshore bonds allow the investor to remove up to 5% of the original capital each year without incurring an immediate tax liability. This allowance accumulates if it is not used up in any year and is not available to roll – up funds. The following example shows how this would work:

Investment = £50,000 (assume unit price at investment is £1), value after 5 years is, say, £77,000. The client takes a withdrawal of £12,500. The tax treatment would be as follows:
Bond	Roll – up fund
£12,500 less allowance (50,000 x 5% x 5) = Nil gain	Price per unit (77,000 / 50,000) = £1.54. To achieve £12,500, 8,117 units are encashed. Gain is therefore, 12,500 less 8,117 = £4,383.

Wrapping a roll - up fund within an offshore bond also gives the investor more control over when to make a full encashment on an offshore bond. This is because switches between roll - up funds, even those managed by the same company, will create a chargeable event, whereas a bond allows switches between funds without creating a tax charge. This is particularly useful, for example, where the investor wishes to switch to a less risky investment without incurring tax liabilities.

Turning to a returning expatriate, there are 2 main differences between the 2 investments which favour the bond structure. The first of these is time - apportionment relief, which gives a direct reduction in bond gains in proportion to the amount of time during the term of the bond that the investor was resident outside the UK. This benefit is not available to roll - up funds, and the whole gain is chargeable. Of course, an investor can always bed and breakfast the roll - up fund before returning but this may be hampered because (i) the manager may charge for the privilege, or (ii) capital value may be lower than the original investment at that time.

The second major advantage of the bond structure is the benefit of top slicing relief where the whole gain causes the investor to move into the higher rate threshold. This works by spreading the investment gain over the total amount of complete policy years the policyholder has been resident in the UK. The effect of top slicing relief and time apportionment relief is illustrated in the following example (assuming rates and thresholds don’t change):

Initial investment: £50,000. Value at surrender after 12 years: £110,000. Investor is UK resident on encashment. 8 years spent non UK resident, and 4 years spent UK resident Other taxable income for year of encashment: £23,000
Bond	Roll - up fund
Gain £110,000 – 50,000 = 60,000 Reduce by time apportionment: 60,000 x 4/12 = £20,000 Top slice by 4 years = £5,000. When added to other income = £28,000, this is within the basic rate threshold, so tax payable = £20,000 x 22% = £4,400	Gain £110,000 – 50,000 = 60,000 Amount liable to basic rate tax (28,400 – 23,000) 5,400 x 22% = 1188 (A) Amount liable to higher rate tax (60,000 – 5400) 54,600 x 40% = £21,840 (B) Total tax (A) + (B) = £23,028

For advisers, it is best not to view roll - up funds and offshore bonds as competing products, but rather as complimentary to each other. Almost any roll - up fund is a suitable investment holding for an offshore bond and, by placing a roll - up fund in a bond, the investor benefits from the expertise of the fund manager, plus the additional tax benefits of a single premium bond. Obviously the tax benefits of wrapping a fund in a bond would need to be balanced with any extra charges the bond adds to the structure. As the above figures show, however, wrapping a roll - up fund in an offshore bond can make sense!!

This article contains general information only and is not intended to be taken as specific investment or tax advice and is based on the assumption that further information would be required and provides only a guide to some of the relevant routes that an intermediary could cover in advising the client.

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