Offshore bonds for corporate clients
Where a company has surplus cash or money set aside for a future project, the directors of that company are frequently looking for more effective ways in which to generate returns from these monies. One such investment that may be used for this purpose is an offshore bond.
Life Assurance or Capital Redemption?
The offshore bond has two variants - the Capital Redemption bond (CRB) and the Life Assurance bond. Where a company wishes to establish the bond on a life assurance basis, then it is possible to appoint such people as the directors or major shareholders of the company as lives assured if required. On the other hand, if the company does not wish to appoint lives assured, they could establish the bond on a CRB basis.
Where a bond is written on a CRB basis, it is not written as a whole of life contract but as a policy which has a term with a minimum maturity value at the end of that term. At maturity (after 99 years), the bond’s value is guaranteed to be at least twice the sum invested less any withdrawals. As with a life assurance contract, a CRB can be surrendered at any time, subject to any applicable surrender fees. The fact that a CRB has no lives assured has tended to make it a more convenient choice for a corporate investor.
An offshore bond can be surrendered in whole or in part at any time (subject to surrender fees). This means that the value of the bond can be readily realised in unforeseen circumstances.
Offshore bonds can be suitable for companies because they offer access to many of the household name fund managers in the UK market, plus many more international and specialist fund managers. This allows access to a wider range of asset classes. Furthermore, the investment choice within offshore bonds can cover all the major world regions and sectors as well as the full risk spectrum, from low risk capital guaranteed funds through to hedge funds and higher-risk specialist funds.
Her Majesty’s Revenue and Customs (HMRC) has confirmed that the Personal Portfolio Bond (PPB) provisions, a particularly severe piece of anti-avoidance legislation contained in sections 515 – 526 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA), does not apply to UK corporate investors. This means that UK companies investing in an offshore bond are free to invest in assets that would be considered ‘highly personalised’ if held by a UK-resident individual. This means the company can benefit from a wider range of investments than would otherwise be available to an individual UK-resident investor.
However, it is worth exercising caution where a UK resident owns an offshore company. This is because there is a special rule that taxes chargeable events on UK ordinarily resident individuals who benefit from a transfer of assets abroad. This means HMRC could apply the punitive PPB tax rules to individuals where their company is not resident in the UK.
Through investment in an offshore bond, it is often possible to obtain institutional discounts on unit trust and Open-Ended Investment Company (OEIC) purchases since these can be negotiated by bond providers on behalf of clients. This can help towards reducing the costs associated with the management of a diversified portfolio. Corporate policyholders are often attracted to deposit-based investments and it is life offices that can often arrange access to such investments at special rates.
Active investment management
There is no Capital Gains Tax (CGT) liability on switching between the underlying funds, which allows a company to pursue an active investment management strategy when required.
An offshore bond does not produce income. This simplifies the reporting requirements.
The ability to withdraw up to 5% of total premiums paid into an offshore bond every policy year without causing an immediate income tax liability is a feature of Chargeable Events legislation which only applies to UK individual policy holders. It does not apply to companies, irrespective of their residency.
Offshore bonds owned by UK companies used to be taxed under the Chargeable Events legislation. This came to an end on 10 February 2005 in the case of capital redemption bonds (CRBs), and was brought to an end by the Finance Act 2008 in the case of Life Assurance bonds.
Both variants were subsequently moved to the Loan Relationships regime. This was introduced in the Finance Act 1996 and is a regime for corporate debt which aims to follow accountancy practice more closely, so that all profits or losses arising to a company from its debt are taxed or relieved as income.
When the taxation of offshore bonds was moved to the Loan Relationships regime, the changes appeared to sound the death knell for UK corporately-owned offshore bonds.
However, on closer inspection, it has become apparent that for many small companies, the practical impact of this change might be negligible.
Under the Loan Relationship rules, there are two basic methods under which a company can account for investments of this type – namely the Fair Value Basis and the Historic Cost Basis.
Fair value basis
The company will pay tax on the increase in the value of the bond each year. All listed companies have a requirement to account on a fair value basis.
Historic cost basis
The company can continue to defer tax on any gain until there is a disposal of some or all of the rights under the bond.
Small companies The Financial Reporting Standard for Smaller Entities (FRSSE) regime simplifies the accountancy requirements for smaller companies. HMRC have confirmed that if a company is accounting using the FRSSE basis of reporting, it can use the historic cost basis and thus there will be no requirement to account for changes in the value of the bond on a year by year basis.
In order for a company to qualify for the historic cost basis they have to be unlisted, and have to meet two of the following conditions:
° Annual turnover £5.6m or less
° Balance Sheet total of £2.8m or less
° Average of 50 or fewer employees What this means is that UK companies eligible to apply the historic cost basis of accountancy can still benefit from tax deferral. This is because only the original value of the investment will normally be shown on their balance sheet each year until the bond is surrendered or otherwise comes to an end and a profit is seen. The profit, or more accurately, the annual increase in value can be deferred for tax purposes until the entire bond (or part of it) is realised, thus controlling the point at which tax is paid and improving the company’s cash-flow position.
It is essential that any independent financial adviser who is considering recommending an offshore bond to a company, must ensure that they work closely with the company’s accountant. It is also crucial to ensure that a company’s directors are conversant with how the bond will be treated for tax purposes before undertaking any further corporate planning.
Please note that every care has been taken to ensure that the information provided is correct and in accordance with our understanding of current law and Her Majesty’s Revenue and Customs (HMRC) practice as at June 2010. You should note, however, that we cannot take on the role of an individual taxation adviser, and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HMRC practice are subject to change.