Offshore bond taxation for UK residents
This concise guide explains all you need to know about the taxation of offshore bonds for UK resident policyholders and explains the various income tax planning opportunities which are available.
An offshore bond is classed as a non qualifying life assurance policy for Income Tax purposes and is taxed under Chargeable Events legislation which is contained within ITTOIA 2005 ss461-546 and what remains of ICTA 1988 ss539-552.
A potential income tax liability arises if a chargeable event is triggered. The chargeable events relating to an offshore bond are as follows:
Triggers for a potential income tax liability
Date on which potential income tax liability occurs
|Death of sole/last surviving life assured which brings the policy to an end||Date of death of the relevant life assured|
|Surrender of entire policy or of a segment/s||Date of surrender|
|Taking withdrawals which exceed the individual’s cumulative 5% allowance of total premiums paid||The last day of the policy year in which the withdrawal was made|
|Assignment of the policy to another individual/entity for money or monies worth||The date the Deed of Assignment is dated|
|Fundamental reconstruction of the policy, such as adding a life assured||The day the changes to the lives assured are made|
|Holding a highly personalised bond||The last day of the policy year which commences after the date the policyholder becomes UK resident|
Offshore bonds do not receive a tax credit as do their onshore counterparts. This is because the funds of an offshore insurance company will not suffer any liability to tax on income or gains arising within the fund. So, with the exception of some withholding taxes on dividends deducted at source in the country of origin, the funds will grow free from tax.
How does the 5% tax deferred allowance work?
With an offshore bond, an amount equal to 5% of total premiums paid may be withdrawn each policy year for 20 years without an immediate liability to income tax arising. If a withdrawal is taken which exceeds this 5% allowance, then the amount by which the 5% allowance is exceeded is called a ‘chargeable excess’ and is subject to income tax regardless of whether or not the policy has made a gain.
On the other hand, if the 5% allowance is not fully used in any given policy year then the unused allowance will be carried forward on a cumulative basis. The 5% allowance does not represent tax free income but is tax deferred since any withdrawals will be added to the surrender value when the policy comes to an end in order to calculate whether or not the policy has made a gain. The total allowance is limited to 100% of each premium paid, so if a policyholder withdraws less than 5% per policy year, the tax deferred withdrawals can last for longer than 20 years.
Once an amount of 100% of the premium has been withdrawn, subsequent withdrawals become immediately taxable.
Do payments to an investment advisor count towards the cumulative 5% allowance?
5% allowance v segment surrender
Where a policy holder has an insufficient cumulative 5% allowance, then in order to avoid the creation of a chargeable excess, it can be more tax efficient to surrender individual segments where monies are required from an offshore bond. This is because the policyholder will only pay income tax if the policy has made a gain and conversely, if the policy has made a loss then there is no income tax to pay.
It should be remembered however that surrendering a segment will reduce the original premium on which future 5% allowances will be based. This is because each segment will have its own 5% allowance, so when segments of a policy are surrendered, any accumulated 5% allowances on that segment are lost. The 5% allowance will then be based on the remaining segments.
How do you calculate a gain?
(Surrender value + total withdrawals) – (total premiums paid + chargeable excesses) = Gain/loss
When would you exclude a chargeable excess from this calculation?
There are three scenarios:
Scenario 1 – Surrendering the policy before the end of the relevant policy year
A large withdrawal is taken which exceeds the cumulative 5% allowance and hence causes a chargeable excess. From an income tax point of view this chargeable excess is deemed to have occurred on the last day of the policy year in which the withdrawal was made. Therefore if the policy is surrendered before the end of the policy year, the chargeable excess which otherwise would have been created, will be wiped out.
Scenario 2 – Final policy year begins and ends in the same tax year
The policy year is treated as coming to an end on the date the policy is surrendered. This policy year is known as the ‘final policy year’. Where the ‘final policy year’ begins and ends in the same tax year, then the final policy year is extended to include the previous policy year.
A policy taken out on 1 July 2010 will have a policy year end date of 30 June. A large withdrawal was taken from the policy on 1 December 2014 which exceeded the cumulative 5% allowance and caused a chargeable excess. This chargeable excess will be deemed to have occurred on 30 June 2015. If the bond is surrendered anytime before 5 April 2016 then the chargeable excess should not be included in the surrender calculation because the final policy year began and ended in the same tax year. However if the bond was surrendered anytime after 6 April 2016, then the chargeable excess would have to be included within the surrender calculation because the final policy year did not begin and end in the same tax year.
If a policy has been surrendered and the individual has previously created a chargeable excess whilst living abroad, then as from 21 March 2012 it is no longer possible to include that chargeable excess figure within the surrender calculation.
This rule does not apply however to policies issued prior to 21 March 2012. This is on the condition however that since this date:
- there have been no further top-ups to the policy or
- the policy has not been used as security for a debt or
- the policy has not been assigned either in full or in part to a third party (which includes a trust).
If there has been a gain – what rate of tax will apply?
Income tax is payable at the policyholder’s highest marginal rate of tax. If however when you add the gain to the policyholder’s other taxable income in that year and it pushes them into a higher tax bracket, then it is possible to use top slicing in order to reduce the rate of tax payable.
What is top slicing?
Top slicing is designed to assist policyholders who would face an increased rate of tax solely due to the chargeable gain being added to their income upon surrender. It is available to taxpayers in the basic and higher rate band in the year of assessment.
The gain is sliced by the number of complete policy years the bond has been in force minus the number of years of non UK residency. The slice is then added to the policyholder’s income to determine the split between basic and higher rate tax (or higher rate (40%) and additional rate (45%) tax).
If for example a policyholder was a basic rate tax payer and when the slice was added to their other taxable income, it kept the slice within the basic rate of tax, then 20% income tax will be payable on the whole of the gain and not just the slice. Alternatively, if the slice pushes the individual into being into the 40% tax bracket, a top slicing calculation will need to be performed in order to calculate the effective rate of tax which will be applied to the whole of the gain.
Here we can show how top slicing could be used for a policy which has been surrendered in year 5 with a gain of £30,000 on their Offshore Bond.
Based on current tax rates for 2015/2016 of 20% of taxable income up to £31,786, 40% on income between £31,786 and £150,000 and 45% on income in excess of £150,000.
The tax payable on a gain of £30,000 for example, after 5 years would be as follows:
a) Assuming other taxable income is between £31,785 and £150,000, the full gain will be liable to 40% tax. If income is over £150,000 the full gain will be liable to 45% tax.
b) Assuming other taxable income amounts to £29,785.
Slice for higher rate tax
- Divide gain by 5 (number of years)
Less Basic Rate Tax threshold
Amount applied to higher rate tax
Therefore amount applied to
Basic rate tax is £6,000 - £4,000
Tax on slice is £2,000 @ 20%
£4,000 @ 40%
Total tax on slice
Effective tax rate on slice is =x 100
Tax payable on total gain is
33.33% of £30,000 =
Are there any reliefs available for expatriates in order to reduce a gain?
HMRC make allowances for the fact that some of the gain on an offshore policy may have arisen whilst a policyholder was non UK resident. This relief is called ‘Time Apportionment Relief’ and is found in ITTOIA 2005, s528.
This relief is of benefit to UK expatriates who return to live in the UK and surrender their policy. The chargeable gain will be reduced by the proportionate amount of time spent outside the UK during the life of the policy. The exact number of days is used to calculate the relief.
A premium of £100,000 was invested 10 years ago and the offshore policy is being surrendered for a value of £180,000. The policyholder spent six years living in the United Arab Emirates and four years in the UK. The chargeable gain is reduced by the fraction A/B.
(A) is the number of days of non UK residence
(B) is the total number of days the bond was in force
(A) 2190 days / (B) 3650 days = 0.6 x £80,000 = £48,000
Taxable gain = £80,000 - £48,000 = £32,000
Are there any reliefs available if the policy has made a loss?
If an offshore bond has made a loss then there is a relief called ‘Corresponding Deficiency Relief’ which may be applicable. The relief means that the policyholder is entitled to a corresponding deduction from their taxable income for that tax year up to the limit of their previous chargeable excesses. It is only possible to offset income which is subject to the 40% rate of tax.
- A policyholder surrenders a policy and it makes a loss of £5,000 and
- in the tax year of surrender they have £20,000 of income which would be subject to the 40% rate of income tax and
- they had previously created a chargeable excess of £3,000 on which income tax had been paid:
the amount of corresponding deficiency relief would be limited to £3000.
Where the policyholder dies who bears the income tax liability?
If the chargeable event is triggered in the same tax year that the policyholder died then any chargeable gain is assessed against the deceased policyholder’s taxable income for the tax year of their death. The tax due would be paid by the Legal Personal Representatives from the value of the estate.
If the chargeable event is triggered in a tax year following the policyholder’s death then any chargeable gain will be assessed against the executors (or administrators). They do not have a personal allowance to offset income tax, but all chargeable gains are liable to income tax at 20%. The Legal Personal Representatives can recover the cost of paying this tax from the value of the estate.
What are RL360°’s reporting requirements to HMRC?
Where a policy has a commencement date prior to 6 April 2000 there is a duty to report to HMRC where the policy has come to an end either because it was surrendered or the last life assured died, and the amount paid out was in excess of £63,570 (tax year 2015/2016). For a policy with a commencement date after 5 April 2000, there is a duty to report to HMRC where there has been a gain which totals £15,893 (2015/2016) or above.
Finally, please note that every care has been taken to ensure that the information provided is correct and in accordance with our understanding of law and Her Majesty’s Revenue and Customs’ (HMRC) practice as at 30 June 2015. You should note however, that we cannot take upon 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.