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Offshore bonds for expatriates

With many expatriates earning salaries in tax free jurisdictions, offshore bonds can be an ideal investment for individuals looking to make the most of the financial planning and tax mitigation strategies they offer. Furthermore, it is possible to choose either single or regular premium products.

An offshore bond is a medium to long term investment where underlying assets grow free of tax in a gross roll-up environment. In other words, any growth within the bond is allowed to build up without the deduction of Income or Capital Gains Tax. There is, however, a small amount of withholding tax. Although this cannot be reclaimed, it can be avoided by opting for funds which are ‘growth’ rather than ‘income’ orientated.

Expatriates may wish to use an offshore bond as a means of supplementing pension provision since there is no limit to the amount you can invest in an offshore bond.

Furthermore, many individuals will be uncomfortable at the thought of all of their savings being tied up in a pension. Many expatriates will remain internationally mobile and could have plans to retire abroad. A client may not wish to be restricted in the timing of taking benefits from their savings and, unlike a pension, the client can access their bond before they reach the age of 55.

Ad hoc withdrawals can also be taken as and when required.

A further benefit is that should the client return to the UK, the bond can be used to supplement their pension provisions by making use of the 5% cumulative deferred tax rule.

Offshore bonds offer a great deal of flexibility to many investors. For example, many offshore bonds offer access to all of the household name fund managers in the UK market plus many more international and specialist fund managers. This allows an investor to access a wider range of asset classes, allowing them to choose from a full risk spectrum of low risk capital guaranteed funds, through to hedge funds and higher risk specialist funds.

Furthermore, having an offshore bond is a cost-effective way of managing a diversified portfolio since institutional discounts on Unit Trusts and OEIC purchases are able to be negotiated by life companies on behalf of their clients. Switching between funds within an offshore policy does not trigger Capital Gains Tax, and therefore provides a more tax-efficient structure for active investment management. This also means that the timing of investment decisions is not constrained by tax considerations.

Where a client owns an offshore bond and decides to move back to the UK, there is an invaluable relief available called ‘Time Apportionment Relief’ (TAR). This relief applies where an offshore bond is held by an individual who is a UK resident for only a part of the period between the policy’s inception and the chargeable event. Where this happens, any chargeable gain is proportionately reduced (ITTOIA 2005, s528) by a fraction relating to the number of years the bond holder has been UK resident and the number of years the bond has been held. In other words, if a client owned a bond for 10 years, and lived abroad for five of those and then the UK for the remaining time, then only 50% of the gain would be liable to income tax at the point of surrender whilst a UK resident.

This relief can also apply to a policy held in trust, although under these circumstances, the mechanism for reducing chargeable gains will only apply where all the trustees are UK resident for the whole of the period between the policy’s inception and the chargeable event (ITTOIA 2005, s529). Consequently any expatriate Settlor who wishes to place their policy into a trust whilst resident abroad, should ensure they only appoint UK resident trustees, and do not include themselves as a trustee. They can always appoint themselves as a trustee upon their return to the UK if they so wish.

If expatriates have left the UK to take up a specific assignment, they can never be sure when they may have to return to the UK. They may plan to work abroad for ten years, but unexpected problems can always arise which make a return to the UK necessary. If an offshore policy is surrendered in a tax year where the client is non-UK resident, any gains will be free of UK income tax, even if the client returns to the UK in the following tax year. This contrasts with investments such as Unit Trusts or OEICs where, if bought at the time of UK residency and sold by the client whilst resident abroad, there would be a liability to UK Capital Gains Tax if the client had to return to the UK within five years of departure.

No doubt upon the acceptance of an overseas assignment, many individuals will be smart enough to sort out their finances prior to departure. However, reviewing financial affairs prior to repatriation to the UK can often be a neglected area of expatriate life. It would, after all, be rather unfortunate to have spent many years building up a substantial amount of capital, only to have a large slice of it taken by Her Majesty’s Revenue and Customs (HMRC) through a lack of foresight on return.

Fortunately, there is much that can be done to mitigate potential tax charges with offshore bonds. For the majority of returning UK expatriates they will become resident, and ordinarily resident in the UK from the day of their arrival in the UK. From that point onwards, they will be fully liable to UK taxes on worldwide income and capital gains (assuming, of course, that they are UK domiciled). Therefore, an important consideration for offshore bonds is how money should be extracted from them prior to repatriation in the UK.

For example, it may be more advantageous to take capital via the surrender of segments in the tax year before the tax year in which the expatriate takes up UK residency. This may be preferable to taking monies by way of a partial encashment. This is because a withdrawal is deemed to occur at the end of the policy year in which it is taken and, by this time, the client could already be UK resident for tax purposes. This could leave the bond holder with an unexpected and unnecessary tax bill.

Upon return to the UK, it is essential to remember that it is the ownership of the offshore bond immediately prior to the chargeable event which is important. Therefore, although the client may be a higher rate tax payer upon their return to the UK, any liability to higher rate tax may be removed by assigning the bond to a non or basic rate tax-paying spouse before encashment. This would be a gift as long as it was not for ‘monies worth’ and, from a UK Inheritance Tax (UK IHT) point of view, it should be an exempt gift if both spouses are UK domiciled. It is also important to note that TAR will not be lost upon assignment.

Having mentioned UK IHT above, it is also worth briefly emphasising that for those expatriates who do plan to return to the UK, an offshore bond in conjunction with the appropriate trust can offer a great succession and estate planning opportunity.

Finally, it is worth mentioning that there are two types of offshore single premium bond, one of which is classed by HMRC as ‘highly personalised’. A highly personalised policy allows the client to hold equities, and many life offices will offer both versions. If an expatriate invests in a highly personalised policy, it is extremely important to ensure that upon their return to the UK, they inform the life office that they are UK resident in order that the policy may be endorsed. If the policy does hold ‘offending’ assets such as equities, the client will have until the end of the policy year in which to arrange for such assets to be sold.

Where offending assets are not sold the policy is viewed as being highly personalised in the eyes of HMRC. The result is that the bond is treated as though it is yielding 15% compound every year, and this is regardless of whether or not the policy is producing any kind of return at all. To cap this, the deemed gain is in addition to any other tax charges which may arise whilst the bond is in force.

Important notes

Please note that every care has been taken to ensure that the information provided is correct and in accordance with RL360’s current understanding of the law and Her Majesty’s Revenue and Customs (HMRC) practice as at April 2010. You should note however, that RL360 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.

While this case study highlights potential opportunities for planning, it is not intended to provide an exhaustive analysis of all of the opportunities or pitfalls.