There are many advantages to how offshore investment bonds are taxed and ways in which they can be used highly effectively as investment vehicles to control when you pay tax, how much you pay and who you pay it to.
Offshore investment bonds are issued overseas, so unless the money, as either income or capital growth, is brought into the UK, it is not subject to UK taxes. Investors must be aware of the tax regime in which they are resident when they encash their bond.
The main tax benefit of investing in an offshore bond is that the bond avoids paying tax at source on the growth of the investment, other than “withholding tax” which is a tax on dividend and interest income which in some countries cannot be reclaimed. This is known as “gross roll-up” and provides the potential for an offshore bond to outperform compared to an onshore bond where the underlying assets are taxed more heavily. Whilst you are invested in an offshore investment bond, tax is liable when you surrender or part surrender it and take the money out. This will depend on your personal tax and residency circumstances at the time you encash the bond. So an offshore investment bond allows you to control when and how much tax you pay on any growth.
The majority of UK expats prefer to invest in offshore funds rather than onshore unit trusts, because when profits are taken from the offshore investment bond, they are taxed as income at whatever tax rate applies to the investor in the country they are residing in. This allows the investor to defer tax and to time the surrender of an offshore investment bond and control what tax they pay and when they pay it.
Time Apportionment Relief
Offshore investment bonds offer potential tax advantages if you spend time residing outside of the UK. This is because you can claim tax relief on gains made while you reside outside the UK. This is called ‘time apportionment relief’ and you can reduce the tax paid by the proportion of time you were resident outside of the UK. For example, if you spent half the time whilst being a bondholder resident outside of the UK, you would reduce the tax on any gains by half.
Conversely, time spent residing overseas reduces the amount of years used when calculating “top slicing” relief. In the event of a full surrender, top-slicing for a non-UK resident uses all the years the offshore investment bond has been held but any full policy years the holder was a non-UK resident are not included in the top slicing calculation. This can be demonstrated in the example below which shows how time apportionment relief interacts with top slicing.
If we take the example of an individual surrendering in full an offshore investment bond who had spent 5 years in the UK and the policy had been in force for 15 years who invested £50,000 into the bond which was now worth £100,000 and had taken past withdrawals of £10,000 and had made no chargeable gains. We would start by working out the gain as being:
Surrender value of the bond + previous withdrawals less original investment amount + any previous chargeable event.
£100,000 + £10,000 less £50,000 + £0 = £60,000
We then apply Time Apportionment Relief:
Number of years UK resident x Gain / Policy years
5 x £60,000 / 15 = £20,000
Now we apply top slicing:
Time apportioned gain/ number of years policy was in force whilst UK resident.
£20,000 / 5 = £4,000
The £4,000 is then added to the investors income in the year of encashment to determine which band of income tax applies to the gain.
Taxation advantages and disadvantages of an Offshore Investment Bond
The advantages and disadvantages have been listed below and they are aimed at UK investors. Should you reside in another country when triggering any “chargeable event”- such as taking more than the 5% per annum deferred withdrawal allowance, you would need to check the local tax legislation in your country of residence.
Tax Advantages of an Offshore Investment Bond
- Dividends and interest received benefit from “gross roll up” but cannot reclaim any “withholding tax”.
- The fund is not taxed on capital gains. Any gains are assessed to income tax in the hand of the bondholder instead of capital gains tax.
- You do not have to disclose details of your offshore bond on your tax return unless you withdraw more than your 5% per annum deferred allowance, surrender your bond or the bond comes to an end because the last life assured dies. It is possible to set up an offshore investment bond with multiple lives assured which can avoid a chargeable event on the death of a bondholder.
- Income tax is only payable on any chargeable gains if the gain takes the investor into the starting rate tax threshold. So non taxpayers pay nothing. Higher rate taxpayers pay 40% tax, additional rate taxpayers pay 45%.
- You are allowed to receive up to 5% per annum withdrawals with no immediate liability to tax. This allowance is cumulative, so if you do not use it one year, you can carry it over to the next.
- “Top slicing” relief applies to encashment of part or all of an offshore investment bond which exceeds the 5% per annum deferred allowance of the original amount invested. Top slicing years are reduced by the number of full policy years the bondholder has been non-UK resident.
- “Time apportionment relief” can be claimed by investors in offshore investment bonds who have lived overseas and during this time were not resident in the UK for tax purposes. In these circumstances, gains can be reduced by the amount of time spent away from the UK. For example, if you have been resident outside of the UK for half the term your bond has been held for, the taxable gain would correspondingly be reduced by half.
- You can switch funds within an offshore investment bond without creating any capital gains tax or income tax liability on the policyholder and you do not need to declare it on your tax return.
- Individuals who make top ups to their offshore investment bonds will benefit from top-slicing relief from the date of the commencement of the bond.
- Offshore investment bonds can be written in trust to help mitigate future inheritance tax liabilities.
Tax Disadvantages of an Offshore Investment Bond
- For individuals resident in the UK any gains from encasing the offshore investment bond will be chargeable to income tax at their highest marginal rate of income tax in the tax year in which the gain is realised. Under the current income tax rules, this could be 0%, 10%, 20%, 40% or 45%.
- You cannot utilise your personal capital gains tax allowance to mitigate gains from your offshore investment bond since the gains are taxable to income tax, not capital gains tax.
- You cannot apply indexation to revalue the base cost of the offshore investment bond when calculating the income tax due following the death of the bondholder.
- A chargeable event results on the last death of the lives assured.
- It is not possible to offset the loss of one offshore investment bond against the gain on another offshore bond. However, it may be possible to offset a loss against other income.
- No credit is given for withholding tax paid when working out chargeable gains.
- Tax relief is not available for management expenses incurred by the product providers.
Whilst it is possible to hold many of the funds available from within an offshore investment bond outside the tax advantaged wrapper it is important to be aware of both the reporting and taxation consequences. To find out more about this refer to our section on the taxation of offshore funds.