An offshore bond is an investment wrapper set up by a life insurance company in a jurisdiction with a favourable tax regime, such as the Isle of Man or Dublin. This means that investors benefit from growth that is largely free of tax, often referred to as “gross roll-up”.
The onshore equivalent in the UK would be an OEIC (Open Ended Investment Company), which are taxed annually on growth. Also OEIC’s are liable to capital gains tax on any fund switches made within them.
Offshore bonds offer regular withdrawals, that give you access to your capital in the most tax-efficient way by withdrawing up to five percent of each investment amount every year as tax-deferred ‘income’. This five percent amount can be taken every year for 20 years, or built up over a number of years and withdrawn less frequently without triggering a ‘chargeable event’ for tax purposes (a ‘chargeable event’ occurs, for example, when you take out more than five percent a year, or you cash in your bond in full, triggering an income tax charge).
Tax deferral is an important feature of offshore bonds. This lets you choose when to pay tax, as this will be when you cash in some, or all, of your bond. The tax payable on a chargeable event will depend on your highest marginal rate at that time. This allows you to put off such an event until you’re either no longer a taxpayer or have moved from being a higher rate taxpayer to a lower or basic rate taxpayer or have moved to a country with lower taxes. You should bear in mind that if you do move to a different jurisdiction, the benefit of tax deferral may be lost.
Wrapping your offshore portfolio bond in trust means you can offset or wholly mitigate taxes due when transferring wealth. If you have any assets above the inheritance tax nil rate band (the threshold above which inheritance tax applies) that aren’t held in trust, they may be liable for inheritance tax at 40 percent. Also, an offshore bond or trust can be structured to allow you access to the funds while you are still alive.
Since offshore bonds are ‘non-income producing assets’, there’s nothing for you to report to the HMRC until a chargeable event. You don’t have to include any information on your tax return before this point, compared with the potentially complicated requirements for reporting income and gains on a portfolio of unit trusts or shares. When you do need to include information on your tax return under self-assessment, it’s also generally much simpler to report a chargeable event gain from an offshore bond than the income from an OEIC.
Offshore bonds are taxed under the chargeable event legislation, which means gains are assessed to income tax, rather than capital gains tax (CGT).
A chargeable event is a specific event which when it arises subjects the bond to tax. For example :
- Death of the relevant life assured for a life assurance bond.
- Maturity of a Bond (where applicable).
- Full surrender of a Bond (or Full surrender of policies within the Bond).
- Regular withdrawals or one off cash amounts taken from the Bond (Part surrenders) in excess of the 5% tax deferred allowance.
As the bond is invested with an offshore insurer, it does not suffer any income tax or CGT within the fund except for any un-reclaimable withholding tax that may have been applied. Any gains, dividends, rent or interest are taxed at 0% within the fund.
For individuals any chargeable event gains will be chargeable to income tax at their appropriate rate: 20%, 40% or 45%. Trustees will pay tax at 45%.
Taxpayers can use their personal allowance and the 20%, 40% and 45% tax bands when calculating overall tax liability. For trustees, the first £1,000 worth of chargeable event gains (assuming no other income) is taxed at 20%.
For highly personalised bonds it’s important to remember that for UK resident bondholders there is a deemed gain of 15% of the premium and the cumulative gains each year that is subject to income tax.
- Bonds are non-income producing assets so there are no annual tax returns for individuals or trustees.
- Funds can be switched within the bond without giving rise to a CGT or income tax liability on the bondholder and with no tax reporting requirements.
- Switches in and out of funds are not subject to the CGT 30 day rule so will not give rise to a taxable event.
- Income received gross within the bond will only suffer income tax on future encashment of the bond.
- Income tax liability is reduced proportionally for time spent as non-UK resident.
- The bond can be assigned by way of gift without giving rise to an income tax charge, although there might be inheritance tax (IHT) considerations.
- 5% tax deferred allowances on each premium paid can be taken each policy year for 20 years without incurring an immediate income tax liability.
- For the purposes of age allowance, withdrawals within the 5% tax deferred allowance are not treated as income.
- Realised chargeable gains may benefit from top slicing relief, which can reduce or remove any higher rate liability and for offshore bonds the number of relevant years on full surrender always refer to complete years since the bond started. The number of relevant years on excess events which occur on bonds taken out prior to 6/4/13 is the same however; bonds taken out from 6/4/13 (or bonds topped up from this date) will be the lower of years since inception or years since the previous excess event.
- Top-ups will benefit from top-slicing from commencement of the bond (individuals only and subject to the above rules on excess events).
- Using multiple lives assured for a life assurance contract can avoid a chargeable event on death of the policyholder.
Alternatively, a capital redemption contract where no lives assured are required can be used.
- Can be gifted into trust and assigned out of trust without giving rise to an income tax or CGT charge.
- Offshore bonds are not normally included where means testing is applied by a local authority for residential care.
- Wide investment parameters.
- Ability to appoint third-party custodians and discretionary managers.
- Where a bond terminates and a chargeable loss is made due to a previous excess event, deficiency relief may be available. This can reduce higher and additional rate income tax liability for the tax year that a chargeable loss occurred.
- The remittance rules for UK resident non-UK domiciled individuals do not apply to offshore bonds. Therefore, provided the capital invested into the bond is clean (no unremitted interest or gains) then no income tax is payable until a chargeable event occurs and there is no CGT payable.
- On encashment, chargeable event gains can suffer income tax up to 45%.
- As withdrawals from a bond are assessable to income tax, it’s not possible to use personal or trustee CGT allowance to reduce gains.
- Base cost of the investment is not re-valued on death for income tax purposes (chargeable event gains are assessable against original investment and any subsequent additional premium paid).
- Death of last of the lives assured on life assurance contracts will create a chargeable event (even if policyholders are still alive).
- Chargeable event gains reduce any available age allowance based on the total gain, not sliced gain.
- May not be suitable where ‘income’ interest exists inside a trust. Investment losses cannot be offset elsewhere.
- On death of the last of the lives assured, income tax and IHT may be due.