Non-dom dilemmas and how offshore bonds can help. For advisers only. Not for use with customers.

Transcription

1 Non-dom dilemmas and how offshore bonds can help For advisers only. Not for use with customers.

2 2 Non-dom dilemmas and how offshore bonds can help Background The UK has long been considered a tax haven for UK resident non-domiciles, as a result of the remittance basis taxation options available to them. Unlike UK resident UK-domiciles who are taxed annually on their worldwide income and gains as it may arise the remittance basis allows UK resident non-domiciles the opportunity to pay UK tax, only on their overseas income and gains that they remit into the UK. Non-domiciles historically did not pay any charge to be taxed on the remittance basis. However, the Finance Act 2008 significantly changed the tax advantages previously enjoyed by non-domiciles. The main changes were: Non-domiciles, who had been resident in the UK for seven out of the last nine tax years, would have to pay an annual tax charge of 30,000 if they wanted to continue to be taxed on the remittance basis of taxation. The loss of annual personal tax allowances for all remittance basis users if they had 2,000 or more of unremitted income or gains per annum, regardless of whether they were subject to the remittance basis charge or not. The closing of loopholes such as the ceased source principle and alienation, which enabled foreign income to be remitted into the UK free of tax. The tightening up of legislation covering the use of offshore trusts and companies, where non-domiciles had been able to use such vehicles as a means of tax efficiently remitting foreign gains to UK beneficiaries. The Finance Act 2012 contained a number of reforms to the existing legislation. This included a new exemption for remitting overseas income and gains to be used for commercial investment in UK qualifying businesses. It also increased the remittance basis charge to 50,000 for non-domiciles who have been UK resident for at least 12 out of the last 14 tax years.

3 Options for UK resident non domiciles The changing tax treatment has resulted in an increase in advice opportunities for advisers with clients who are non-domiciles. UK resident, non-domiciles with unremitted income, gains of 2,000 or more per annum and who have been UK resident for at least seven of the last nine tax years, appear to have three options: 1 To leave the UK. This may not be a viable option because of employment and/or family circumstances. 2 To pay the annual 30,000 or 50,000 charge for the privilege of using the remittance basis, with the applicable charge dependent on how long they have been UK resident. This is unlikely to be a seen as a significant charge by super wealthy non-domiciles, but may well represent a significant annual sum to many non-domiciles. 3 To elect to be treated in the same way as UK resident, UK-domiciles and be taxed on the arising basis on their worldwide income and gains, regardless of whether remitted to the UK or not. If leaving the UK is not an option, non-domiciles will often look to calculate whether it is worth paying the annual charge, based on the income and gains arising in any given tax year. Where the tax due on any income or gains exceeds the appropriate remittance basis charge, the best option is often to pay the comparatively lower remittance basis charge. However, this annual exercise may not be necessary after considering two structures which are capable of mitigating the annual charge offshore trusts and offshore bonds. Non-dom dilemmas and how offshore bonds can help 3

4 4 Non-dom dilemmas and how offshore bonds can help Offshore trusts In order to establish the benefits and limitations of offshore trusts to nondomiciles, it is important to consider the position in relation to income tax and capital gains tax separately. Income tax Income arising under an offshore trust will, in most cases, be assessed on the non-domiciled settlor (rather than the trustees) on an arising basis, unless the non-domiciled individual elects to be taxed on the remittance basis. Depending on the number of tax years the non-domiciled individual has been resident in the UK, this may mean paying a remittance basis charge of up to 30,000 or 50,000 annually, as established earlier in this article. Capital Gains Tax (CGT) Overseas gains realised by non-domiciles within offshore trusts offer a significant advantage over foreign capital gains realised by non-domiciles holding the assets personally. Where the assets are held by non-domiciles personally, they are liable to tax on an arising basis, or alternatively they may elect to be taxed on the remittance basis. However, where foreign assets are settled into an offshore trust, any gains realised within the trust are only liable to UK CGT, if capital relating to that gain is paid out to a UK resident beneficiary. The advantage of offshore trusts therefore is that the non-resident trustees can manage the investments and realise gains: without any UK CGT tax charge arising on the non-domiciled settlor; without the gains being subject to UK CGT on an arising basis; without the need to pay the remittance basis charge. Care does need to be exercised by the trustees when distributing capital to UK resident beneficiaries from an offshore trust as any gains will then become subject to UK tax on the beneficiary, unless they have elected to be taxed on the remittance basis themselves and the gains are not remitted to the UK. It can therefore be seen that from a tax standpoint, it could be advantageous to minimise trust income within offshore trusts and use capital-gains-focused assets instead. Provided that capital payments are not distributed to UK resident beneficiaries, no capital gains tax will arise and the non-domiciled settlor will not need to pay the remittance basis charge.

5 Offshore bonds Many non-domiciled individuals will hold portfolios containing investments that produce ongoing income, which is therefore subject to UK income tax. This includes interest paid on cash, fixed interest and property investments as well as dividends on equities. This is where an offshore bond offers an even greater advantage to nondomiciles compared with an offshore trust as it provides an opportunity to mitigate the remittance basis charge on investment income as well as on capital gains. Offshore bonds are structured as life assurance or capital redemption policies, which comprise of a series of individual policies or contracts. They are non-income and gain producing wrappers, where no tax is deducted annually on income/gains generated on the assets held within the bond, with the exception of irrecoverable withholding tax. The bond only becomes subject to UK income tax when a chargeable event arises, which occurs on the death of the last life assured (if the bond is written as a whole of life policy) and in most cases when the policy is encashed. By wrapping assets within an offshore bond, this provides a legitimate means of sheltering investment income and gains. From a taxation point of view, this enables the individual to elect to be taxed on the arising basis, in the knowledge that no income or gains will actually arise, until the bond is encashed. As they have elected to be taxed on the arising basis it then makes the payment of the annual remittance basis charge unnecessary. This is likely to be extremely attractive to non-domiciles looking for ways to mitigate paying tax on investment income gains annually, or paying the 30,000 or 50,000 remittance basis charge. Non-dom dilemmas and how offshore bonds can help 5

6 6 Non-dom dilemmas and how offshore bonds can help Using an offshore bond to provide an income stream Offshore bonds also offer a means to legitimately bring money into the UK without being subject to UK tax. This is possible by using an offshore bond s 5% annual withdrawal allowance facility, which represents a return of capital and therefore is not immediately taxable when it is received by the individual in the UK. In order to benefit from this advantage, it is essential that the source of the premium paid into the offshore bond represents clean capital, i.e. capital held in an overseas account which has not been tainted with income and gains, or alternatively capital which has already been remitted to and taxed in the UK. If the source of the investment is not clean capital then the withdrawals will become subject to tax in the UK. Cashing in the offshore bond The ideal encashment scenario often involves the non-domiciled individual encashing the bond after leaving the UK. Provided non-uk tax residence is established, and maintained for 5 years, the gains on the bond would not be subject to UK tax. Specific advice would need to be taken to establish the tax treatment of the bond in the jurisdiction in which the policyholder is resident. It should be noted that if the individual encashes the offshore bond whilst still resident in the UK and wishes for the proceeds to be sent to an overseas bank account, any gain will always be subject to tax on the arising basis of taxation. They would not be able to elect for the bond gains to be taxed on the remittance basis. The remittance basis is irrelevant for bond encashments, so even if the remittance basis charge is paid and a bond gain is then realised in that tax year, it will be assessable to UK tax (even where the settlor receives none of the proceeds in the UK). For this reason offshore bonds are likely to be particularly attractive to non-domiciles who intend to surrender the bond when non-uk residence has been established.

7 Case study Michael is domiciled in Queensland, Australia but is UK resident He has been UK resident for the last 6 tax years and is an additional (45%) taxpayer He has an investment portfolio which holds: 250,000 in cash, receiving interest at 3% = 7, m in fixed interest funds receiving 4% pa = 60,000 1m in equity funds paying dividends of approx 4% pa ( 40,000) which he also hopes to receive capital growth on As Michael is approaching the seven year mark, he feels that he needs to decide whether to pay the 30,000 remittance basis charge, or elect to be taxed on his worldwide income on the arising basis of taxation. What is the position if the assets are held directly? Cash 7,500 45% tax rate = 3,375 Fixed interest funds 60,000 45% tax rate = 27,000 Equity funds 40,000 gross dividend 37.50% tax = 15,000 Total income tax on arising basis of = 45,375 He would also pay tax 28% capital gains tax on any gains realised in the tax year of encashment on the fixed interest and equity funds. Therefore he may consider paying the remittance basis charge of 30,000, as this is lower than the tax that would be due on his investments if he were to elect to be taxed on the arising basis. Non-dom dilemmas and how offshore bonds can help 7

8 8 Non-dom dilemmas and how offshore bonds can help What if the assets were held within an offshore bond? Alternatively, Michael could transfer his capital into a Friends Provident International Reserve Advance Offshore Bond, using it to shelter ongoing income and gains. This would mean he could: elect to be taxed on his worldwide income and gains on the arising basis of taxation, rather than pay the remittance basis charge of 30,000; benefit from the bond s gross roll up status; be subject to no annual tax liability on income and gains within the bond. Michael will look to surrender the offshore bond in Australia when he returns, taking advantage of the favourable tax treatment available on bond surrenders. It is imperative that advice is taken at this stage.

9 Existing offshore trusts investing in offshore bonds When considering the merits of investing in an offshore bond, it is important to think about the type of assets the non-domiciled individual holds, or may wish to hold going forward. The investment choice available within offshore bonds is vast, providing access to cash deposits and a virtually unlimited choice of collective investment schemes. The investment regulations governing offshore bonds (section ITTOIA 2005) make it unattractive from a tax standpoint to hold direct investments in fixed interest securities, equities, physical property and commodities. Therefore exposure to such asset classes within an offshore bond must be through collective investment schemes. If a non-domiciled individual requires access to certain capital growth focused assets which are not permitted to be held within offshore bonds, one strategy that could be worth considering is for an offshore trust to hold the capital gains focused assets directly, taking advantage of the exemption to UK CGT. The trustees could then invest the remaining income, producing assets such as fixed deposits, equity and fixed-interest funds within an offshore bond, provided they comply with the governing investment regulations. The result of this is that the trustees could achieve a means of holding a wide range of investments which utilise: the CGT advantages available to non-domiciled settlors of offshore trusts; an offshore bond s ability to roll up income and gains without an immediate liability to tax. Inheritance Tax (IHT) planning for non-domiciles Finally, for non-domiciles who may become UK domiciled under general law, or deemed domiciled for UK inheritance tax purposes, holding the offshore bond within an excluded property trust (please remove inverted commas) is an excellent solution. Provided that the trust property remains invested in non-uk situs assets (such as an offshore bond) it remains excluded property and therefore out of the UK IHT net. For more information on Friends Provident International s Excluded Property Trust, please refer to our Excluded Property Trust brochure or speak to your Sales Consultant. Non-dom dilemmas and how offshore bonds can help 9

10 Important Information The information in this document is based on Friends Provident International Limited s understanding of UK and Isle of Man tax law and HM Revenue & Customs practice as at August 2013, which may change in the future. No liability can be accepted for the personal tax consequences of this Trust or for the effect of future tax and legislative changes. Each policy/contract is governed by and shall be construed in accordance with the law of the Isle of Man. If your client effects a policy whilst resident in the United Arab Emirates, all disputes regarding the policy shall be subject to the non-exclusive jurisdiction of the courts of the United Arab Emirates. The value of the bond cannot be guaranteed; your clients could get back less than they paid in. Some telephone communications with the Company are recorded and may be randomly monitored or interrupted. All policyholders will receive the protection of the Life Assurance (Compensation of Policyholders) Regulations 1991 of the Isle of Man, wherever their place of residence. Investors should be aware that specific investor protection and compensation schemes that may exist in relation to collective investments and deposits accounts are unlikely to apply in the event of failure of such an investment held within insurance contracts. Complaints we cannot settle can be referred to the Financial Services Ombudsman Scheme for the Isle of Man. (Not applicable to Corporate Trustees.) A written statement of the policy terms and conditions of the products may be obtained from Friends Provident International Limited on request. Copyright 2013 Friends Provident International Limited. All rights reserved. Friends Provident International Limited Registered & Head Office: Royal Court, Castletown, Isle of Man, British Isles, IM9 1RA Telephone: +44(0) Fax: +44(0) Website: Incorporated company limited by shares Registered in the Isle of Man No Authorised by the Isle of Man Insurance & Pensions Authority Provider of life assurance and investment products Authorised by the Office of the Commissioner of Insurance to conduct long-term insurance business in Hong Kong Registered in the United Arab Emirates as an insurance company (Registration No.76) and as a foreign company (Registration No. 2013) Registration date: 18 April 2007 Authorised by the United Arab Emirates Insurance Authority to conduct life insurance and savings business Registered in Singapore No. F06835G Registered by the Monetary Authority of Singapore to conduct life insurance business in Singapore XIM/EP/NonDom (39358)