An investment product designed for. everyone. A guide to the suitability of offshore bonds for UK professional advisers

Transcription

1 An investment product designed for everyone A guide to the suitability of offshore bonds for UK professional advisers

2 2 Why you should read this guide Tax is the key driver for most offshore life bond investments and the market opportunity is substantial With generally lower investment returns forecast, the impact of tax planning on net returns is becoming even more important to UK professional financial advisers and their clients This brochure has been produced after the 2008 Finance Bill, which confirmed most of the UK Chancellor s 2008 Budget and 2007 Pre-Budget announcements, introducing a number of important changes to personal taxation Following these changes, it is clear that the offshore life bond proposition remains very relevant to UK financial advisers and their clients This is particularly important when viewed against the background of the demographic shift towards a wealthier, older population and the concurrent rise of inheritance tax as an everyday problem, for instance Another demographic change, increasing international mobility, also calls for the tax-efficiency, flexibility and portability that are the hallmarks of the offshore bond The offshore investment and portfolio bonds available in the UK today have their origins in the offshore products of the past, but they have evolved into modern products which stand comparison with any onshore equivalent Although similar in structure to onshore bonds, offshore bonds have a number of key generic benefits that all financial advisers should consider nowadays when making recommendations to their clients: Virtually tax-free investment growth Greater control over how much, and when, tax is paid Superior investment choice from around the world Trusted global brands serving the needs of the market Highly reputable jurisdictions all with regulations to protect investors Product flexibility and choice High quality service Suitable investment for individuals, trustees and companies These features and the impact of the 2008 Finance Bill changes are considered in more detail in this brochure which aims to help advisers make the most of the financial planning opportunities presented by offshore bonds For financial advisers only Not to be relied upon by, or distributed to, private investors

3 3 Contents Advice and recommendations 4 Offshore bonds the benefits 5 Financial Planning 12 Products 19 Investment Choice 22 Commitment to service 23 Global Companies 24 First class jurisdictions 26 Offshore Bond Sales in the UK In 2007, UK advisers invested over 8 billion of their clients' funds in the offshore life bonds of AILO member companies Source: Acuity Consultants The guide is published by the Association of International Life Offices (AILO), an independent body whose member companies have more than 25 billion of client funds under management, held within offshore life insurance products

4 4 Advice and recommendations Advice and recommendations This guide explains some important generic facts about offshore bonds and their uses within contemporary UK financial planning It is designed to complement the specific advice and information that financial advisers provide to their clients The financial planning environment for high net worth clients in the UK saw its biggest changes for many years with the publication of the 2008 Finance Bill While there has been no real change in the fundamental reasons why an offshore bond may be recommended to many types of client, your advice needs to take these changes into account It can be argued that financial advisers in the UK will increasingly need to be comfortable that they have fully considered the merits of an offshore bond when reviewing the suitability of products for their clients Offshore life bonds offer all the key benefits of onshore life bonds, but have a number of in-built additional benefits, including flexibility, increased control over taxation aspects and wider investment choice, that may make them the most suitable product for a client s long term investment strategy 2008 Finance Bill Tax Changes The changes contained in the 2008 Finance Bill that are most relevant to the use of offshore bonds are: The introduction of a new simplified 18% flat rate of Capital Gains Tax Married couples and civil partners being able to pass on unused inheritance tax allowances Changes in the remittance basis of taxation for non-domiciles, including the introduction of a 30,000 charge on non-domiciles resident long term in the UK who elect to be taxed on the remittance basis Application of the loan relationship rules to life insurance policies held by companies The Capital Gains Tax changes, which were first proposed in the 2007 Pre-Budget Report, reduced the rate of Capital Gains Tax to a flat 18% regardless of the investor's income tax rate, while abolishing indexation allowance and taper relief from 6 April 2008 Most higher rate tax-paying investors will pay less Capital Gains Tax on realised gains under the new regime, with rates reducing from between 24% and 40% to 18% on gains that exceed the annual exemption ( 9,600 for individuals in 2008/09) How this Capital Gains Tax regime change affects individual investors will obviously depend on their circumstances, stressing the requirement and the opportunity for informed financial advice 2008 Finance Bill Tax Changes continued This change caused obvious concern among financial advisers that offshore life bonds, especially portfolio bonds, may no longer be a sound investment recommendation, as higher rate tax-payers will continue to be liable to pay 40% income tax on chargeable event gains This means that direct investment in mutual funds appears to enjoy a tax advantage via the 18% Capital Gains Tax rate, at least at the headline level However, this simple headline level comparison hides many issues Perhaps the most significant issue is that a high proportion of the investment growth in collectives held directly by UK investors creates an annual income tax liability as investment returns are generated by interest or dividend income and not by capital growth in the underlying assets (including offshore funds the majority of which have non-distributor status) This means that many investors still face an immediate annual income tax charge at their highest marginal tax rate, rather than Capital Gains Tax Investors' returns in many 'alternative' investments are taxed annually as income, generally at the higher rate, rather than as Capital Gains Tax The income from the same assets held in an offshore bond would not be taxed annually and this tax deferral feature means that the investor has greater control over how much, and when, tax is paid Where the investor s assets are structured to provide exclusively capital growth, they may be better off from a tax perspective with direct equity and mutual funds holdings The reality, however, is that a significant proportion of UK client investments go into income-producing funds which will still benefit from being held in an offshore bond wrapper, both in terms of tax treatment and administration simplicity Another key consideration is that an active investor switching funds within a portfolio of direct equity or unit trust investments will incur a potential Capital Gains Tax charge in the tax year during which the switches were made Fund switches within offshore bonds do not trigger a personal liability to Capital Gains Tax, providing a more tax efficient structure for active investment management An important factor in advisers use of offshore bonds with high net worth investors has always been the 5% deferred tax withdrawal facility, which allows investors effectively to turn their existing capital into a tax-efficient income stream Nothing in the 2008 Finance Bill has changed these attractive features of offshore bonds Offshore bonds can also enable advisers to implement financial planning strategies designed to achieve important objectives for a range of clients, including those who are UK resident and domicile, UK non-domiciles and UK expatriates Although the offshore bond product providers are not based in the UK, the sale of offshore bonds sold to UK residents are subject to the same rigorous regulatory regime as for onshore bonds This means that the sale of an offshore bond is subject to the same requirements that normally apply to the advice and sales process for onshore regulated investment products

5 5 Offshore bonds the benefits The specific benefits of an offshore bond depend upon your client's individual circumstances However, there are a number of generic benefits for UK residents which tend to apply in most situations: Virtual tax-free growth No Capital Gains Tax Often referred to as the 'gross roll-up' effect, Fund switches made within offshore bonds do investment in an offshore bond grows free of not trigger a personal liability to Capital Gains Tax year-on-year income tax and Capital Gains Tax Such switches within a portfolio of onshore direct charges, unlike comparable onshore bonds which equity or unit trust investments would incur a suffer tax on their growth at a maximum of 20% potential Capital Gains Tax charge in the tax year Small amounts of irrecoverable withholding tax may during which the switches were made Offshore be payable on certain investment funds bonds, therefore, often provide a more tax efficient structure for active investment management, As the mathematical principle in Table 1 shows the subject to the use of the Capital Gains Tax return is greater if tax is deducted on encashment, as annual exemption amount in the case of an offshore bond, rather than on a yearly basis This is shown to demonstrate the value Table 2 overleaf compares the tax treatment of a of gross roll-up UK higher rate taxpayers with an portfolio of directly held collective investment onshore bond will pay some tax on a yearly basis schemes with an offshore bond and on encashment Offshore bonds the benefits Table 1 The Benefits of Gross Roll-Up Funds within offshore bonds are not liable to tax at source*, subject to irrecoverable withholding tax Therefore the money that would normally be removed by ongoing tax charges is allowed to remain in the investment and continues to enjoy accumulative growth, year on year The table below illustrates the effect of gross roll-up on an investment of 100,000 growing at 7% a year, with tax deducted at a rate of 40% on encashment, compared with the tax treatment of a hypothetical investment where tax is deducted at 40% each year: Investment Period Gross Value ( ) Net Value After Net Value after Difference (years) Tax is Paid on Tax is Paid Encashment ( ) Yearly( ) 0 100, , , , , ,839 1, , , ,896 7, , , ,360 20, , , ,605 44,486 *With offshore bonds the tax is not paid yearly This can add to the bond's growth, and has an accumulative effect over time Please note that the above table illustrates a mathematical example and does not show the effect of product charges or irrecoverable withholding tax that can extend the period before the benefit of gross roll-up is noticed

6 6 Table 2 Offshore Bond vs Direct Collective Investment Scheme Investing The table shows a comparison of tax in an offshore bond compared to a portfolio of collectives Offshore bonds the benefits Portfolio of Collective Investment Schemes Offshore Bond Interest Income Dividend Capital Gains Income Tax Capital Gains (Income Tax) Income Tax Tax paid by fund Fund Pays 20% Pays 10% 0% if an FSA None (apart from None with no further authorised fund small amounts of tax on UK irrecoverable dividends as 10% withholding tax on credit satisfies some dividends basic rate tax liability and interest paid) Tax paid by the investor Depending upon the underlying asset mix of the unit trust, the investor will either receive interest payments (eg if mainly cash and gilts) and dividends (eg if not mainly cash and gilts) The tax position in both cases is shown below Non- Can Cannot May be liable for Pays income tax No liability to taxpayer reclaim tax reclaim tax Capital Gains Tax on on the chargeable Capital Gains Tax redemption/switch gain at applicable on redemption (18%)* rate(s) only if the or switching gain takes the between assets investor into or beyond the lower basic rate tax band over their personal allowance Basic rate No further No further May be liable for Pays income tax No liability to taxpayer tax liability tax liability Capital Gains Tax on on the chargeable Capital Gains Tax redemption/switch gain at rate(s) on redemption (18%)* applicable to or switching the investor between assets High rate Liable for Liable for May be liable for Chargeable gain No liability to taxpayer higher rate tax higher rate tax Capital Gains Tax on taxed at higher rate Capital Gains Tax (40%) (325%) redemption/switch (40%) on redemption (18%)* or switching between assets Onshore portfolio of collective investment schemes: Even if the investor holds only accumulation units, where dividends and interest are reinvested in the fund, they must still be declared and tax paid on an annual basis * Capital Gains Tax is only payable whenever a gain is realised over the annual exemption limit ( 9,600 for the 2008/09 tax year) Offshore bond: The investor achieves virtually tax free investment growth, is not liable to Capital Gains Tax (even when switching between funds), and is only liable to income tax when a chargeable event is triggered eg when cashing in all of the bond

7 7 Tax control Access to money Tax deferment is a key feature of offshore bonds Compared with an onshore bond, your clients will have greater control on how much, and when, income tax is paid This enables the investor to choose when a tax charge may occur, for example when they cash-in some of or their entire bond The tax payable at the point of a chargeable event will depend on the investor s highest marginal rate at that time, giving the option to defer such an event until the investor is either no longer a taxpayer, or has moved from being a higher rate taxpayer to a basic rate taxpayer, or has moved to a country with lower taxes Investors can also benefit from top slicing tax relief, as explained below For many investors today, the ability to take regular withdrawals from their investments is very important Most offshore bonds enable your clients to have access to some or all of their investment monies should they need to Investing in an offshore bond keeps your clients' options open Regular withdrawals can be taken from an offshore bond soon after investing or that decision can be deferred until a future date This can be done through the 5% deferred tax withdrawal facility, which allows investors to turn their existing capital into a tax-efficient income stream A growth investment strategy can be followed initially, with a subsequent switch into income generating investments if and when that is desired Offshore bonds the benefits Chargeable Events A chargeable event is a transaction that would trigger a potential UK income tax charge on a bond These events include: death of the last life insured, maturity, encashment or surrender of the policy, withdrawals in excess of the cumulative 5% a year tax deferred allowance, assignment for money or money s worth, and significant policy changes, such as changes to the lives insured Table 3 Top Slicing Relief Top Slicing Relief is available to basic rate taxpayers where a chargeable event gain causes their income to exceed the higher rate tax threshold Relief is determined by dividing the gain by the number of policy years that the policyholder has been UK resident and then adding this 'slice' to other income If the slice remains within the basic rate band then the whole gain is taxable at the basic rate of tax Where part of the slice exceeds the higher rate tax threshold, higher rate tax will only be chargeable on the gain in proportion to that part of the slice An offshore bond can have another advantage when compared with an onshore bond, as top slicing applies to the full life of the offshore bond (from inception), assuming the policyholder has always lived in the UK whereas with an onshore bond it only applies to the period since the last chargeable event With the 5% deferred tax withdrawal facility your clients can take regular withdrawals from their offshore bonds, accessing the capital in a tax efficient way by withdrawing up to 5% of each investment amount every year without an immediate liability to tax This is a very valuable benefit for higher rate taxpayers Taking similar withdrawals from a portfolio of unit trusts may result in an annual tax charge This 5% amount can be taken every year for 20 years, or accumulated over a number of years and withdrawn less frequently without triggering a chargeable event for tax purposes Should a withdrawal be taken that is based on accumulating a number of annual 5% amounts, this may create a product charge As offshore bonds are long term investments there may be some charges which apply if money is withdrawn in the early years

8 Offshore bonds the benefits 8 Inheritance Tax Planning Many UK domiciled individuals are drawn into the Inheritance Tax (IHT) net, with assets above the nilrate band (the threshold above which IHT applies) potentially being liable to IHT at 40% The immediate changes to IHT announced by the Chancellor in his October 2007 Pre-Budget Report made it possible for spouses and civil partners to transfer their IHT nil-rate band allowances so that any part of the nil-rate band not used when the first spouse or civil partner died could be transferred to the individual's surviving spouse or civil partner for use on their death Assets above the nil rate band (the threshold above which IHT applies) are potentially liable to IHT at 40% This means that a combined total of 624,000 (2008/09) can now be sheltered from IHT on their deaths by a married couple or civil partners This combined total will rise to 700,000 by April 2010 While this is a welcome change in tax policy, many clients of UK advisers have assets that exceed substantially this double IHT allowance Residential property alone will often use up the combined nilrate band The ability to transfer any unused nil-rate band is also restricted to married couples and civil partners In today s society, that excludes many people from being able to take advantage of this arrangement Structuring your client s assets through an offshore bond held in trust can mitigate, or avoid altogether, taxes due on transfers of wealth Such trust and offshore bond combinations are popular with financial advisers as making a gift or transfer to trustees is a transfer of value for IHT purposes and can reduce the settlor s estate When considering a trust and offshore bond combination, the basic choice for the adviser and client is whether to set up the trust under a bare or discretionary rules trust structure The key advantage of the bare trust is that it can be very The Widening Inheritance Tax Net The IHT Trap as it has become known is a growing and alarming problem for an increasing number of UK domiciled individuals, largely down to the fact that house prices have increased so sharply in recent years If the IHT threshold had increased in line with house price inflation since 1995/96, it would have been at a level of 460,000 in 2007, more than 50% above the actual 300,000 IHT threshold The combined nil-rate band allowance would have been 920,000 (compared with the actual combined allowance of 624,000 in 2008/09, rising to 700,000 by April 2010) In 2007 the average detached property value in London was already above the combined IHT threshold (at almost 700,000) and in many other parts of the UK the top 10% of properties would also consume the entire combined nil-rate band The total amount of IHT paid in 2006/07 was a record 36bn, up from 33bn in 2005/06 Government estimates are for IHT revenue to be 39bn in 2007/08 but revenue is expected to fall to 33bn in 2008/09 33,000 estates are estimated to have paid IHT in 2006/07, compared with only 18,000 estates in 1997/98 Property tax revenues, including IHT and stamp duty, in the UK are the highest in the OECD Property taxes as a percentage of total taxes in the UK have risen from just over 10% in 1995 to 12% in 2005 With property-related taxes equivalent to 44 percent of GDP, the UK also takes pole position among OECD economies on this measure Sources: HBOS plc, OECD and HM Revenue & Customs tax efficient, provided there is certainty over who will be the beneficiaries Discretionary trusts, on the other hand, are very flexible but can be less efficient in mitigating IHT In most cases, however, a level of trust investment into discretionary trusts can be chosen that does not give rise to an initial IHT charge and is unlikely to incur periodic charges Using a discretionary trust in circumstances where tax charges are triggered, for instance with larger investments, preserves flexibility This can also help with tax efficiency as it is likely that the trust will pay less tax than the potential IHT charge that would apply on the settlor s death if the assets were

9 9 not placed in a suitable trust Bare trusts are also used with larger investments, but advisers and clients must be comfortable with their lack of flexibility and control Additionally, an offshore bond and trust arrangement can be structured to allow restricted access to the funds prior to your client s death, while the funds invested enjoy the benefit of virtually tax-free growth For clients who may wish to do some IHT planning in the future, structuring their assets through an offshore bond can mitigate, or avoid altogether, taxes due on transfers of wealth An existing bond can be assigned to another individual or into trust without triggering a chargeable event for income tax purposes, whereas a similar gift of collectives may give rise to an immediate CGT charge if not made to a spouse or civil partner Self assessment friendly As offshore bonds are non-income producing assets, there is nothing for investors to report on their self assessment form to the HM Revenue & Customs until a chargeable event occurs, eg when taking a withdrawal in excess of the cumulative tax deferred withdrawal allowance of 5% per annum of each amount invested This compares favourably with the complicated requirements for the income from portfolio of unit trusts At the point that investors do need to include information on their tax return under self assessment, it is also generally much simpler to report chargeable event gains from an offshore bond, compared with the reporting required in respect of individual holdings The information needed to complete the self assessment form would appear on the chargeable events certificate produced by the life company Offshore bonds the benefits Combined NRB Administration Requirements After accepting the Chancellor's generosity at face value when he made it possible to claim a deceased spouse's or civil partner's unused nil-rate band allowance, it has become clear that this isn't quite as straightforward as might have been expected The claim to transfer any unused nil-rate band must be made by the personal representatives when the surviving spouse or civil partner dies and not when the first person dies The administrative burden is onerous, even for the personal representatives of the surviving partner of someone dying since the new rules were introduced A claim form must be submitted within 24 months along with documents to support the claim HMRC requires a range of documents, such as death certificate, marriage certificate, wills, probate etc, along with detailed evidence of asset types, gifts, pensions and trusts While many of these can be obtained from public bodies if they are missing, many people will have great practical difficulty in providing all the information and evidence required to enable them to claim the unused portion of the nil-rate band, and they will have to deal with this at a very stressful time in their lives One complicating factor likely to become increasingly common is that many personal representatives will need to take into account the increasing incidence of second and subsequent marriages The new rules allow any unused nil rate band to be transferred from more than one deceased spouse or civil partner up to a total limit of one additional nil rate band ie a maximum total amount of 624,000 (2008/09) Trust and offshore bond combinations, which have long been popular with financial advisers, can help to ease the burden of settling an estate as most of the administrative requirements can be pre-arranged Self Assessment Friendly Unit trusts and investment trusts Income from unit trusts and investment trusts is subject to income tax annually and Capital Gains Tax arises on disposal A portfolio of directly-held investments may have complicated reporting requirements: Capital Gains Tax can be a real problem for any investor actively managing their portfolio Every time they switch their investment into another fund any gain has to be calculated and may be liable to Capital Gains Tax Under the current self assessment regime any tax on gains in excess of the annual exemption must be calculated, if the tax return is submitted after the HM Revenue & Customs deadline, currently 30th September each year Any investor with a well diversified portfolio will have the administrative hassle of calculating and recording all their investment income (whether realised or deemed) every year on their self assessment form All tax vouchers must be kept for 7 years Offshore bonds Compared with the above requirements, investments in offshore bonds are much more self assessment friendly, as they are classified as a non-income producing asset Your clients do not need to include any information about their bond on their annual self assessment form unless there is a chargeable event Clients can also switch between funds as much as they like (often free of charge) without incurring a Capital Gains Tax liability When cashing in all (or more than 5%) of their bond, the offshore life company will normally issue its client with a Chargeable Events Certificate which gives the information needed to complete the tax return

10 10 Offshore bonds the benefits Non-UK status As offshore bonds are not UK-based investments, this can help your clients mitigate their UK tax bill if they are a UK expatriate or a foreign national living in the UK If your client is a UK expatriate, there will be no potential UK tax liability associated with an offshore bond, which compares favourably with onshore bonds and collective investments There may, of course, be a tax liability for all types of investments in the country in which your client is resident UK residents who have been non-uk resident for a period of years can also potentially benefit from time apportionment relief, which means that the growth in their bond will escape UK tax in proportion to the period they were not in the UK as explained in Table 3 below The case study on the following page highlights the potential beneficial effect of time apportionment relief when combined with top slicing relief If your client is a foreign national resident in the UK an offshore bond can provide a core element of their financial planning Whether your client is using the remittance basis of taxation or not, an offshore bond will allow them to hold their worldwide investments in a way that does not generate annual income or an IHT liability It will also allow them to control the timing and amount of any tax charge caused by cashing in part or all of their bond Creating a chargeable event for an offshore bond in the UK is not advisable for foreign nationals in the UK Table 3 Calculating the Tax Liability Following Periods Outside the UK Time Apportionment Relief When a chargeable event arises on an offshore bond, a potential income tax liability arises on any gains The amount chargeable to tax is calculated as follows: (Proceeds + all previous withdrawals) (total premiums paid + any previous chargeable excesses) = Gain If your client has been non UK resident at any time during the lifetime of the bond they can claim time apportionment relief which can reduce the amount of the gain: Period of ownership as UK resident x gain Period policy has been in force The amount of the gain is then assessable to income tax and added to an individual s other income and chargeable to 20% or higher rate tax as appropriate This may not apply to some policies held in trust

11 11 Case Study: Former UK Expatriate now UK Resident again Client and bond summary: Premium = 25,000 Withdrawals = 5,000 Period policy has been in force = 15 years Time resident in the UK = 10 years Surrender Value = 35,000 Calculating time apportionment relief and top slicing relief: (Proceeds + all previous withdrawals) (total premiums paid + previous chargeable event) = Gain ( 35, ,000) ( 25, ) = 15,000 Offshore bonds the benefits Time apportionment relief Period of ownership as UK resident x gain 10 x 15,000 = 10,000 Period policy has been in force 15 Top slicing relief Time apportioned gain 10,000 = 1,000 Period policy in force (in UK) 10 Scenario 1 Client has 26,000 of other taxable income plus 1,000 gain on offshore bond = total income of 27,000 Higher rate tax threshold = 34,800 (08/09) therefore whole gain is taxed at 20% = 10,000 x 20% = 2,000 Scenario 2 Client has 36,000 of other taxable income plus 1,000 gain on offshore bond = total income of 37,000 Higher rate tax threshold = 34,800 (08/09) therefore whole gain is taxed at 40% = 10,000 x 40% = 4,000 Scenario 3 Client has 33,900 of other taxable income plus 1,000 gain on offshore bond = total income of 34,900 Higher rate tax threshold = 34,800 (08/09) therefore 90% of gain is taxed at 20% = 9,000 x 20% = 1,800 and 10% is taxed at 40% = 1,000 x 40% (08/09) = 400 The total tax liability is 2,200

12 12 Financial Planning Financial Planning There are a number of situations that are most likely to result in advisers recommending an offshore bond to a client The offshore bond forms part of wider inheritance tax planning Holding an offshore life bond in one of a range of trusts can provide a number of significant advantages to your inheritance tax planning for clients and should be considered in any estate planning exercise Trust and offshore bond combinations have remained very popular with advisers despite the IHT treatment of some trusts changing after the UK Chancellor s 2006 Budget Most non-exempt transfers into lifetime trusts which were previously treated as Potentially Exempt Transfers (PET) are now treated as Chargeable Lifetime Transfers (CLT) This wider application of the discretionary trust regime means that transfers into trusts may be subject to an immediate charge and to subsequent periodic and exit charges However, in most cases the level of trust investment chosen does not give rise to an initial IHT charge and will be unlikely to give rise to periodic charges in the future While the specific situation of each client may vary, there are some general guiding principles that apply to IHT and income tax mitigation using combinations of offshore bonds and trusts These are principally to make use of each individual s nil rate band and annual exemption ( 312,000 and 3000 in 2008/09 respectively) and to review each client s IHT planning regularly, in particular every seven years from establishing a trust as, assuming that the settlor(s) is still alive, no further IHT will be payable on any CLTs, any PETs will be fully exempt from IHT, and the financial planning for the next seven years can then be put in place So, to benefit fully from the opportunities to reduce future IHT bills, the planning process should start early in life and be done in stages Some of the most common situations are given as examples below There are also general guiding principles that can apply to the choice of the type of trust Gifts to bare trusts are free of IHT for the settlor after 7 years as they are a PET, but the beneficiaries cannot be changed and normally the beneficiaries will gain access to the transfer from age 18 (16 in Scotland) With a transfer to a discretionary trust, the trustees have full discretion on who benefits from the trust and when, but the transfer may suffer tax when it is set up, on exit and at each ten year anniversary Placing an offshore bond in a discretionary trust can also give greater control over the amount and timing of future income tax charges, as the tax liability can be managed to fall on the settlor, the trustees or the beneficiaries, depending upon who has the optimum rate of taxation Should a chargeable gain be triggered during the settlor s lifetime, or in the year of their death, then this gain will be liable to personal income tax on the settlor, offset by available reliefs such as top slicing relief Alternatively, where the settlor is survived by at least one life assured, the bond can continue until it is cashed in by the trustees or passed to the beneficiaries The trustees can cash in the bond, with the tax liability falling on the trust (if they are UK resident) Should the bond be passed onto the beneficiaries, they will be liable for tax on any gains when the bond is cashed in This flexibility doesn t apply to bare trust investments, where the tax liability falls on the adult beneficiary Many offshore companies also provide specific Inheritance Tax planning products to allow investors access to a combination of IHT mitigation and restricted access to the amount gifted These usually comprise a single premium bond wrapped in a specific type of trust, known as a Discounted Gift Trust This can be offered either as a bare or a

13 13 discretionary trust The structure of the trust will In addition, some offshore companies offer flexible allow your client to take pre-determined amounts of non qualifying whole of life protection contracts that withdrawals from the trust, while the value of the can be used for IHT planning These contracts are bond that does not exceed the available exemptions similar to onshore whole of life protection contracts and the nil rate band will not be subject to an When written in trust, flexible whole of life contracts immediate IHT charge, even for discretionary trusts can provide monies to cover any IHT bill due on the death of the settlor and they are particularly useful IHT products are a specialist area in which offshore for clients who do not have liquid assets to invest in companies have a wealth of experience and, in a single premium bond as described above many cases, are able to provide invaluable technical support to financial advisers Focus on the use of trusts and offshore bonds in Inheritance Tax planning Financial Planning Trusts and Offshore Life Bond Wider Advantages In addition to the tax benefits, holding an offshore life bond in a trust can provide a number of significant advantages to your client s wealth preservation and wealth transfer planning for clients, depending upon their personal circumstances, for instance: The settlor can generally include their widow/widower as one of the trust s beneficiaries without falling foul of the gifts with reservations provision Trusts circumvent the need to obtain probate on the death of policyholders, thereby speeding up the process of transferring the bond to or obtaining the policy proceeds for the beneficiaries Following a death, before probate can be obtained the tax due must be paid and this causes a Catch 22 situation for many estates where the personal representatives need access to the assets to pay the tax to get probate To break this circular problem, the proceeds from the offshore bond can sometimes be used to settle the tax bill and allow probate to be granted Settlors have control on how and to whom wealth is transferred under a discretionary trust The Settlor can determine who the trustees should be, providing an important element of control Using trusts can also mean that beneficiaries inherit monies only when they are old enough to use it sensibly It is important to remember that none of this flexibility applies to bare trusts Using Trusts with Offshore Bonds You can use a wide range of trusts in conjunction with an offshore bond, including: Bare (absolute) trust this is the simplest of trusts where the settlor nominates a beneficiary who is absolutely entitled to the income and capital The beneficiary cannot be changed, must be informed of the existence of the trust and can demand the trust assets at age 18 (16 in Scotland) Bare trusts were not affected by the 2006 Budget changes, thus a gift to a bare trust is still a PET Bare trusts are now sometimes used for larger investments despite their inflexibility Flexible interest in possession trust this used to be the most widely used trust in combination with life policies and means that the beneficiaries are entitled to any income produced (even if there is no income as with a life policy) and distribution of capital is at the discretion of the trustees The settlor cannot be a beneficiary from this trust As flexible interest in possession trusts are now subject to the same IHT rules as discretionary trusts most companies replaced them with discretionary trusts Discretionary trust the trust contains a wide range of possible beneficiaries, excluding the settlor, and the trustees can distribute income and capital at their discretion As well as the possible tax charge on establishment of the trust, the trustees may also have to pay IHT at 10 year anniversaries and when capital leaves the trust

14 14 Using Trusts with Offshore Bonds continued Financial Planning Loan trusts this provides a compromise solution offering some IHT mitigation coupled with flexible access The settlor makes a loan to either a bare or a discretionary trust which the trustees invest in an offshore bond The loan is not a gift so even if a discretionary trust is used there is no CLT and hence no immediate IHT charge no matter how large the loan is The loan will generally be repaid to the settlor over time, with the trustees taking advantage of the bond s cumulative tax deferred 5% withdrawal allowance The value of the trust fund for any periodic IHT charges will be reduced by the amount of any outstanding loan Thus it is effectively the value of the investment growth that will be subject to these charges Loan repayments do not trigger exit charges although payments to the ultimate beneficiaries may trigger these Any outstanding loan remains part of the settlor s estate Reversionary trust the bond is subject to a bare or discretionary trust for a fixed term at the end of which all benefits revert to the settlor If the settlor dies before then, the benefits are paid out to the beneficiaries Inheritance tax packages there are various specially designed trust and bond IHT packages which are normally based on carve out or reversionary trusts eg Discounted Gift Trusts Discounted Gift Trust These are popular forms of trust used by offshore companies for IHT planning A Discounted Gift Trust (DGT) may reduce the size of an individual s estate for IHT purposes while allowing the investor to receive a series of pre-agreed payments from the trust: With a Discretionary DGT, gifts made into the trust are regarded as CLTs The settlor has no personal liability to IHT after 7 years However, CLTs will not be subject to an immediate IHT charge unless the value exceeds the available exemptions and the nil rate band The trust fund may also be subject to periodic IHT charges at every 10 year anniversary of its creation and exit charges may apply to capital distributed to beneficiaries The discounted value of the gift is the amount used in these calculations Under a Bare DGT, gifts made are Potentially Exempt Transfers and are free of IHT for the settlor after 7 years With both forms of DGT the settlor retains access to the invested assets through the ability to receive payments from the trust at pre-determined entitlement dates The fact that the individual is entitled to repayments from the trust means that the value of the CLT or PET may be lower than the original investment, effectively creating a discount The repayments received are included in the settlor s estate for IHT purposes Any discount is immediately free of IHT The value of the discount is dependent on the settlor s age, sex, health and pattern of repayments selected HMRC has now introduced a standard method of discounting which must be used to ensure the availability of a discount This includes underwriting, which many offshore life companies provide at no extra cost Discretionary DGTs use a carve out or "revert to settlor" trust, both of which allow the settlor to receive payments at pre-determined dates The settlor either retains the right to a payment stream established by the policy or is said to have a reversionary interest, which overcomes the problem of "gift with reservation of benefit" HM Revenue and Customs has confirmed that it considers these schemes to be acceptable in principle though individual company arrangements may not have been scrutinised However, companies may often have favourable Counsel s opinion Under a Bare DGT the settlor s rights to pre-determined payments from the bond are defined in the bond s policy documents (a carve out arrangement ) and these specified rights are held in trust for the settlor The trustees are appointed at the outset by the settlor (who may also be a trustee) With a Discretionary DGT the trustees have a power to choose who will benefit, from the chosen class of beneficiaries Under a Bare DGT the beneficiaries and their shares are specified at outset and cannot be changed subsequently Investment accumulates on a virtually tax-free gross roll-up basis

15 15 Your client is the director of a successful small to medium size company looking to access a range of cash funds for the company s cash reserves Many companies are cash rich, but with monies held on deposit earning poor returns An offshore bond can provide access to a wide range of cash funds and high interest deposits while accepting that tax on the interest will be paid annually Legislation was introduced in the 2008 Finance Bill which applies the loan relationship rules to life insurance policies held by limited companies from April 2008 This removes the opportunity for companies to allow their offshore life investments to roll up free from annual taxation, similar to deposit accounts and in line with the changes in the tax treatment of capital redemption bonds made in 2005 As the underlying investments within an offshore bond can be lower risk than alternative investment options available, whilst still offering the potential for better than deposit rate returns, an offshore bond may still be an attractive investment option for a company Your client can defer cashing-in their investment, or taking income from it, until a time when they will be within a lower income tax band If your client is a higher rate taxpayer, offshore bonds have certain tax advantages over a series of collective investments held directly This is because offshore bonds are taxed when a chargeable gain arises and not on an ongoing basis During the lifetime of the bond, assets are allowed to roll-up virtually free of tax Therefore your client can control when that tax charge is taken, for instance in a period when they are in a lower tax band Your client is planning to become (or is already) an expatriate ie working or retiring outside of the UK Offshore bonds are particularly useful for clients who intend to live outside the UK for a period of time, or indefinitely In contrast to an onshore bond, investments in an offshore bond are allowed to grow virtually free of tax, subject to any irrecoverable withholding taxes levied Additionally, if benefits are taken from an onshore bond this may give rise to a UK tax liability and any tax due on an onshore bond cannot be offset against foreign liabilities Britons Abroad Around 55 million Britons live overseas A further 1 million will leave the UK over the next five years More than 200,000 Britons left in 2006 Around 1 million Britons own a home overseas The value of foreign property owned by UK households in 2003/04 was 23 bn, more than double the estimate for 1999/00 24bn was spent in 2007 by Britons buying property abroad Sources: NatWest IPB/ Centre of Future Studies, ONS, National Statistics, AIPP The taxation rules of the country in which the policyholder is resident will apply and taxation often occurs when the proceeds are taken This could be advantageous to your client if they are located in a low tax jurisdiction or one which taxes life policies favourably In addition, if your expatriate client returns to the UK during the bond s lifetime, they may get time apportionment relief for the period of non-residence should a chargeable event occur Financial Planning

16 16 Financial Planning Your client is a foreign national living in the UK income tax or Capital Gains Tax allowances available against which to offset any UK tax liabilities An offshore bond investment does not create any For many years individuals resident, but not liability to UK income tax or Capital Gains Tax, domiciled, in the UK have enjoyed the remittance provided that no withdrawals are made in excess of basis of UK taxation, only paying UK income tax or the cumulative 5% per year tax deferred allowance, CGT when they remit overseas income or and provided that no other chargeable events occur, investment gains to the UK such as the death of the last life assured or changes However, major tax changes affecting non-domiciles made to the lives assured Non-domiciles can also resident in the UK took effect from April 2008 The use the 5% a year tax deferred withdrawal facility new rules mean that non-domiciles can continue to to remit an income to the UK without triggering an access the remittance basis, but they have no personal immediate tax charge allowances for income tax and no annual exempt Creating a chargeable event for an offshore bond is amount for Capital Gains Tax, unless their unremitted not advisable for foreign nationals residing in the UK foreign income or gains are less than 2,000 In addition, those non-domiciles who have been Your client is a trustee looking to resident in the UK for more than 7 out of the past make a tax efficient investment 9 years will only be able to choose the remittance basis if they pay an annual tax charge of 30,000 When considering whether a trustee investment The annual charge will be payable in addition to any should be made directly into collectives or through UK tax due on remitted income or gains Nondomiciles will have the choice each year of whether consider: the gift to the trustees; the trustees tax an offshore bond, there are three key issues to or not to pay the charge and claim the remittance position; and the payments to the beneficiaries basis, or be taxed on all their overseas earnings and An offshore bond can provide benefits to your capital gains trustee clients in all three of these stages, in Following these changes, offshore bonds can play an addition to providing an almost unlimited important role in helping you to manage your nondomiciled clients investments whilst minimising If the initial gift to the trustees is an offshore bond, investment choice their UK taxation then this can be assigned by way of gift without If a non-domicile chooses not to use the remittance triggering a chargeable event and no income tax or basis, they can effectively be regarded as a normal Capital Gains Tax arises If the initial gift is in the UK resident for tax purposes and all the usual form of collective investments, this may qualify for offshore bond benefits apply Another important Capital Gains Tax holdover relief, but it may be better consideration for a non-domicile in that any assets to crystallise a gain to allow the trustees to manage they own in the UK are subject to IHT on death the funds without the concern of a CGT liability Helpfully an offshore bond is not a UK-situated asset With an offshore bond, trustees will only pay income In addition to this important IHT planning aspect, a tax if a chargeable event is triggered To help avoid key consideration for your non-domiciled clients this, the 5% deferred tax withdrawal facility can be choosing the remittance basis is that they have no used to provide an income Offshore bonds are not

17 17 generally subject to Capital Gains Tax and this Your client is uncertain about their provides the trustees with the freedom to change future financial planning requirements investments and meet this requirement under the Trustee Act 2000 With a portfolio of directly held In today s uncertain world, many of your clients will collectives, the trustees would face an annual find it increasingly difficult to be definitive about income tax charge of 40% or 325% special trust their longer term financial objectives An offshore tax rate, with no option to defer income tax The bond can provide the platform for tax efficient portfolio of collectives would be subject to Capital wealth management, both immediately and across Gains Tax at 18%, which would apply to gains the years to come realised on redemption and switches between funds, A key benefit of an offshore bond is that it keeps with the annual exemption limit for trustees your client s options open, providing flexibility to generally being half the rate for individuals Your change investment objectives and income trustee clients would also face a major requirements without incurring unnecessary tax bills administration issue and cost to complete their Initially, the objective may be to achieve growth on annual tax returns and accounts a mainstream investment portfolio, with the When considering how best to make payments to offshore bond helping by enabling virtually tax-free beneficiaries, using an offshore bond has further investment growth benefits The 5% deferred tax withdrawal facility You may subsequently recommend an asset can provide an income that doesn t trigger a tax diversification strategy to your client, perhaps in liability It is also possible to assign the bond by conjunction with an additional investment into the way of gift to manage the tax rate applicable on bond The unfettered nature of an offshore bond encashment, and top-slicing may be available to provides access to the widest selection of reduce the tax liability further With a portfolio of investment fund managers around the world, from collectives the main problem with providing the largest global managers through to the more payments to beneficiaries arises when there is specialist boutique fund houses insufficient taxed income to allow for the payments It is often the case that the actual tax rate, where Perhaps later in life your client may wish to invest in dividends are paid to beneficiaries, is as high as a more cautious portfolio that generates income 45% There may also be an exposure to Capital when you discuss pre-retirement planning together Gains Tax on an annual basis, whereas an offshore An offshore bond gives access to a very wide range bond is generally not subject to Capital Gains Tax of lower risk funds, including alternative investments, while the 5% deferred tax withdrawal facility can provide an income that doesn t trigger a tax liability Financial Planning Finally, when considering how to pass assets on to future generations, placing the offshore bond in trust can mitigate, or avoid altogether, taxes due on transfers of wealth The existing bond can be assigned by way of gift to the trustees without triggering a chargeable event and with no income tax or Capital Gains Tax arising

18 18 Financial Planning Your client is an internationally mobile executive, or a wealthy high net worth individual, who, after exploiting all onshore tax advantaged investment opportunities, still wishes to invest in a tax efficient pension or investment plan to build significant funds for his/her retirement There are a number of advantages to be gained through investing for retirement using offshore life products, but the key benefit is flexibility Using offshore products for retirement planning means that investors are not constrained by the UK HM Revenue & Customs rules on contributions (eg funding only up to a pre-defined lifetime limit) and how income is taken at retirement, whilst still benefiting from a tax advantaged environment for saving If any of your clients spend long periods of time abroad because of their work commitments, they may not be eligible for, or want to join, a UK pension scheme Offshore life products can provide the portability required by the more internationally mobile investor as they can still make contributions towards retirement without the hassle of dealing with complicated pensions regulations in two different countries, or having to take out a new plan each time they move Care should be taken to assess local tax rules and to check that providers are prepared to accept cases from those countries within the same contract Withdrawals can also be taken from the offshore life product in a flexible way to suit your clients needs, either in the form of regular payments or through one-off lump sums More information on the use of offshore bonds within retirement planning can be found in AILO's retirement planning guide for UK professional advisers which is available from the AILO website and from most offshore life companies Your client requires access to types of funds which are not commonly available within the UK domestic insured bond market Many equivalent onshore products offer investors a limited range of underlying investment links, usually their own internal life funds More sophisticated clients often require greater portfolio diversification through the use of alternative investments (eg non-uk authorised collective investments denominated in other currencies), or greater global spread, and access to assets not available onshore If your client wishes to access a wider portfolio of collective investment choices, whilst retaining the advantages of investing through an insured bond, an offshore bond can be a tax efficient way to do this Offshore life products can be company-sponsored and it is possible with some companies to make regular or single contributions as circumstances dictate, often Sales Support AILO can further help advisers and their clients who have been recommended offshore bonds through a series of guides aimed at offshore bond investors: UK tax guides to inheritance tax planning and investing company money Guides for UK residents about to move abroad either to work or retire Expatriate tax guides guides to the tax regime in the key countries around the world Supporting brochure to this guide for your clients A guide to offshore bonds These sales aids are available from the AILO website wwwailoorg as pdfs for you to print or distribute electronically The client guide to offshore bonds is also available as a printed colour brochure from most offshore life companies

19 19 Products Offshore companies, in the main, offer products that are broadly equivalent to onshore investment bonds, but there are some important additional features that can assist you in your financial planning, particularly for your higher net worth clients Insured Bonds Another offshore bond tax advantage that can be tremendously beneficial for the investor, particularly Offshore insured life bonds generally allow wider those with actively managed portfolios who investment links than their onshore counterparts generally use their Capital Gains Tax annual Minimum premiums range from 5,000 to 50,000 exemption allowance, is that switches between and most offshore insured bonds accept additional funds within the bond do not create a UK Capital premiums at any time during the lifetime of the Gains Tax liability contract One key difference when compared with onshore bonds is that offshore bonds usually offer a Some offshore companies also offer highly choice of currencies in which the bond can be personalised bonds to non-uk resident investors denominated and can accept premiums and make These allow access to almost any type of payments in different currencies from the bond s investment asset, including individual stocks and denomination This is particularly useful for clients shares (individual company and jurisdictional moving abroad who may wish to take withdrawals in restrictions apply), wrapped in a tax-efficient life currencies other than sterling insurance structure Advisers considering these bonds for their non-uk resident clients should make Offshore insured bonds can invest in the in-house sure that the client does not intend to become UK funds of the life company which cover a full resident during the lifetime of the bond, as punitive spectrum of risk profiles and often allow access to a tax penalties can apply The tax rules in the client's wide range of external fund management groups country of residence will also need to be considered Portfolio Bonds Offshore portfolio bonds do not just offer tax Advisers and their clients often require access to an advantages They are a very efficient way of even wider choice of assets and this is where handling an investment portfolio while giving access offshore portfolio bonds come into their own to a very wide choice of funds, often at institutional prices The life company will handle all the day-today administration of the bond and there are no Offshore portfolio bonds offer sophisticated investors an open architecture structure which can invest in ongoing complicated tax calculations to consider an extensive range of collective investment schemes Your client can also appoint an investment adviser throughout in the world (individual company and or discretionary manager to handle all the jurisdictional restrictions apply) These portfolio investment decisions within the bond bonds offer all the tax advantages of offshore investing associated with using a life wrapper while having very few restrictions on the types of collectives held Because investment is limited to collective investment schemes, these wrappers do not fall foul of the UK Personalised Portfolio Bond rules Products

20 20 Products Portfolio Bond Cash Accounts Portfolio Bonds operate with what is known as a Cash Account, Dealing Account or General Transaction Account (GTA) This is a cash fund that sits alongside your client s chosen assets and acts in a similar way to a bank account through which all transactions are processed The first transaction to the GTA will be the credit of your client s premium Transactions, including purchasing and selling of investments, charges and withdrawals, will then be credited or debited to the GTA accordingly At the outset clients should leave a percentage of their investment in the GTA to cover charges The life company may pay or charge interest to the accounts for credit and debit balances It is therefore important that GTA accounts are monitored Standing instructions can be set up to ensure that debit balances are not allowed to build up Regular premium investing In addition to lump sum investment, some offshore life companies offer regular premium investment options These come in two forms: regular savings plans and flexible whole of life protection contracts Regular savings plans offer the same wide investment choice as single premium insured bonds and the plan also grows in a tax efficient manner These plans are particularly useful for clients who are looking for an alternative to traditional pensions products in the UK, or who are going to work abroad and still want to make tax efficient long term savings towards retirement Offshore flexible whole of life products offer the same benefits as their non-qualifying onshore counterparts, but often provide more competitive rates at standard cover, partly because of the gross roll-up effect Advisers mainly use these flexible whole of life products in Inheritance Tax (IHT) planning, as the proceeds of the policy when written in trust can be used to cover any IHT liability that the client may have on death Use of flexible whole of life protection contracts in IHT planning When they get to the stage of IHT planning, many clients assets may already be tied up in illiquid forms of investment and they may not have readily realisable capital to invest in a single premium offshore bond When written in trust, an offshore flexible whole of life policy can be used to pay the expected amount of IHT liability without the need to obtain probate first, as there will be a guaranteed sum available of death The trust is designed to run alongside a client s will and the beneficiaries will be the same Payments of regular premiums to a life policy in trust are often exempt from IHT as they can generally be treated as being normal expenditure out of income, or fall under the personal annual IHT allowances of 3,000 ( 6,000 for a married couple) Another unique feature of the offshore market, which Life and capital redemption contracts has genuine benefits to some types of client, is the capital redemption bond A capital redemption bond is a long term contract that has similar tax treatment in the UK to life insurance, but without the need for lives assured This means that the contract only has a policyholder or policyholders, and does not end when the owner dies Instead the bond has a fixed term, usually of 99 years, and will have a guaranteed value at that time The policyholders can surrender the bond at any time The capital redemption structure has uses for trustbased investments and individuals who want to pass their wealth on in a tax efficient manner Many of the offshore companies in the UK market offer the capital redemption option on their investment bonds Charges and portfolio bonds One criticism often levied at offshore bonds is that they have tended to be expensive in terms of charges taken when compared with their onshore equivalent In recent years, however, because of investment in technology, increased competition and a strategic focus on the UK market, the pricing of offshore products has broadly fallen into line with their onshore equivalents Of course, the offshore products also offer the tax mitigation benefits and investment choice not achievable through onshore bonds and collective investments