We examine the advantages of offshore bonds in income and IHT planning.
Investors in the stock market tend to use direct equities, unit trust funds or open-ended investment companies (OEICs) as tax-efficient vehicles for income and IHT planning.
Any capital gains that they make are liable to capital gains tax, subject to taper relief and their annual exemption. If the assets are transferred to anyone other than their spouse or a trust, the capital gains are crystallised immediately and tax may become payable. Having said this, capital gains tax vanishes at death, leaving only IHT to pay.
Dividends received from such investments are subject to tax at the individual’s marginal rate, although credit is given for withholding taxes.
Another way ahead
Offshore bonds are non-qualifying policies of insurance, and are provided by insurers in a number of jurisdictions, notably the Isle of Man, Luxemburg and Dublin. Unlike assets that are subject to capital gains tax, offshore bonds have their own unique income tax treatment that can, in some circumstances, provide advantages in tax planning.
The underlying investments are made into the stock market using unit trusts and OEICs or funds that mirror them, and many offshore bonds offer the widest selection possible. UK investors cannot hold offshore bonds that invest in single stocks and shares, otherwise they will expose any gains to punitive tax charges.
The offshore advantage
Offshore bonds are non-income producing assets, so any growth and income on the investments are not subject to any form of tax. Furthermore, as long as annual withdrawals from the bond do not exceed 5% of the original capital invested (on a cumulative basis), there is no tax to pay on any underlying growth at that time.
However, if this 5% allowance is exceeded, or the bond is fully encashed, an income tax charge at both basic and higher rate tax might apply, subject to top-slicing relief. It is possible to manage this income tax liability by transferring the offshore bond to someone else. Unlike assets that are subject to capital gains, tax assignments do not crystallise gains. Any underlying tax liabilities are assumed by the bond assignee, who may be subject to tax at a lower rate than the bond assignor.
Offshore bonds are tax efficient for individuals who have already used their pensions allowance, as encashments can be planned to coincide with a time when either their own or their spouse’s tax rate is lower. As assignments of offshore bonds do not crystallise tax liabilities, these investments are also efficient in IHT planning, as they can be passed on to the next generation at any time without crystallising tax liabilities on gains on the underlying investments.
A flexible way to manage funds
Offshore bonds also offer a lot of investment flexibility. For example, if investors want their discretionary fund manager to manage the investments within the bond, they can do this either by using funds or by establishing a specific fund, depending on the amounts invested. Finally, many trustees are now turning to offshore bonds to reduce both the administration within the trust and its tax liabilities. Assignments of offshore bonds or their segments to beneficiaries is an effective way of keeping tax liabilities to a minimum.
If you are interested in learning more about offshore bonds, their uses in tax planning and the risks involved, please contact us.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
