Taxation of offshore policies: planning ideas
See how to plan for individuals with offshore life assurance bonds.
- Offshore bonds grow in a virtually tax-free environment, which is known as gross roll-up.
Planning using time apportionment relief to reduce the gain.
Individuals may be able to make use of top slicing to reduce the tax payable on the gain.
What are offshore investment bonds?
Offshore investment bonds are non-income producing assets subject to a tax regime which imposes an income tax charge when a 'chargeable event' occurs and a gain arises on that.
The same legislation determines the tax treatment of both offshore and UK bonds. The principles are examined in detail in the Taxation of UK Investment Bonds article.
In certain circumstances, special rules apply to offshore policies and these are examined in the Taxation of offshore policies article.
The following tax planning matters are considered in our Tax Planning With UK Investment Bonds article:
- Change of ownership
- Large 'one-off' withdrawals
- 'Escaping' a large partial withdrawal gain
- Additional lives assured
- Personal pension contributions
- Preservation of personal allowances
These points are not duplicated here but it should be noted that the principles are also relevant to offshore bonds.
Regarding 'additional lives assured', an offshore capital redemption bond would be an alternative rather than a life assurance bond with additional lives. Contracts within such business are long-term insurance business but not life business. Under a capital redemption bond a premium is paid to an insurer for a specific return paid out later on the basis of an actuarial calculation. Prior to redemption the bond may be surrendered in whole or part in the same manner as a life assurance bond. Gains on capital redemption policies are taxed on individuals in a similar way to those on life policies.
Time apportionment relief
The chargeable gain for an offshore policy is reduced for tax purposes if the person liable to tax was not UK resident throughout the policy period. This relief is extended to policies issued by UK insurers on or after 6 April 2013 and to existing policies issued by UK insurers which are modified on or after that date.
The chargeable event gain is reduced by an appropriate fraction equal to A/B:
A= the number of days on which the individual was not UK resident in the policy period
B= the number of days in that period
The policy period means the period for which the policy has run before the chargeable event occurs
The implications of this are:
- If the person chargeable to tax was non-UK resident for the whole period, the chargeable gain will be nil
- If the person chargeable to tax was UK resident for the whole period, the whole gain will be chargeable
- An individual proposing to return to the UK after a period of non-residence may decide to rely on the relief by waiting until UK residence resumed before encashing rather than encashing overseas, which could have adverse overseas tax consequences depending on the particular jurisdiction.
Example: time apportioned relief
Tom, who is currently UK resident for tax purposes, realises a chargeable gain on his offshore bond of £100,000. He has owned the bond for 2,000 days and during that period
He has been non-UK resident for 1,250 days
He has been UK resident for only 750 days
Tom is due a reduction in the gain of £100,000 x (1,250/2,000) = £62,500.
Therefore the gain subject to UK tax = £100,000 - £62,500 = £37,500.
Where a gain under such a policy is reported on a chargeable event certificate, the full gain will be shown on the policy. If an apportionment for periods of non-residence is due, it is up to the person liable to calculate the apportioned gain and enter it on the tax return.
Where top-slicing relief is relevant in determining whether the individual is liable to higher or additional rate income tax, the number of complete policy years the policy has been held will be reduced by the number of complete years that the individual was non-UK resident
It is important to note that the reduction doesn’t apply where the policy is or was held by a non-UK resident trustee(s).
Note that it is only the residence history of the person liable that is to be taken into account, and the relevant period of time is the time that person is the beneficial owner (or, the settlor of the trust) of the policy in question.
For the avoidance of doubt, note that time apportionment relief is only relevant when the individual is UK resident for tax purposes at the time of encashment. If the individual is resident overseas when the bond is encashed, then the overseas tax regime will apply (this could be more penal than the equivalent UK charge).
Under the statutory residence test provisions, there is an anti-avoidance rule under which gains arising during a period of temporary non-residence will be treated as income arising in the year the individual returns to the UK. Time apportionment relief and top slicing relief will be available in this situation.
UK resident but non-domiciled individuals have access to a tax regime called the 'remittance basis'. They are:
- Liable to UK tax on all their income and capital gains which arise in the UK; but
- Only liable to UK tax on non-UK income and capital gains if remitted to the UK.
All other residents are liable to UK tax on all their worldwide income and capital gains.
In 2008 an annual charge of £30,000 was introduced for those non-domiciles who make a claim to be taxed on the remittance basis in a tax year and have been resident in at least seven of the nine tax years prior to the year of claim. Those who choose to claim the remittance basis lose their entitlement to the UK personal allowance for income tax and the annual exempt amount for capital gains tax.
From 6 April 2012 there is an increased charge of £50,000 for those who have been UK resident in at least 12 of the 14 tax years prior to the year of claim.
In the 2014 autumn statement, the chancellor announced that non-domiciles who elect to use the remittance basis will pay a higher charge when they have been living in the UK for a long time. So there’s an increased charge of £60,000 for non-domiciles who have been resident in the UK for 12 of the past 14 years. The charge for those resident for seven of the past nine years remains unchanged.
For many individuals the cost of claiming the remittance basis will be prohibitive when compared to the potential tax saving. Individuals who don’t wish to claim can instead choose to be liable to tax on all their worldwide income and capital gains whenever they arise. Accordingly an investment into a non-income producing offshore bond may be an attractive proposition.
Non-domiciled individuals who are taxable on the remittance basis may also consider an investment into a non-income producing offshore bond. It will be possible to take 5% tax deferred withdrawals into the UK without them being regarded as taxable remittances. Note however that such payments will be treated as taxable remittances to the extent that the purchase of the original premium was made with the individual's untaxed foreign income and gains that would have been taxed on the remittance basis if remitted to the UK. Such remittances are regarded as derived from the untaxed foreign income and gains used to purchase the policy.
If the bond is encashed then any chargeable event gain is taxable, as it arises since the remittance basis doesn’t apply to such gains.
With regard to inheritance tax (IHT), if an individual is domiciled or deemed to be domiciled in the UK, IHT applies to their assets wherever situated. If an individual is domiciled abroad, IHT applies only to the UK assets and there is no charge on excluded property. This includes property situated outside the UK (eg an offshore bond), providing the person beneficially entitled to the property is not domiciled in the UK (S6(1) IHTA 1984).
Even if a person is domiciled outside the UK under common law, there is a special rule which applies to those who have been resident in the UK for tax purposes for many years. This is the 15 out of 20 years rule (IHTA84 S267). If this rule applies, the individual is treated as domiciled within the UK for IHT purposes. The definition of domicile for IHT therefore includes deemed domicile. For all other purposes, for example, succession, the general law currently applies.
Once deemed UK domiciled, an individual will no longer be able to use the remittance basis of tax, nor can they rely on any other rules for people who are not domiciled in the UK. Their foreign and UK assets will be subject to inheritance tax (IHT). Certain protections will be introduced for offshore trusts and arrangements caught by the Transfer of Assets legislation, provided they were set up before the individual became deemed-UK domiciled. Once an individual has become deemed UK domiciled, they’ll need to leave the UK for six or more consecutive tax years to lose their deemed domicile status. In practice, once the individual ceases to be UK tax resident, deemed tax domicile is likely only to be relevant for IHT purposes.
Note also that from April 2017, individuals who are born in the UK to parents who are domiciled here will no longer be able to claim non-domiciled status while resident in the UK.
The 15 out of 20 years rule
For the rule to apply the taxpayer must have been resident (for income tax purposes) in the UK on or after 10 December 1974 and in not less than 15 out of the 20 years of assessment, ending with the year of assessment in which the relevant event falls. The year of assessment is a tax year, so it runs from 6 April to 5 April.
Excluded property trust
This is a trust designed for individuals who are currently non-UK domiciled, but may in future become UK domiciled or deemed as such for IHT purposes. The trust will be set up while the individual is non-UK domiciled, but the assets in it will remain excluded property even if the individual's domicile changes.
S48(3) IHTA 1984 excludes from charge non-UK property in a settlement made by an individual who was not domiciled in the UK at the date of settlement. The position is unaffected whether the settlor is a beneficiary of the trust.
This type of trust may also be used by those who are not UK domiciled, but may have beneficiaries who are. After the settlor's death, any assets that remain in the trust will continue to be excluded property and will not form part of the beneficiaries' estates for IHT purposes.
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Taxation of offshore bonds: the facts
Information on taxation of offshore bonds. Find out how offshore life assurance bonds are taxed in the hands of individuals and trustees.
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What you need to know about top slicing relief, how it works and more.
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