Offshore bonds are subject to the tax laws of the jurisdiction in which the life office is set up. Generally, the offices are established in areas that have favourable tax regimes, including a lack of income tax and capital gains tax on the funds of the policyholder, this practice is known as a ‘gross roll-up”. However in some cases withholding tax may be charged, if income is brought in from other jurisdictions. It is possible to lessen the rate of withholding tax by making investments for capital growth as opposed to income.
The differences in taxes that affect the underlying funds will be reflective of the way UK investors are subjected to income tax when the bond is either ultimately encashed, or withdrawals of over five percent per year are made. Individuals in possession of offshore bonds are given a tax credit worth 20 percent on their taxable gains, which nullifies basic rate tax liability. Individuals paying the higher tax rate will face an additional charge of 20 percent on net gain, equalling a 36 percent overall rate. People who pay no tax, or the lower rate, cannot claim the tax credit.
There are no correspondent tax credits available for gains from offshore bonds. Higher rate taxpayers face a 40 percent charge on the total gain, 20 percent for basic rate taxpayers.
The complex nature of these differing tax treatments can be confusing, especially since a tax credit is a normal deduction but the different treatments that the underlying funds are subject to have a compounding result. Another factor that has a considerable effect is the effective tax rate that the policy holders funds are subjected to via the UK life office. The life office taxes differently depending on the type of asset, so an underlying asset mix will face different rates.
What this shows us is that UK taxpayers can opt for an onshore bond if the policy is short term, but for longer terms the tax advantages will be greater with an offshore bond.
Offshore bonds often have a greater charging structure than bonds sourced from the UK. Reasons for this include:
An inability to claim tax relief on expenses
Increased expenses incurred from promoting products on a worldwide scale, and in turn satisfying the regulatory laws in each respective country in which they are sold. Offshore companies target many markets throughout the world, including the UK.
Grander scale for investment remittances, which can lead to larger costs depending on the sector used.
Generally, more costs may also be counted at Head Office, as a small business will have more than mature UK life companies.
Onshore bonds may give growth projections of around four percent, six percent or eight percent, which is in accordance with the FSA’s requirements for business conduct. Offshore bonds, on the other hand, may show greater rates of projection at around five percent, seven percent or nine percent. This is because of a lack of UK tax on the underlying funds. Although you should note that investors from the UK will inevitably have to pay tax on their chargeable gains. Thus the amount to compare offshore and onshore bonds to is the number left after tax has been paid.
You can also figure out the charge effects by comparing the yield figure reductions.
Also be aware of annual management charges, these apply to all of the fund, and not only the growth factor.
Investor protection is strong in many offshore jurisdictions such as the Channel Islands, Isle of Man, Gibraltar and Luxembourg. The confidentiality here is often far superior to that of the UK. However, some of the more exotic offshore jurisdictions, like the Caribbean, have more erratic levels of protection.
For UK bonds, you are usually restricted to only having life assurance for a maximum of two individual, however offshore bonds often allow up to 10 people to be accommodated.
Insurable interest is not really recognised away from the UK so it is not a problem for a UK resident with an offshore bond.
In the event of an offshore bond holding investor passing away, the executors will have gain a local grant of probate in order for the proceeds to be released. But this can be bypassed via a probate avoidance trust.
Offshore bond companies often offer extra services via their in-house trusts, but usually at an extra cost.
As evidenced, there are a number of factors that come into play when comparing offshore and onshore bonds. However offshore bonds come into their own in the following circumstances-
If an investor intends to move ore retire aboard and will then be subject to their new local tax and not UK tax.
If an investor will not be paying tax during a chargeable event
If an investor is making a long term investment that gives greater scope to capitalise on the offshore benefits, and thus outperforming an onshore equivalent.