Can Non Doms Use Offshore Bonds to Save Tax?

For any non doms looking at ways to hold assets abroad without being liable to the £30,000 annual charge, identifying overseas investments that don't crystallise income can be crucial. One way of avoiding having any income at all is to use an offshore investment bond. This is a type of insurance based product (but with minimal insurance cover) which allows you to invest into an offshore fund.

If you invested in a UK bond the fund manager would be subject to tax on the fund profits. However an offshore bond would be free of UK tax which allows your investment to grow at a higher rate.

Pros to using an Offshore Bond

The key benefit for non UK domiciliaries though is that offshore investment bonds don't generate income and therefore there is often no income tax charge during the lifetime of the bond. It's usually only when you sell it (known as 'encashing' the bond) that there is a UK tax liability.

This is attractive for non UK domiciliaries if they're otherwise subject to the £30,000 charge for using the remittance basis of tax as they could instead invest in an offshore bond and just opt for the arising basis - saving themselves the £30,000.

Providing they hold overseas investments via the offshore bond they'll avoid generating any income and therefore there would be no UK tax liability. This is a neat way to sidestep the £30,000 requirement.

Offshore investment bonds also allow withdrawals of up to 5% of the initial investment per tax year which aren't classed as income. This means that you can extract cash from the bond free of UK tax.

You may have heard of this referred to as a 5% exemption. Strictly speaking it's not though an exemption as it only postpones any charge until the maturity of the bond or subsequent disposal.

Having said that if your circumstances change so that you are non resident or not otherwise liable to tax the 5% extractions would operate as an effective exemption as at the time the deferred charge arises no tax would be payable.

Many non doms have been looking to use offshore bonds to hold assets abroad and avoid the £30,000 tax charge. They could therefore invest funds into an offshore bond and simply opt for the arising basis of tax. They wouldn't lose their UK allowances, wouldn't need to pay the £30,000 tax charge and there would be no tax on the bond as any extractions would be covered by the 5% allowance. They'd then ensure that they had left the UK for the later disposal of the bond and avoid UK tax in full.

Cons of Offshore Bonds

You should however be careful. If you're UK resident at the date of the 'disposal' of the bond you'll then be subject to income tax on the gain made under special tax rules. This means that you could be taxed at rates of up to 40% on the gain made (subject to relief). By contrast as a UK resident if you'd invested in overseas investments directly you'd have the annual exemption and the much lower CGT rate of 18%.

The other drawback is that the current finance bill is drafted very wide in terms of defining a remittance. So you'd need to watch out if you were looking at transferring cash from overseas bank accounts which consist of untaxed income or gains to an offshore bond.

The finance bill states that there is a remittance where two conditions are satisfied:

• Money or other property is brought to the UK, or is received or used here, by or for the benefit of you, your wife or partner, children or grandchildren aged under 18: or
  

   



• the property is, or is wholly or partly derived from, the income or capital gain,

In the case of a bringing your 5% withdrawals into the UK Condition 1) is satisfied the question would be whether 2) is met. In particular whether the remitted cash derives from the overseas income or gain (directly or indirectly).

The Revenue use tracing rules to trace gains through different investments so there could be a case for arguing that the cash remitted although not taxed as capital constitutes a remittance of the earlier income or gain. This would then mean that the earlier income or gain would be taxed on a remittance of cash from the offshore bond even if you had opted for the arising basis.

Therefore whilst offshore bonds can certainly be effective in terms of deferring income to allow the arising basis to be used (and therefore avoiding the £30,000 tax charge) you'd need to be careful if you used untaxed income or gains to purchase the bond. Ensure you take detailed advice on the latest provisions in the finance bill.