Questions from technical helpline – Tax and trusts
19 March 2018
We have numerous queries asking how offshore bond gains are taxed. Neil outlines the basic points below. However where the policyholder has had periods of non UK residence during the term of the bond ‘Time Apportionment Relief’ may apply. This is a complicated subject which is covered in our tech centre article ‘Taxation of Offshore Policies Planning’ .
Q1. How are offshore bond gains taxed on UK residents?
Offshore bond gains are taxed as savings income so any gains which fall within the personal allowance, starting rate band for savings income and personal savings allowance are taxed at 0%. This means if someone has no other income they could trigger gains of up to £17,500, tax year 2017-18, with no tax to pay.
Logan invested £70,000 in an offshore bond on 2 November 2007. He is UK resident throughout the term, takes no withdrawals and encashes the bond on 5 November 2017 when the surrender value is £131,000. Logan has no other income.
The full gain on encashment is calculated using the formula below:
It is a common misconception that top slicing relief does not apply to offshore bonds but this is not the case. Top slicing relief can be used to mitigate higher or additional rate tax but cannot be used to avoid basic rate tax where part of the gain falls within basic rate band or within the personal allowance and/or 0% bands.
The top slicing relief calculation for offshore bonds follows the same 6 steps that apply when dealing with onshore bond gains.
Add the total gain onto the individual’s total income and calculate how much of this falls into the higher rate tax band. Any gift aid payments must be disregarded both in this computation and in the remaining steps below.
If all of the gain falls in the basic rate band, or the higher band, then no top slicing relief is due and steps two to six are not needed.
In our example, £16,000 of the £61,000 gain falls into the higher rate band
Calculate the step two liability which is simply the step one amount of gain falling into the higher rate tax band x 20% (difference between higher and basic rate tax)
£16,000 x 20% = £3,200
Calculate the ‘annual equivalent’ of the gains by dividing it by “N” where “N” is the number of relevant years. In this case we can use the full number of years the policy has been in force as it is a full surrender and the policyholder has been UK resident throughout the term.
£61,000/10 = £6,100
Add the total ‘annual equivalent’ onto the individual’s total income. How much of this falls into the higher rate tax band?
The slice of £6,100 does not fall into the higher rate tax band so the step four figure is 0.
Calculate the step five liability which is a two-step process. Firstly the step four amount of ‘annual equivalent’ falling into the higher rate tax band x 20% (40%-20%), then multiply this amount of tax by N.
£0 x 20% x 10 = £0
The amount of top slicing relief is the step two liability less the step five liability.
£3,200 – £0 = £3,200
The top slicing relief of £3,200 is deducted from the policyholder’s tax liability which means the total tax payable on the gain is £8,800.
Q2. How are offshore bond gains taxed on non UK residents?
In order to answer this question you would need to have knowledge of the tax regime where the policyholder is resident. Without knowing how the bond will be taxed in a particular country it is not possible to say whether an offshore bond is a tax efficient investment for someone who is, or is going to be non UK resident. Specialist tax advice should be sought in these circumstances.
Q3. Does the 5% tax deferred allowance apply to offshore bonds?
The 5% tax deferred allowance is a feature of the UK tax regime which applies to UK residents. Where the policyholder is resident in the UK the 5% tax deferred allowance will apply. However where the policyholder is not resident in the UK it may not so you would need to understand the tax regime which applies to the non UK resident policyholder.