The Prudential Technical Team examine Offshore Bonds and how are they taxed for individuals and personal representatives.
Offshore bonds and protection products are ‘foreign policies of life insurance and foreign capital redemption policies’ for UK tax purposes (Section 476 of the Income Tax (Trading & other Income) Act 2005). From 17 November 1983, a policy issued by a non-UK life office will be ‘non-qualifying’ for tax purposes, meaning all gains are potentially taxable. Similarly, UK investment bonds are also non-qualifying. Indeed, the same tax legislation determines the tax treatment of these respective policies. Accordingly, the principles covered in the Taxation of UK Investment Bonds (/knowledge-literature/oracle-plus/taxation-uk-investment-bonds) article hold good for offshore policies but certain special rules apply.
In this section we will consider how offshore policies are taxed for individuals, personal representatives and trustees.
Taxation of individuals
Individuals liable for tax on a gain on a UK bond are treated as having paid tax on the gain at basic rate (currently 20%). The reason for this is that the underlying fund is taxed. As a result, tax is only payable by those individuals with a marginal rate of 40% or 45%.
In contrast, offshore policies can be issued by life companies based in jurisdictions which impose no tax on the income and gains of the underlying funds – this is known as ‘gross roll-up’. Growth may not be entirely tax-free however, due to the impact of irrecoverable withholding tax which may be deducted from interest and dividends received by the fund.
When an offshore policy is surrendered, an individual can be charged income tax at nil if the personal allowance is available; starting rate 0%; basic rate 20%, higher rate 40% and additional rate 45%. If you need to make higher rate and additional rate calculations, see our article Top slicing relief (/knowledge-literature/oracle-plus/top-slicing-relief-facts). Top slicing relief is available for the higher rate and additional rate calculations.
Effective from 6 April 2016, a new personal savings allowance was introduced. Each individual has an annual savings allowance of £1,000 unless he/she has any higher rate income for the year (in which case the allowance will be £500) or any additional rate income (in which case the allowance will be nil). ‘Savings income’ includes gains on offshore bonds.
Example: Taxation of an individual
In 2020/21, Helen who is 50 years old and has zero income realises a chargeable event gain of £19,000 on the full surrender of an offshore bond. Tax payable would be as follows:
To put this into context, if Helen realised the same gain on an onshore bond then she would have had no personal income tax liability based on these figures since the gain is comfortably within the basic rate limit.
So in very broad terms:
- Basic rate taxpayers are subject to 20% tax on the gain
- Higher rate taxpayers are subject to 40% tax on the gain
- Additional rate taxpayers are subject to 45% tax on the gain.
It’s not as simple as that however, since gains are generally treated as forming the highest slice of income. A basic rate taxpayer can therefore be pushed into higher rate, or a higher rate taxpayer can be pushed into additional rate. ‘Top slicing’ relief may therefore assist in reducing the rate of tax charged by applying a spreading mechanism.
Chargeable event gains (without top slicing) are included in an individual’s income when assessing entitlement to personal allowances Personal Allowances planning article (/knowledge-literature/knowledge-library/personal-allowances-planning). Withdrawals within 5% limits do not affect personal allowance entitlement.
Taxation of personal representatives
Personal representatives pay income tax at basic rate (and 7.5% for dividend income). When income arising during the administration period is distributed to a beneficiary, then the beneficiary will include the gross equivalent in his/her tax return. The personal representatives will provide the beneficiary with a statement, showing the amount of estate income paid to that beneficiary and the amount of tax deemed to have been paid on that income.
In the case of a bond, the personal representatives might encash where the beneficial owner has died but the bond has continued due to the existence of another life assured. Any chargeable event gain arising on the continuing policy is treated as income of the estate and the personal representatives will be liable to tax on that gain. With an offshore bond, gains are charged at basic rate in the hands of the personal representatives.
When the proceeds are later distributed to the beneficiary, the chargeable event gain will be taxable on the beneficiary who will be treated as having paid tax on the gain at 20% basic rate.
Taxation of trustees
The circumstances when trustees are taxable are considered in the Taxation of UK Bonds article (/knowledge-literature/oracle-plus/taxation-uk-investment-bonds). Where trustees are taxable, and it is an offshore policy, then:
For discretionary trusts, basic rate applies on gains up to £1,000, where this hasn’t already been set against other non-savings income, otherwise
The rate applicable to trusts applies (45%).
Example: The trustees of the MacPherson Discretionary Will Trust
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