What are Offshore Bonds? (2024)

investing in an offshore bond

An offshore bond is an investment wrapper that can be used as an investment vehicle to control:

1. whenyou pay tax;
2. how muchyou pay; and
3. whomyou pay it to.

Offshore investment bonds are also referred to as portfolio bonds and tax wrappers.

An offshore investment bond is a wrapper set up by a life insurance company and domiciled ina jurisdiction with a favourable tax regime, such as the Isle of Man, Luxembourg, or Guernsey.

Increasingly, international clients are also opting to use Dublin to benefit from perceived increased regulatory protection and tax efficiency.

Internationally, offshore bonds are typically provided by global life insurance companies such as Quilter International and Generali Worldwide.

An offshore bond is a tax efficient wrapper that can hold a variety of assets, like stocks and shares or mutual funds. One reasons bonds are issued offshore is because this adds the legal and tax shield of a life insurance policy to an investment portfolio. The offshore investment bond can be structured to combine a life insurance policy and a portfolio to create a wrapper that investors can buy, manage and sell their assets through.

Because we review a lot of offshore bonds and providers, a commonly asked question is ‘do these offshore bonds work’ particularly for international executives. They are certainly sold prolifically to those with lump sums to invest, butthey are not always sold with transparent fee structures, and that can be the undoing of an otherwise excellent solution.

Your personal tax statuswill determine whether your investments are taxable, and at what rate.

In very general terms, offshore bonds can offer regular withdrawals that give investors access to capital in a tax-efficient way by enabling the withdrawal of up to five percent of each investment amount every year as tax-deferred income. This five percent can be taken every year for 20 years, or built up over a number of years and withdrawn less frequently, without triggering a chargeable event for tax purposes.

The tax deferral features of anoffshore investment bondin theory let you choose when to pay tax, as this will be when you cash in some, or all, of your bond. The tax payable on a chargeable event such as this will depend on your highest marginal income tax rate at that time.

Therefore, many expats are advised to postpone such an event until they are either no longer a taxpayer (because they have moved toa low tax destination like the UAE), or have moved from being a higher rate taxpayer to a lower or basic rate taxpayer, perhaps when they retire.

If you have or are considering an offshore investment bond, you should understand the following:

The structure of an investment bond

An offshore portfolio bond is another name for an offshore investment bond. It is a potentially tax efficient investment wrapper that can hold different assets, such as stocks and shares and mutual funds.

It is critical to note that the tax efficiency of an offshore portfolio bond is not always advantageous or applicable, and depends on your country of tax residence, and tax status.

One of the most common questions our financial planners are asked is "why use an offshore bond?"

Here are 10 key features of an offshore investment bond:

1. Offshore bonds can be used as a tax efficient platform or wrap where you can manage your investments.
2. They can offer an offshore bank account together with your own chequebook, credit card and internet banking facilities.
3. Under certain circ*mstances they can make tax reporting more straightforward. Offshore bonds are not deemed to be ‘income producing assets’ - which negates the need for individuals or trustees to complete self-assessment tax returns.
4. Gross roll up – investments within the bond can be switched without the requirement for any tax reporting and without rise to CGT.
5. Income produced by investments within the bond is received gross, and will only suffer income tax on future encashment of the bond.
6. Time apportionment relief - income tax liability is reduced proportionally for time spent as non-UK resident. For example, if you have been resident outside of the UK for half the term your bond has been held, the taxable gain would correspondingly be reduced by half.
7. The bond can be assigned by way of gift without giving rise to an income tax charge, although there might be inheritance tax (IHT) considerations.
8. 5% of the original premium can be withdrawn from the bond for 20 years cumulatively without being subject to tax, being treated as a return of capital.
9. Bonds can be partially of wholly assigned (to another family member or individual), unlike ISAs or pensions.
10. Bonds can be placed in trust - and taken out of a trust - without rise to an income tax charge or CGT.

Here is a practical example of how top slicing works for those with offshore investment bonds who are or become UK residents for tax purposes. Say you have £30,000 of income over your personal allowance, which is taxable in this tax year,andyou’ve made a gain of £15,000 from your offshore bond, which you’ve held for three complete policy years...

Time apportionment relief applies where an offshore bond is held by a chargeable person who is a UK resident for onlypartof the period between the policy’s inception and the chargeable event.

Where this happens, any chargeable gain is proportionately reduced based on the number of days absent from the UK, divided by the number of days since the policy commenced.

Personal Portfolio Bonds (PPBs) are life insurance or capital redemption polices that allow the policy holder to choose assets beyond those described in PPB legislation. Generally, holding structured products, individual equities or bonds, or unauthorised investment trusts within your offshore bond will mean it’s a PPB.

If your bond is classed as a PPB, when you’re a UK resident you will pay tax on a 15% annual deemed gain, based on your original premium and cumulative deemed gains, whether your bond increases in value or not. This deemed gain will be taxed at the policy owners highest marginal rate of income tax each year. You may be eligible for time apportionment relief, but not top-slicing relief.

For example:

David, a UK resident, took out a plan with a single premium of £500,000. He then surrenders the plan in year 6, for £530,000.

If the plan did not hold any problematic assets and was never classed as highly personalised, the gain to be assessed for income tax would be £30,000 (£530,000 - £500,000).

However, if David’s plan held offending assets and was considered therefore highly personalised, he would have been assessed for UK income tax each year on the deemed gain basis. As a result, the tax charge would be approximately £131,175 by the end of plan year 5.

It's worth noting that no deemed gain is applied in the plan year that the plan is fully surrendered.

If David had lived in another country when he opened the plan, and moved to the UK in year 4, and did not sell the offending assets he held by the end of year 4, his plan would become a PPB at the end of the plan year. As such, David would be issued with a Chargeable Event Certificate for deemed gain of £114,066. If the offending assets were sold before the plan anniversary, there would be no deemed gains as the plan would not be highly personalised.

The PPB legislation states that if your bond only contains assets from the following list, it will NOT be deemed a PPB:

• Property appropriated by the insurer to an internal linked fund;
• Units in an authorised unit trust;
• Shares in an approved investment trust, or an overseas equivalent;
• Shares in an open-ended investment company (OEIC);
• Cash (but not acquired for speculative purposes);
• Interests in collective investment schemes, which are units in non-UK unit trusts or any other arrangement that creates rights in the nature of co-ownership under the law of a territory outside the UK;
• Shares in a UK Real Estate Investment Trust (REIT) or an overseas equivalent
• An interest in an authorised contractual scheme.

Offshore investment bonds are issued by international insurance or life assurance companies based in low or no tax jurisdictions like the Isle of Man and Dublin, where there are often investor protection schemes in place, making them of maximum appeal to onshore and offshore investors.

These offshore investment bonds can be written on either a life (whole of life) assurance or a capital redemption basis. Where they are written on a life assurance basis, the policy comes to an end on the death of the sole or last surviving life assured. The bond can be surrendered at any time however, but may be subject to the deduction of early surrender fees over a specific period.

1. Investors who are, and will definitely be, non-UK taxpayers at the time of a chargeable event.
2. Investors wishing to benefit from the ‘gross roll-up’ effect, for example, an individual who is planning to live orretire abroadto a jurisdiction with lower rates of income tax than the UK, and who would be subject to local tax on chargeable gains.
3. Investors wanting to place their investment within a trust forIHT mitigationpurposes.

• Tax deferred withdrawals of up to 5% per annum over 20 years.
• Dividend and other income may be subject to withholding tax which is non-recoverable.
• Income and realised gains in the funds are not taxed locally or may suffer a low rate of tax.
• On surrender, a higher or additional rate taxpayer pays tax at the higher or additional rate on any chargeable gain.
• A basic rate taxpayer pays 20% on any chargeable gain and a starter rate taxpayer 10%.
• Top-slicing relief will be available to basic rate taxpayers who become higher rate taxpayers on receipt of the bond proceeds, or higher rate tax payers pushed in to the additional rate band.

Offshore bonds, as their name implies, are outside the UK for tax purposes. This means that they do not come under the UK’s consumer protection rules.

It is important to understand the consumer protection offered by the jurisdiction where the offshore bond sits e.g. Isle of Man, Dublin, or Guernsey.

Only when you understand and are comfortable with that protection should you consider using a provider that favours one jurisdiction over another.

There is nothing intrinsically wrong with offshore investment bonds. They can be beneficial and suitable solutions for many people - both onshore and offshore. However, it’s the way they are sold that can cause problems.

The main problem with offshore investment bonds that investors experience ishigh, hidden and confusing fees and charges. Even the most successful underlying investments will fail to thrive when subject to excessively high charges.

All providers and all bonds have different charging structures, and it is an unfortunate feature of the most popular offshore investment bonds that their fees and charges are indecipherable.

We havea dedicated offshore bond sectionon our site where we review the product providers and their bonds, and where we outline typical costs, which can include: -

Investing in offshore bonds can be advantageous for those with a lump sum to invest for at least the medium-term, but costs need to be controlled, and underlying investments well-diversified.Also, the tax benefits of offshore bonds are not always advantageous for those they are marketed to.

If you are an international executive and you have a lump sum to invest, you may therefore be advised to wrap it in an offshore investment bond. Whether that is in your best interests or not should ideally be explored witha fee-based, not commission based, financial planner.

All too often the offshore bonds recommended are too expensive and restrictive, and much better and cost-effective options are available.