INVESTORS have piled into offshore bonds to escape a Europe-wide crackdown on tax evasion, but advisers warn that the schemes could be mis-sold to savers who will get no tax benefits.
Sales of offshore bonds to British residents soared 60% to £5 billion last year, compared with a rise of just 20% in onshore bond sales, according to a report by Defaqto, a research group.
Advisers say the boom is largely because offshore bonds are not caught by the European Union’s savings-tax directive, which was introduced last July to prevent people hiding assets from the authorities by keeping them abroad.
Under the rules, most EU states agreed to share information about people who earn savings income in their country but live elsewhere. So if a UK resident has a bank account in France, the French authorities will share information with Revenue & Customs.
Three EU states — Austria, Belgium and Luxembourg — and the offshore centres of Jersey, Guernsey, the Isle of Man and the British Virgin Islands, implemented the directive differently. Rather than share customers’ information automatically, they levy an annual withholding tax on savings income if the saver lives in another country. Customers can avoid the tax only if they prove they are not liable in their home country, or if they authorise their bank to share information with the relevant authorities.
The rules apply to interest from bank deposits and income from gilts and cash-based unit trusts — but not, crucially, income from offshore bonds as well as dividends, structured products and some trusts.
Thousands of UK savers with money offshore have therefore piled into bonds run from centres such as the Channel Islands. The boom may be misguided, however. While income from offshore bonds does not usually have to be declared annually, it does not escape the Revenue’s clutches for ever — UK residents must pay income tax on the proceeds when the bond is cashed in.
Christine Ross of SG Hambros, a private bank, said: “With offshore bonds, you get nothing more than tax deferral, not tax avoidance. Having said that, tax deferred is tax saved.”
Investors hoping to hide the proceeds of their bonds should think again — the taxman is becoming increasingly aggressive in locating offshore assets.
In May the Revenue won a landmark ruling that forced Barclays to hand over details of its customers’ offshore accounts. Up to £1.5 billion in unpaid income tax is thought to be sheltered in offshore accounts.
Commentators have therefore warned that offshore bonds could be mis-sold to savers for whom there is no tax benefit, especially because the schemes have higher charges than other investments and commission can be up to 10% upfront and 2% a year, according to Defaqto.
Fraser Donaldson at Defaqto said: “When recommending offshore bonds, advisers need to be very clear that their decision is based purely on genuine benefit to the client, and not influenced by the levels of commission available, to ensure the industry avoids the kind of mis-selling scandals that have affected other areas of the market in the past.”
Nevertheless, advisers insist there are circumstances when offshore bonds are worthwhile.Jonathan Spring-Rice of Towry Law said: “We have seen an upturn in inquiries about offshore bonds because of the EU savings directive, although in truth we have not written that many policies once we have explained how they work. Offshore schemes may sound glamorous but the reality is more prosaic. There are advantages, but only in certain circumstances.”
They can be useful if you are a higher-rate taxpayer now, but expect to drop into a lower bracket in future.
The bonds may also be worthwhile if you are one of the growing band of Britons intending to retire abroad. About one in five is expected to do so by 2020, according to Defaqto.
Offshore bonds are simply investment schemes offered by life insurers such as Axa, Clerical Medical and Canada Life from offices in the Channel Islands, Isle of Man or Dublin.
Like onshore bonds, they are simply a tax wrapper that can be put round any investment — cash, equities, investment funds and even derivatives.
However, onshore and offshore bonds are treated differently for tax purposes. The underlying assets in an onshore scheme are subject to corporation tax at 20% on any investment gains every year. When an individual cashes the bond, higher-rate taxpayers owe a further 20%, but people in the basic-rate band have nothing more to pay.
Offshore bonds, however, are not subject to corporation tax every year; they are taxed only when the individual sells. At that point, a higher-rate taxpayer owes 40% on their gains, while someone in the basic-rate band must pay 20%.
Donaldson said: “While the overall tax rate is the same, the offshore client has had the benefit of paying no tax during the lifetime of the policy, so they are earning interest on money that would otherwise have gone to the Revenue. The gains will have been rolled up gross, possibly with a considerable compounding effect.”
If you invested £50,000 in an onshore bond, you would have a lump sum of £72,294 after 10 years with growth of 7% a year, according to SG Hambros.
But if you invested the same amount in an offshore bond, you would have £72,833 at the end of the term — an extra £539 because your gains have rolled up gross. The figures assume higher-rate tax is paid in each case.
Advisers point out that the extra gains could be wiped out by high charges, but there are other benefits.
You can take an income of up to 5% a year from a bond — onshore or offshore — with no immediate tax to pay. It is added to your gains when you cash in the bond and then taxed at your highest rate. This gives investors, particularly higher-rate taxpayers, considerable room for manoeuvre.
A higher-rate taxpayer could draw income of 5% a year from an offshore bond, with no tax to pay (an onshore bond would have already incurred tax at 20%) and then cash the bond when they have retired to a country with lower taxes — and are probably earning less anyway.
Ross said: “We have had cases where offshore bonds have been entirely tax-free because there is no tax at source and the bondholder has moved to a lower-tax jurisdiction before cashing in.”
You should always take advice on the tax rules in the foreign country, however.
Even if you stay in Britain, there are perks. You could draw income of 5% while you are still a higher-rate taxpayer and then cash in the bond when you drop into a lower bracket, perhaps at retirement.
Donaldson said: “This is one of the key reasons for buying an offshore bond — they allow you to plan your finances to take best advantage of your tax position.”
However, Spring-Rice said he would recommend an offshore bond only when clients have exhausted all other options. “Remember that on other investments such as unit trusts a husband and wife can make profits of up to £17,600 a year before facing capital-gains tax,” he said. “A couple would have to be making gains in excess of this threshold before I would recommend an offshore bond.”
Tax is not the only reason to choose an offshore investment, though. They can be useful for sophisticated investors who want greater choice. Offshore bonds give access to an average of 130 funds compared with only 90 for onshore bonds, according to Defaqto.
And many specialist funds, such as those investing in the Bric economies of Brazil, Russia, India and China, were initially only available offshore.
Consider an offshore bond if your pension fund is precariously close to the £1.5m lifetime limit, after which it will be subject to extra tax penalties. “As with UK pension funds, offshore funds benefit from gross roll-up. For people already close to the pension cap, they might be an attractive option,” said Donaldson.
Many investors like offshore schemes because they want privacy, although recent developments have considerably reduced the attractions. Banks did not traditionally have to disclose details of their customers’ accounts to the British authorities, although the EU savings directive and the Barclays case have eroded this principle.
And if you are wealthy man who is going through a divorce and wants to hide assets from your former spouse following the huge payouts in the Miller and McFarlane cases last month, take care. You have a legal duty to disclose your assets and if you do not and are found out by lawyers, you will be contravening the UK courts and it could affect your settlement.
Susie Barter of Speechly Bircham, a law firm, said: “While it is illegal to hide assets during a divorce settlement by keeping them offshore, it is possible if you are particularly devious and are not worried about being in breach of the UK courts.”
WHEN SHOULD I CONSIDER OFFSHORE BONDS?
If you want secrecy — although this has been eroded.
