Before I go into this, many expats are mis-sold bond due to their tax efficiency, however, they just end up being expensive for the expat and high commission for the advisor. Who do you think is the winner?
There are times where they are useful, depending on the country you are in but I will go in to that now!
Contrary, many expats believe if you have been a non-resident in the U.K for 5 years and hold stock’s or shares in the U.K even outside of an ISA and take gains it could be tax-free (depending on the tax treaty that you have with the U.K. and your current country’s tax residence), unlike property where it is subject to CGT tax if you are a non-resident or not. Funds are not subject to the same taxation laws.
https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/updates
If you have any assets of stock, funds, or other securities in a broker or a saving account in the U.K and don’t plan on moving back to the U.K, as well as having lived outside the U.K for five years in a low to zero tax location (such as Singapore 0% on capital gain) you might not have any need to move your investments. This depends on personal circumstances, preference and a lot of other factors.
The same applies to popular U.K expat destinations such as the UAE, many of the offshore bonds are sold on tax efficiency by advisors. These bonds have been mis-sold by the advisor as they have little use and high fees for many expats.
So, if not for expats or more specifically U.K expats how can offshore bonds be used?
What about the typical British person who is both a UK resident and UK domiciled? Are there any offshore techniques they can use to minimise UK tax?
The first point to bear in mind is that, as a UK resident, you will be taxed on your worldwide income and gains under domestic tax legislation. Therefore, the scope to generate returns in a more tax-efficient manner is limited.
Example:
Joe a UK resident and domiciled individual would like to invest in overseas equities. He decides to invest purely through an offshore broker and will invest in shares quoted on the US stock market. He will be fully liable for UK capital gains tax on his profits.
However, there are specific exceptions contained within the tax legislation that applies to offshore bonds.
Offshore Bonds for Expats
Qualifying offshore bonds allow investors to ‘roll up’ their returns; this means tax is only paid at the end of the investment period (usually five to 10 years) when the investment is cashed in.
A withdrawal of up to 5% can be taken each year, with tax payable only at the end of the investment period. If you exceed the 5% limit, the tax liability is triggered.
It is also possible to switch in and out of different investment funds within an offshore bond wrapper without these transfers being classified as chargeable events for capital gains tax purposes.
Investment in these qualifying offshore bonds can prove highly tax effective. Investments grow virtually tax-free within the fund, benefiting from what is known as ‘gross roll up’. This means that, rather than an investment being taxed on an ongoing basis, the funds grow without the encumbrance of tax.
Whilst there may be personal tax to pay when the investment is cashed in, proper tax planning, such as arranging your affairs so that you are a non-UK resident at the date of encashment, can help reduce this.
Gross roll up can lead to a dramatic increase in the amount of money invested.
Capital gains tax is not levied within the fund on offshore bonds, so an investment may be actively managed to focus solely on the investment considerations rather than being subject, as in the UK, to capital gains tax within the fund.
Savings can often be made with offshore bonds since investors can buy and sell qualifying investments held within the bond without any liability to capital gains tax. Many offshore bond providers offer links to a third-party, household name, and investment companies, so finding a suitable investment shouldn’t be difficult.
However, after the 2008 and 2009 Budgets, HMRC announced changes that will affect when certain offshore funds will be able to benefit from the income tax and gross roll-up treatment described above.
These changes are quite technical, and as such, it would be advisable to seek confirmation from any potential fund provider whether the chosen fund falls within the above tax rules.
If the fund does not qualify for the gross roll-up, the investment would be treated just like any other UK investment. This would eliminate the UK tax benefit. Purchases and disposals of the investments or units within the bond would be subject to UK capital gains tax.
Making the Most of Tax-Free Capital Gains While Non-Resident of the UK
While you are a non-resident of the UK it makes sense to take advantage of the fact that you are exempt from capital gains tax (CGT).
This is particularly the case if you are a non-resident and are thinking about returning to the UK.
After you return to the UK, you could be subject to CGT on any asset disposals. The fact that you bought the assets when you lived in the UK or overseas is irrelevant.
All that matters is your tax status on the date of sale. When you return to the UK, you will fall into the CGT net once again.
Your best bet may be to sell your assets to an external third party in the tax year before you return to the UK. Provided you have met the five-year anti-avoidance rule (if it applies) you will then avoid UK CGT.
But what if you don’t have time to sell your assets before you return to the UK, or you want to keep hold of them in case they rise in value? Here are a few options:
Transfer to a Family Member
A transfer to a family member for nil consideration (i.e., no disposal proceeds) would be a market value transfer for CGT purposes. As such you’d be treated as realising a capital gain which would then be exempt from CGT. The family member in question would then hold the asset at a base cost equivalent to the market value at the date of transfer.
This would therefore eliminate the capital gains tax up to the date of the transfer.
It doesn’t matter if the family member is a UK resident or not. If they are not they would be exempt from UK CGT in any case. If they are UK resident, they would be subject to CGT on future disposal but would only be taxed on any uplift in value from the date of transfer. One exception is that transferring to a spouse would crystallise the gain.
On a future sale, the recipient would only be taxed on any uplift in value (assuming they were UK resident). They could potentially pass the sale proceeds back to the transferor as long as there is evidence that the original transfer was a genuine transfer of the beneficial interest in the property and was not made ‘with strings attached’. (For example, the original transfer should not be made conditional on the proceeds eventually being returned).
Trust
Another option would be to transfer to a trust. A trust transfer would be a chargeable lifetime transfer if it were a simple gift to the trust. As such any gifted sum above the nil rate band could be subject to a lifetime inheritance tax charge at 40%.
You would probably arrange the transfer as a disposal and as such there would be no gifted element.
The trust would then own the assets and would be likely to be taxed at the 28% rate of CGT on a future disposal. You have a choice to either a UK or offshore based trust.
Non-Doms (Non-Domicile) would probably go for an offshore trust whilst for most UK resident, UK domiciliaries UK trusts would be preferred as they would avoid the offshore anti-avoidance rules.
Conclusion
If you are an expat, it would be wise to seek professional financial advice on your assets as many aspects come into play regarding taxation. As I have written above if you do have assets in the U.K, although in most cases you will not be able to top up your investment as a non-resident if you declare your self a non-resident, from a CGT it might not be subject if you are out of the U.K for five years and where you are presently a resident.
If you are a U.K expat although, CRS investing offshore with after-tax pounds (or dollars) is nothing wrong and can be a way to defer your tax much like the U.S IRA account.
Finally, if you are looking to mitigate your tax liabilities can be done though, trusts using the gift allowance to mitigate IHT tax.
If you want to talk over your situation and get some clarity on what you can do with your assets, please email me using the form at the bottom of the page!
