From 21 March 2012 new investors are no longer be able to utilise deemed gains, but with careful planning existing investors can maintain already accrued sums and even continue to accrue tax credits.
Legislation introducing deemed gains in the late 90’s followed the case of Professor Willoughby who the Inland Revenue (now HMRC) claimed was using an offshore bond structure purely for tax avoidance purposes. One of the law lords, Lord Nolan, in his summing up suggested that Parliament had introduced legislation that allowed for such a practise and so HMRC could not subsequently rely on anti-avoidance provisions to prevent what Parliament had previously enacted.
As a result legislation was passed for offshore bonds capable of holding what became known as ‘offensive assets’ (such as shares) which meant that the premium would be deemed to grow by 15% p.a. compound and be annually liable at the investor’s marginal rate of UK income tax.
This was irrespective of actual investment performance and was sufficiently punitive to discourage most UK investors from holding such assets in offshore portfolio bonds. However, to prevent double taxation, any deemed gains taxed in this way could be offset against actual gains on a final event (such as full surrender).
This presented an opportunity for non resident UK taxpayers who may subsequently become UK resident. The 15% compounded deemed gains were still accrued even as a non-UK tax payer. Then on a final event they could be offset against actual gains realised as a UK tax payer.
A simple endorsement to prohibit the holding of offensive assets in the highly personalised portfolio bond around the time of repatriation easily prevented future deemed gains from accruing and being taxed. Frequently the result was that most, if not all, gains realised as a UK resident were cancelled out by deemed gains that had accrued whilst a non-UK resident.
This has now been removed and new investors from 21 March 2012 will only be able to offset deemed gains from gains – broadly only if UK tax has previously been paid. This action essentially closes down the opportunity referred to above, however, crucially this does not apply to existing investors provided that on or after 21 March 2012 they do not:
• Add further investments to the policy,
• Assign the policy wholly or in part to a third party (including a trust), or
• Use the policy as security for a debt.
Nonetheless, for existing investors, we must now be mindful that those wishing to contribute further have another factor to consider. Establishing a new arrangement, as opposed to topping up an existing policy, may involve additional fixed costs and prevent previously accrued time apportionment relief from applying to the new money. Since placing a trust around an existing arrangement will constitute an assignment and would already negate any time apportionment relief, perhaps placing extra investments into a new arrangement for future trust planning is a reasonable compromise.
Two further tax planning strategies have also been closed by this change in legislation. Deficiency planning involved a large partial withdrawal being taken whilst non-UK tax resident, often considerably above the available 5% tax deferred withdrawals. This created a chargeable excess, not taxable whilst non-UK resident, but deductable in a final event calculation. If this excess was large enough it would result in a loss that could then be offset against other income subject to UK higher rate income tax. Similarly, if the excess was not large enough to create a loss, it could at least be used to reduce the taxable gain on the bond. Both these strategies are affected in the same way as deemed gains.
The budget also announced a review of time apportionment relief but this seems to imply a widening of provisions, perhaps to incorporate onshore bonds, rather than proposing a reduction in benefit.
Reports that segmentation and assignment have been rendered ineffective are false and stem from the closure of a planning opportunity that involved all gains accruing in one segment. This allowed other segments to be surrendered showing no profit. New arrangements set up after budget day will now be treated as a single policy for the purpose of the chargeable event regime. This measure does not affect standard industry arrangements where individual segments are treated identically.
All of the administration benefits of offshore bonds still exist: open architecture with simplified dealing terms and reduced anti money laundering, transfer and consolidation of existing assets, simplicity of probate requirements and multi currency options – to name just a few; all remain compelling reasons to use this type of vehicle. Equally, there has been no impact on offshore bonds positioned as an investment or administration platform within pension trusts.
In summary, offshore bonds continue to be at the forefront of tax planning solutions for repatriating UK clients as well as for UK resident clients. Offsetting deemed gains made whilst non-UK resident within the final event calculation may now be unavailable for new investors but there remain many other convincing tax and administration reasons to recommend these products, arguably legitimised further by this change in legislation.
