There was certainly an overarching message in this year’s Budget to those of us working in the offshore tax environment. It appears the distinction between tax avoidance and tax evasion may have been blurred again. The Chancellor said he regarded tax evasion as “morally repugnant”, and the big question most of us are asking ourselves now is: what exactly does he regard as “aggressive” tax planning?
One way to answer this is to look at the recent Budget itself. Focusing on the life insurance sector, we saw three significant changes announced.
Golden policy
‘Golden policy’ schemes have been offered by a few overseas life insurance providers. These allowed policyholders to access their initial capital at any time without incurring a tax charge. To understand what has changed, we first need to understand the relationship between the bond and the underlying policies.
Rather than issue one single policy, insurance companies operating in the UK have long since adopted a technique of issuing multiple policies to their clients, thus spreading the premium so any policy gains are apportioned across a series of
individual policies.
In the past, each of these policies was issued by the life office using a separate policy schedule, so the policyholder would receive a batch of policies at inception.
Over time, and in a bid to save the rainforests and expensive postage costs, a practice emerged in the industry so that each separate policy would often be shown all on one single policy schedule, which we now refer to as a ‘bond’.
Each policy (or segment) held within the bond is still a policy in its own right, with the right to surrender, assign and so on. When considering tax, the bond wrapper should therefore be viewed as just an administrational device and not a taxable vehicle as such. Instead, the bond wrapper should be broken down and considered as what it really is: a series of individual policies.
The 5% rule
When considering taking withdrawals, the UK chargeable event legislation provides an annual tax deferred entitlement. A policyholder can take 5% of their initial capital from each policy every year with no immediate tax charge. If this is not taken in one year it can be rolled over into another year; this is commonly referred to in the life insurance industry as the ‘5% rule’.
This rule is a very useful tax planning tool to defer gains, but of course it is of no use if the client wants to take large withdrawals perhaps early in the life of the policy, when little entitlement has been built up. Here all the excess taken over the 5% entitlement would be treated as chargeable gain and would be liable to tax. The policyholder would often be better surrendering policies within the bond in order to raise the funds.
The golden policy schemes pushed the boundaries somewhat by structuring the overall bond gains to roll over onto one policy only within the cluster bond, while ens¬uring losses were spread across all policies within the bond.
The policies in the bond were therefore linked by this ‘value shifting’ mechanism and, as a result, the policies had to be surrendered in order with the golden policy surrendered last. This structuring then allowed clients to take their initial capital back at any time without incurring a tax charge, in some ways removing the need for the 5% rule.
Various questions
There was perhaps always a question as to whether HM Revenue and Customs (HMRC) would seek to challenge such cluster bond structures at some point on the basis they were not really a series of separate and individual policies. With these structures, the policies are clearly linked by the value shifting mechanism and each policy could not really stand on its own two feet, at least from a commercial perspective.
After all, who would buy the policies that had no gains attached to them but suffered any investment loss? In reality, only the golden policy would ever be capable of being sold.
In a standard bond, the policies are only linked in so much as the charges and investment links are usually spread and apportioned across all policies within the bond evenly.
However, each policy can legally stand alone and as a result, policies are occasionally assigned for consideration (bought for value by another person), which is perhaps the proof of this.
The recent changes in the Budget have made sure that any bonds structured to shift gains to one policy are caught as one policy if issued on or after 21 March, 2012.
Furthermore, any existing golden policy scheme will also be caught retrospectively under the new rules and treated as one policy if they are:
- assigned for consideration (monies worth) or by way of gift;
- topped up;
- assigned to cover a debt obligation.
There was some concern that the drafting of the new rules could impact on standard onshore and offshore bond arrangements. However, HMRC has commented that this is not the intention of these rules and that they were designed to target golden policy schemes only. The Budget commentary also made this point clear and it is expected that HMRC will issue guidance to cover this point at some stage.
By issuing the new rules, HMRC has effectively stopped the use of these structures from 21 March and has made sure that any benefits on existing contracts cannot be increased.
Personal portfolio
A similar loophole could also be used with personal portfolio bond (PPB) events, where any overseas contract that held ‘offensive’ assets would be considered as still creating an annual PPB event, even though UK tax was not actually paid on the PPB events when the client was resident overseas. These PPB events could then be used to create an artificial loss when the client returned to the UK.
The new legislation closes this loophole as well because the overseas PPB event is not subject to UK tax and thus it cannot be offset.
This may seem like a fair amendment to the rules if the overseas jurisdiction did not tax the gain, which would always be the case with a PPB event.
However, if part of a partial withdrawal was taxed, which it would be in several European countries, then there is now an element of double taxation because of these new rules.
If there was a suitable double taxation agreement in place then this could be used, but if one did not exist, the policyholder would be stuck with the double tax charge.
In the example above, time apportionment relief (TAR) may be used to reduce the gain for the time spent overseas.
TAR works on a proportional day count basis and reduces the final gain for the time spent overseas. For example, if the policyholder has spent half the policy term overseas then the gains are reduced by half.
However, the Govern¬ment has announced TAR is to be reviewed, although at the moment it is not clear how they may wish to change this.
Clearly, with these new rules in place, any withdrawals taken overseas by clients looking to return to the UK will need to be carefully managed to ensure that there is no element of double taxation on return to the UK.
Qualifying rules
The Budget also announced changes to qualifying policies and measures will be put in place from 6 April, 2013 to limit the premiums that can be paid into policies to a maximum of £3,600 a year. Perhaps these changes were introduced in an attempt to stop people who had exceeded their pension allowance using such policies to still claim tax-free benefits? The new rules will restrict the use of qualifying policies such as maximum investment plans.
The fact that specific schemes have been targeted and others have not is a good test as to what is considered as ‘aggressive’. HMRC has provided guidance for schemes such as discounted gift schemes and loan trusts and we have seen no reviews of these schemes in the Budget, which is perhaps an indication that they are not viewed as aggressive.
It would seem that any new scheme that seeks to push the boundaries of the rules to create a significant tax reduction will probably be targeted and shut down. The lesson is to stick with the tried and tested.
