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Do you want to gain a loss?

Many IFAs have clients who are expatriates with existing offshore insurance bonds. Most of these clients will eventually return to the UK and, I hope, will look to the IFA for suitable advice on what action to take before returning to these shores. Looking at just the bond alone, what actions should they consider?

Clearly, one choice is to cash in the policy before returning to the UK. In this way the client realises the chargeable event gain while non-resident and not subject to UK income tax (although they should check the tax position in the country of residence). However, what if the client wishes to keep the investment?

It is well known that where a client who has spent time abroad cashes in an offshore policy while UK resident and triggers a chargeable event gain, time apportionment relief is available to lessen the gain.

Thus if a client realises a gain of, say, £40,000 on cashing-in but was non-resident for three-quarters of the lifetime of the policy, only £10,000 will be chargeable to income tax.

Can you help your client to lessen further the tax liability on final cashing-in? Indeed, might it be possible to create a deficiency on final cashing-in, resulting in corresponding deficiency relief under S549 ICTA 1988 for higher rate income tax purposes?

Let us assume the client invested £100,000 in a bond 10 years ago. It is now worth £260,000 and he is intending to return to the UK early in the new tax year. If he surrendered the contract now, before becoming UK-resident, the gain of £160,000 would escape UK income tax.

However, he wishes to cash it in around five or six years after he returns, when he intends to semi-retire and buy a second home in the country. The alternative would therefore be to do nothing and benefit from time apportionment relief.

Let us assume that your client surrenders the contract for £400,000 after it has been in force for 15 years and that he was non-resident for 10 of those years.

The gain assessable to income tax would be £100,000 ((400,000 – 100,000) x 5/15). In practice, the periods of residence and non-residence will be calculated in days but this is not important for this example.

However, let us consider a different strategy. Assume that, before he returns to the UK, your client makes a part withdrawal of £250,000. This will create a chargeable gain of £200,000 (250,000 – 5% x 10 x 100,000). Provided the policy year occurs in a tax year when he is non-resident, however, this will not be taxable.

On becoming resident he then reinvests the £250,000 back into the contract. Obviously there will be some expenses and charges associated with the part withdrawal and reinvestment but, for the sake of simplification, these will be ignored.

We can therefore assume that he is still able to surrender the contract five years later for £400,000. What would be the UK tax position in these circumstances?

To calculate the gain, we have to consider previous “relevant capital payments” as well as previous realised gains. You can find the formula in S541(1)(b) ICTA 1988. Thus the gain will be the surrender value plus any previous relevant capital payments (that is the previous part surrender of £250,000) less the sum of premiums paid (including the reinvested £250,000) and any previous chargeable gains. Using the numbers in the example results in:

Chargeable event gain = (400,000 + 250,000) – (100,000 + 250,000 + 200,000) = -£100,000.

In other words, not a gain at all, but a corresponding deficiency of £100,000, which your client can use to lessen his higher rate income tax liability by up to £40,000.

You will see that with some planning and action before the client returns to the UK, not only can he avoid a large income tax bill but he can also turn it into a potential gift from the inland revenue.

Now that is something you do not see every day. As a result of your advice your client avoids the loss of tax and instead receives the gain of tax relief.

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