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Gainful employment

Last week, I rounded off the calculation process for gains made under offshore funds and great it was, too. But, re-reading my explanation, it occurred to me that there is a simple alternative that will lead you to determining the gain made under an offshore roll-up fund.

This comparatively simple rule-of-thumb method is to multiply the number of shares sold by the acquisition cost. Then multiply that same number of shares by the proceeds raised on sale. The difference is the gain taxable as income.

For example, say 20,000 shares of £1 each are issued and compound growth is 7 per cent a year. At the end of year one, each share is worth £1.07 (£21,400 divided by 20,000). To provide encashment proceeds of £1,000, 935 shares will need to be sold (£1,000 divided by £1.07). The tax position on the 935 shares that are sold is: 935 @ £1.07 = £1,000.45 less 935 @ £1 = £935. So, the offshore income gain = £65.45.

At the end of year two, 19,065 shares are left. Each of these shares is worth £1.145 (£21,828 divided by 19,065). To provide encashment proceeds of £1,000, 873 shares will need to be sold (£1,000 divided by £1.145). The tax position on the 873 shares that are sold is: 873 @ £1.145 = £999.59 less 873 @ £1.00 = £873. The offshore income gain = £126.59.

So, an investor can make substantial regular encashments (possibly to supplement income) with only a small percentage of the total proceeds being brought into charge to income tax. As more encashments are taken, this amount will increase as the acquisition value matched to the encashments reduces. This is demonstrated by the table (below).

There may, of course, be a substantial gain when the investor finally realises his investment due to the falling acquisition cost. It may be possible to mitigate any potential tax liability by judicious transfer of the remainder of the investment to a lower or non-taxpaying spouse.

To determine the tax suitability of an offshore fund, it is worth comparing this outcome with that emerging if a client invested in an offshore bond and took either a series of withdrawals (part-encashments across the whole investment) or whole-policy (segment) surrenders. By comparing the position of the two investment types on final encashment, one should have a reasonable basis on which to make a decision, on tax grounds at least.

I would like to consider the position if a gift of an offshore roll-up fund is made. Ignoring gifts to a spouse, any gift of shares will be a disposal and trigger an offshore income gain based on the value of the shares at the date of gift less the acquisition value. No indexation, taper relief or annual exemption will be available. This must be compared with the assignment of an investment bond, which is not a chargeable event if it is not for consideration in money or money&#39s worth.

For an offshore roll-up fund, on a disposal or conversion of shares, both an income tax and CGT calculation must be carried out. The tax calculations are made as follows:

•Any offshore income gain is calculated using general CGT principles but without the benefit of indexation or taper relief. The income gain is then subject to income tax. A loss is treated as a nil income gain. Disposal on death also requires an income gain calculation.

•The disposal or conversion of shares is also a disposal for CGT purposes. The gain is calculated on CGT principles. However, indexation and taper relief are available where appropriate. Indexation relief cannot create or enhance a CGT loss. The disposal proceeds are reduced by the amount of any income gain to prevent double taxation, so it is most likely that a CGT charge will not arise. This means the disposal of shares will not use up an investor&#39s annual exemption.

So, this really does bring us to the end of our journey of discovery. Hopefully, you have discovered one or two things that will be of use in making investment recommendations to clients. While tax is not the be all and end all of determining the suitability of a product, it does deserve a little more airtime than it gets.

Even if an offshore rollup fund is not chosen, this decision should be based on a full understanding of how the product works and is taxed so that justifiable reasons why not can be given.

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