Last week, I promised an example to demonstrate how a gain under an offshore roll-up fund is calculated when a part-encashment is made. The basis of this process is to apply the following formula:
A x C
A + B
Say an investment of £50,000 is made into a fund. After six years it is worth £80,000 and an encashment of £5,000 is made. The gain will be as follows:
Proceeds of part encashment = £5,000
Less allowable deduction calculated by reference to the part-disposal formula
A x C
A + B
where A = £5,000 (proceeds of part-encashment), B = £75,000 (value of investment after encashment) and C = £50,000 (original value of investment).£5,000 x £50,000 (£5,000 + £75,000)= £3,125
Gain subject to tax = £1,875.
It should be noted that no indexation allowance pre-April 6, 1998 or taper relief is available.
This gain will be subject to income tax in the tax year of encashment by addition to the taxpayer’s other taxable income for that year. If the investor is a higher-rate taxpayer, then a tax liability of 40 per cent of £1,875 (£750) will be due. This equates to 15 per cent of the proceeds of the part-encashment in this example.
For part-encashments in subsequent years, the calculation process is the same except that C (the value of the original investment) is reduced by any amounts of capital deducted in past part-disposal calculations. Such a deduction from the original investment would also be necessary in calculating the gain on final encashment.
Thus, if in the next year the investor took a further part-encashment of £5,000, the amount used as C in the calculation would reduce from £50,000 to £46,875 (£50,000 – £3,125). This would also be the amount used if the second disposal were a final encashment.
The following example illustrates how the final encashment gain would be calculated. Assumptions:
– £200,000 invested.
– Growth at 6 per cent a year after all charges.
– 6 per cent a year taken as a part-encashment for nine years.
– £212,000 investment value at the end of 10 years, all growth having been stripped out in each of the previous nine years but not wholly taxed due to the part-encashment rules treating a large part of each amount taken as a return of capital.
– Original £200,000 reduced by £81,616 of deductible capital deemed to have been included in the part-encashments made in each of the previous nine years = £118,384.
This means the offshore income gain would be £93,616 (£212,000 less £118,384). This would be added to taxable income in the tax year of final encashment and assessed to tax accordingly.
Death is an occasion of charge in respect of roll-up funds. Any liability arising, calculated by reference to the market value of the investment at the date of the investor’s death, will be taxed on the deceased taking account of his other taxable income to the date of death. Any liability arising will be met by the personal representatives as a debt of the deceased’s estate.
Are there any tax implications when a gift of a roll-up fund is made, say, in inheritance tax planning? Apart from any IHT liability, it is necessary to consider the income tax implications.
Whether a gain arises depends substantially on the relationship of the donee to the donor. Where the gift is to other than the donor’s spouse, the disposal is deemed to have taken place at full market value and the gain is calculated as described above.
On the other hand, if the donee is the donor’s spouse and the spouses are living together, the disposal will not give rise to an offshore income gain. The donee spouse will be deemed to acquire the roll-up fund at the donor’s acquisition cost. Any gain is, in effect, held over to the donee.
On subsequent disposal by the donee spouse (otherwise than on a disposal back to the donee’s spouse) any gain will be calculated by reference to the difference between the disposal proceeds and the value of the investment when the donor acquired it and not when the donee acquired it.
So who is chargeable? Capital gains tax rules are applied in determining who is chargeable to tax under the offshore funds legislation. This means that:
– Tax is charged on an investor who realises offshore income gains in a tax year during any part of which he is resident or ordinarily resident in the UK (section 2(1) TCGA 1992 as applied by section 761(2) ICTA 1988).
– Tax is chargeable on a trader or trading company not resident or ordinarily resident in the UK but carrying on a trade in the UK through a branch or agency, if the interest disposed of is an asset of the trade or an asset acquired for use by the branch or agency.
– Charities are exempt from tax on offshore income gains (section 761(6) ICTA 1988).
– Trustees will only be chargeable if the settlor was resident, ordinarily resident or domiciled in the UK when the trust was made and if one of the trustees is UK resident.
Where a disposal takes place on death, tax due under the offshore funds legislation is an allowable deduction for inheritance tax (section 174(1)(a) IHTA 1984).
As is the case for UK resident domiciliaries, for non-UK-domiciled investors, the capital gains tax rules apply in ascertaining who may be charged to tax on offshore income gains.