Negative headlines have made offshore investing look fraught with difficulties, but overlooking them could be doing clients a disservice
In the lead-up to 30 September you may have read a bit about the “requirement to correct” with regards to the offshore investments of UK residents. You may also have wondered exactly what it was.
The RTC came about as a result of tax transparency delivered by the Common Reporting Standard and beneficial ownership registers. It is a statutory obligation for taxpayers with overseas assets to correct any issues with their UK tax position.
Those who fail to do so face punitive financial penalties and other severe sanctions.
The RTC applies to any person with a potential undeclared UK income tax, capital gains tax and/or inheritance tax liability, whether that be individuals, partnerships, trustees or non-resident landlord companies.
The RTC period started on 6 April 2017 and taxpayers must have taken steps to correct their UK tax position by 30 September this year.
Basically, HM Revenue & Customs wants all taxpayers who have or who have had any offshore financial connections (including those who consider themselves to be non-UK domiciled and/or non-UK resident) to review their UK affairs to ensure their tax returns are correct. On the face of it, not an unreasonable objective.
Additionally, taxpayers should ensure they have submitted tax returns for all years for which they owed tax on income or gains. It is not fundamentally wrong to own offshore assets but you do need to declare any income and gains from them and they are part of your taxable estate for IHT if you are UK-domiciled.
So, a requirement to review offshore structures, anti-avoidance legislation and remittances.
After the 30 September deadline, the “failure to correct” regime started, with tough penalties, including:
- A tax-geared penalty of between 100 per cent and 200 per cent of the tax not corrected;
- A potential asset-based penalty of up to 10 per cent of the value of the relevant asset where the tax at stake is more than £25,000 in any tax year;
- Potential naming and shaming where more than £25,000 of tax per investigation is involved;
A potential additional penalty of 50 per cent of the amount of the standard penalty, if HMRC can show that assets or funds had been moved in an attempt to avoid the RTC.
No penalty will be chargeable where the taxpayer has a reasonable excuse for failing to correct the position.
From some of the headlines reminding of the 30 September RTC deadline, you would have been forgiven for thinking anything remotely linked to offshore investment is fraught with problems and has high potential for HMRC intervention. But you would be mistaken.
Of course, not disclosing and paying the right amount of tax on any non-exempt income or capital gain, whatever its source, is not to be recommended. And yes, it may well have been the case – based on the “out of sight, out of mind” principle – that a reasonable amount of the non-disclosure of income has been related to offshore investments and deposits.
In certain cases, I dare say some investors would have “innocently” non-disclosed based on the misunderstanding you only pay tax on income that either physically arises in the UK or is physically received in the UK.
That, apparently, has extended to interest from offshore bank accounts and even declared, but automatically reinvested, income from offshore reporting (in the past, “distributor”) funds.
Of course, neither misconception is correct and the RTC was aimed at ensuring such misunderstandings are corrected and the right declarations of income are made going forward.
What is allowed?
So, given the steady stream of anti-offshore narrative, just what is the position in relation to such investments made by UK investors? Are they permissible and are they worthwhile?
First, permissibility. Subject to satisfying the national identity/sourcing funds checks, there is nothing to stop you having an offshore bank account, offshore fund or offshore investment bond.
There are, of course, many other types of offshore investment that can be made but let us concentrate for now on cash deposits, funds and investment bonds invested in by UK-resident and domiciled individuals.
It goes without saying that interest from offshore bank accounts will be paid in most cases without deduction of tax at source but must be fully declared for UK tax purposes, regardless of whether the interest is withdrawn or spent here in the UK.
The suitability of an offshore deposit will be determined in most cases by practical expediency (e.g. if you have a property abroad or are a frequent visitor) and economic attraction (e.g. the interest rate). Security and confidence will also be relevant.
Cashflow advantage through legitimate gross payments is now, of course, matched by most ordinary UK deposits.
Income from an offshore reporting fund is taxable on a UK-resident and domiciled taxpayer regardless of whether it is paid out to the investor or automatically reinvested. For dividends or interest distributions, a UK tax liability may therefore arise if the income exceeds the available dividend allowance in the year or the zero starting rate band/personal savings allowance respectively.
Given the CGT position for these funds is the same as for a UK fund, there is no obvious personal tax motivation for having an offshore reporting fund as opposed to a UK fund. Non-reporting (roll-up) funds offer the opportunity for complete tax deferment during the investment period with realised gains (calculated on a CGT basis but with no annual exemption) being subject to income tax.
Top-slicing relief does not apply and the gains are subject to income tax on death rather than being “wiped out”.
Offshore investment bonds also offer legitimate tax deferment as well as the use of top-slicing relief in determining whether and, if so, how much higher/additional rate tax is payable on any realised chargeable event gain (see image).
This relief results in the division of the chargeable event gain by the number of complete policy years the policy being fully encashed has been in force, or normally since the last chargeable event under the policy in the event of a partial encashment.
The result of this division is then used to determine whether, when added to other taxable income in the year, the threshold above which higher rate and/or additional rate tax is payable is exceeded.
To the extent it is, this will mean a liability to higher and/or additional rate tax will arise. In any event, and regardless of the outcome of top-slicing relief, basic rate tax will be payable to the extent the full chargeable event gain exceeds the available personal allowance, zero-starting rate band and personal savings allowance.
It is worth reiterating that realised chargeable event gains made from offshore investment bonds are classed as savings income for tax purposes, so both offshore non-reporting funds and offshore bonds give legitimate, permissible opportunities for tax deferment, leading to possible outright tax saving in the future, without any requirement to disclose until a chargeable event gain arises on full or partial encashment.
Thanks to the adverse publicity generated by aggressive tax avoidance arrangements incorporating some offshore element, it has become increasingly necessary to reassure clients the deferment and capability to exit plan offered by offshore investment bonds is completely legitimate.
The same is true of planning with UK investment bonds. When it comes to the onshore versus offshore choice for investment bonds, it is worth remembering the UK life fund delivers tax freedom on UK dividends received at fund level and, usually, a lower rate of tax reserved for in relation to fund capital gains. Sadly, the indexation allowance is no longer available in respect of gains accruing on or after 1 January 2018. That said, the basic rate tax credit is a long-standing and valuable benefit.
Yes, the Office of Tax Simplification has looked at whether the rules in relation to part-encashments under investment bonds can be simplified but, at the moment, there is no hard proposal to change them, leaving deferment and exit planning completely legitimate.
It is essential to keep clients’ plans under review to adjust as and when necessary, depending on changes to circumstances and objectives, and tax and legal rules. And therein lies the true value of adviser engagement.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn