Graeme Robb, Senior Technical Manager at Prudential, explores the current state of the nation for offshore issues and highlights areas which may be particularly relevant to advisers.
In the context of insurance companies, 'offshore' can be a relatively straightforward matter.
Like their onshore equivalent, offshore bonds are 'non-qualifying' for tax purposes, meaning that all gains are potentially taxable. Indeed, the same UK tax legislation determines the tax treatment of these respective policies. Top slicing relief is available both onshore and offshore. There are also similarities when it comes to reporting as in most circumstances, information about chargeable events must be provided to policyholders and Her Majesty Revenue & Customs (HMRC) in a broadly similar fashion for both onshore and offshore.
Differences of course arise with respect to fund taxation. Individuals liable for tax on a gain on a UK bond are treated as having paid tax on the gain at basic rate, as the underlying fund is taxed. In contrast, offshore bonds can be issued by life companies based in jurisdictions which impose no tax on the income and gains of the underlying funds – this is known as 'gross roll-up' (subject to any irrecoverable withholding tax).
The nature of offshore life insurance and capital redemption policies is such that they may be suitable vehicles for personal investment (including non UK domiciles), trustees, corporates and those engaged in Inheritance Tax (IHT) and/or school or university fees planning.
With this in mind, it is interesting to consider the HMRC 'latest' news section on its website where there are a considerable number of documents dealing with offshore matters. Some of these relate to consultation exercises now, finally, coming to a head. These documents reflect the potential complexities which can arise with certain 'offshore' activities.
This article explores the current state of the nation for offshore issues and highlights areas which may be particularly relevant to advisers.
Changing the deemed domicile rule – income tax, IHT and CGT
In the Summer Budget 2015, the Government announced that it would change the tax regime for individuals who have a foreign domicile ('non-doms'). A consultation exercise on this matter closed towards the end of 2016.
Draft provisions for Finance Bill 2017 deem certain individuals to be domiciled here for the purposes of income tax, IHT and CGT where they meet one of two conditions:
- where an individual was born in the UK with a UK domicile of origin and whilst they are UK resident or return to the UK having obtained a domicile of choice elsewhere
- where an individual who has been resident in the UK for at least 15 out of the previous 20 years
Anyone deemed UK domiciled by virtue of either condition cannot then access the 'remittance basis' and will be taxed on any arising worldwide income and gains in the same way as UK domiciles. Certain transitional protections (outwith the scope of this article) will be given where an individual becomes deemed UK domicile under the 15 out of 20 rule in April 2017.
The changes will take effect from the start of the 2017/18 tax year on 6 April 2017.
In broad terms therefore the tax treatment of most long-term UK resident non-domiciles is being brought in line with UK domiciled residents.
For IHT purposes the new regime shortens the current rules, which provide that a UK resident non-domicile will become deemed domiciled if they had been resident for 17 out of the previous 20 tax years. Those who go abroad and stay abroad will lose deemed domicile status for the purposes of IHT at the start of the fourth tax year of non-residence.
Remember also the new separate rule which provides that an individual born in the UK with a UK domicile of origin who has acquired a domicile of choice elsewhere will be treated as domiciled for IHT purposes if at any time they are resident in the UK and have been resident in the UK in at least one out of the two previous tax years.
For those non-domiciles conscious of becoming deemed domiciled, then consideration may be given to establishing an excluded property trust now – perhaps with an offshore bond or UK Open Ended Investment Company's (Oeics). Be aware, however, that where an individual who was born in the UK and who had a UK domicile of origin creates a trust whilst non domiciled, that trust will be subject to IHT, whilst they are UK resident, in the same way as a trust which had been created by somebody who was domiciled in the UK.
Personal Portfolio Bonds (PPBs) – updating acceptable property categories
The PPB legislation is a UK anti-avoidance measure which imposes a yearly charge to tax on life insurance and capital redemption policies and life annuity contracts in some circumstances, where the property that determines the benefits is able to be selected by the policyholder. These rules prevent an individual from placing their personal assets within a life insurance policy in order to defer any tax charges on the income or gains arising from those assets until they take cash from the policy.
Broadly, however, where the terms of the policy or contract restrict the selection of property to certain categories, the policy will not be a PPB (includes, for example, insurance company internal linked funds and shares in an OEIC). These categories are enshrined in legislation and have been in place since 1998.
In the Budget 2016, the government announced its intention to review these acceptable property categories and a consultation exercise was subsequently launched.
After Finance Bill 2017 receives Royal Assent, the government will have the power to update (i.e. add or reduce) the acceptable 'list' by regulations. This will enable a more frequent updating of the list as new asset types are developed.
This new flexibility seems sensible.
Draft regulations have already been published to add UK real estate investment trusts, overseas equivalents of investment trust companies and authorised contractual schemes.
Insurance bonds – large part surrenders and part assignments
In 2004, Joost Lobler, came to the UK. He sold the family home in Holland and invested the proceeds in a US Dollar denominated offshore bond. He later borrowed $700,000 from a bank and incremented his bond. By March 2006 his bond was valued at $1,406,000.
In 2007 and 2008 he withdrew 97.5% of the amount originally invested to repay his bank borrowings and partly pay for a recently purchased family home. Although his original investment was “advised”, Mr Lobler didn't seek advice in respect of these partial surrenders – he didn't think he needed to. The tax consequences were disastrous. The part surrenders triggered income tax chargeable events. In both 2007 and 2008 the 5% tax deferred withdrawal limit was very significantly exceeded. Each year's taxable gain was the amount received less 5% of the premium originally paid. Mr Lobler had made no substantial profit from the investment but had managed to generate taxable income of some $1.3m with a consequent $560,000 tax liability. He was facing bankruptcy. On appeal to the Upper Tribunal, his lawyer had to accept that the chargeable event analysis advanced by HMRC was correct. However, he advanced an argument based on contract law arguing that Mr Lobler had made a 'mistake' which negated the 'consent' and rescinded the contract. The judge stated that nobody would willingly contract to pay an amount of tax that would effectively lead to bankruptcy if there were a choice not to do so. The judge held therefore that Mr Lobler's tax position was to be determined as if the part surrenders had not taken place.
With the above in mind, the government launched a consultation exercise on possible options for change to assist those policyholders who inadvertently generated disproportionate gains when making a part surrender or part assignment (onshore or offshore bond).
The conclusion was that from 6 April 2017, policyholders who have generated a wholly disproportionate gain can apply to HMRC to have the gain recalculated on a just and reasonable basis. Applications must be made in writing and received by HMRC within 2 years after the end of the insurance year in which the gain arose. A longer period may be allowed if the officer agrees. HMRC will then notify the applicant of the result of the recalculation of the gain.
Detailed guidance will be published in due course.
Mr Lobler wasn't the first and won't be the last to fall into the trap of taking a significant part surrender in excess of 5% allowances and inadvertently triggering a considerable chargeable event gain. This issue is covered in the 'Taxation of UK Investment Bonds Planning' article in the Technical Centre section of www.PruAdviser.co.uk. Note particularly the potential remedy of a full surrender in the same tax year as the part surrender gain. The best course of action is to avoid this pitfall altogether as it may be that HMRC will be reluctant to recalculate gains where advice was given by an adviser on the withdrawal method (Mr Lobler's part surrenders were not advised).
Insurance companies can try their best to identify and prevent significant part surrender gains arising in error but this isn't fool proof – especially for offshore insurers. Accordingly, where a significant withdrawal is contemplated then the consequences of full surrender of individual segments versus a part withdrawal across all segments should be compared.
It is worthy of note that the government advise that these forthcoming measures are “expected to affect fewer than 10 individual policyholders per year”. This seems unduly low.
Client notification letter – income or assets overseas
Changes were made on 30 September 2016 to the International Tax Compliance Regulations 2015 (SI 2015/878) that created an obligation on certain types of business to tell their clients:
- That HMRC will soon be getting data on overseas financial accounts
- That there are opportunities to come forward about your overseas tax affairs, if you need to
- About what could happen to those who don't come forward
In many cases, financial institutions and advisers know more than HMRC about clients overseas financial affairs (for example, offshore bond ownership). According to HMRC, those industries should be making their clients aware of their obligations in respect of reporting UK taxable income. In many cases this is already happening, but the Regulations ensure that it happens in a consistent way across the board.
The obligation targets businesses who give advice or services in respect of financial accounts (including insurance bonds) outside the UK or sources of taxable income outside the UK, or who have referred a client to a connected person outside the UK for advice or services. It is not entirely clear whether all businesses which provide advice on financial accounts are 'caught' or only those which provide tax advice.
The notification must be issued by 31 August 2017.
Failure to identify and notify the relevant account holders or clients can result in a flat rate penalty of £3,000.
These provisions are detailed in the Client Notification Letter' article in the Technical Centre section of www.PruAdviser.co.uk
UK non-domiciles & UK residential property – IHT implications
Currently, an individual who is not domiciled in the UK is not liable to IHT on any of their property which is situated outside the UK (excluded property). The IHT legislation provides the same treatment where property is held in a trust created by a settlor who is domiciled outside the UK (an 'excluded property' trust). A UK residential property which is held by such an individual through an overseas company, trust or similar structure, would be treated as situated outside the UK and therefore outside the scope of IHT.
Legislation will be introduced in Finance Act 2017 to amend IHT legislation. This will extend the scope of IHT to residential properties situated in the UK which are held by non-domiciled individuals through an overseas company, trust or partnership. This will be the case whether or not the individual is resident in the UK.
This extension was originally announced at Budget 2015 and a consultation exercise was undertaken thereafter. The measure will apply to all chargeable transfers which take place on and after 6 April 2017.
The government considers this is all about fairness and ensures that residential properties in the UK are subject to IHT where they are held by non-domiciled persons through overseas structures.
Offshore tax evasion – Requirement to Correct (RTC)
This dates back to Autumn Statement 2015, then confirmed at Budget 2016. Draft legislation was subsequently published on 5 December 2016.
Taxpayers who have previously undeclared UK tax liabilities in respect of offshore interests will be required to correct that position by disclosing the relevant information to HMRC. If this is not done by 30 September 2018 then new tougher sanctions for Failure to Correct (FTC) will apply.
The tax liabilities may be income tax, IHT or CGT.
Various new sanctions apply post 30 September 2018, and notably include a tax geared penalty of between 100% and 200% of the tax not corrected – penalties will be reduced within this range to reflect the taxpayer's co-operation with HMRC.
Clients with overseas interests should review their affairs to either:
- satisfy themselves they are compliant
2. correct the non-compliance by disclosing the relevant information to HMRC
Enablers of offshore tax evasion – civil penalties
This measure was announced at Budget 2015 and a consultation exercise was then undertaken.
It concerns the introduction of new civil penalties and naming provisions for those who have deliberately assisted taxpayers to hide assets, taxable income and gains outside of the UK to evade UK tax. Penalties are applicable to income tax, IHT and CGT and only apply where:
- the enabler's behaviour was deliberate; and
- the evader has received a penalty relating to offshore tax non-compliance, either through deliberate behaviour or because they failed to take reasonable care.
The penalty for the enabler can be up to 100% of the tax evaded.
Naming will be reserved for the most serious enablers.
From 1 January 2017, these penalties are now in force.
Beware those who have deliberately assisted taxpayers, hide assets, income and gains overseas to evade UK tax responsibilities.
Offshore tax evasion – notifying HMRC of offshore structures
On 5 December 2016, HMRC published a consultation document regarding the above.
The consultation aims to establish a high level legal framework for advisers, agents or businesses that create or promote certain complex offshore financial arrangements to notify HMRC of their creation, and provide a list of clients using them. Clients will be expected to notify HMRC of their involvement via a notification number on their self-assessment tax return / personal tax account. The aim is to target arrangements which could easily be used for tax evasion purposes (i.e. non legitimate).
Failure to comply with these requirements will incur civil sanctions. HMRC envisage this will apply to creators both within and outside the UK.
Closing date for comments is 27 February 2017. Should the decision be taken to proceed, a further consultation will take place on the details.
In relation to UK tax avoidance we have two regimes which require certain persons to notify the existence of the arrangements and those who implement them. The Disclosure of Tax Avoidance Schemes (DOTAS) regulations are currently in force, and in Finance Bill 2017, the government is introducing a new VAT Disclosure Regime. This initiative therefore concerns the development of a similar regime to provide information about certain offshore arrangements.