Offshore investment bonds can be a beneficial addition to an expat investment portfolio. If you’re new to this type of product, please visit our earlier guide to Offshore Bonds for further introductory information.
One of the primary benefits, specifically relevant to expats, is that policyholders can use time apportionment relief (TAR) if they are non-UK residents during the term of the bond.
In this article we’ll explain a little more about how this works, how to calculate the tax payable on offshore investment bond returns, and a few caveats to bear in mind.
If you have an offshore investment bond and were resident outside of the UK during the time that your policy was in force, you can reduce the tax liability normally paid against a chargeable gain.
In effect, you calculate the number of days you owned your offshore investment bond as a non-UK resident and reduce your tax obligation by that proportion.
Example of Time Apportionment Relief
Using a theoretical example is the easiest way to demonstrate how this works.
Our investor takes out an offshore investment bond for £150,000. They live overseas for the first three years and then return to the UK before encashing (or surrendering) the bond after a total five-year term.
The bond is now worth £250,000 and no previous withdrawals have been made, so the chargeable gain would normally be £100,000.
However, because the investor was a UK resident for only 40% of those five years, they are only liable for the tax on the same proportion of the gain.
The relevant metrics are:
- Chargeable gain = £100,000
- Number of days as a UK resident = 730 days (two years x 365)
- Number of days bond held for = 1,825 (five years x 365)
- Final chargeable gain = (730/1825) x £100,000 = £40,000
Using this same illustration, if the investor had been non-resident for a larger proportion of the period, the taxable gain would have been reduced more significantly, with the same calculation applied to apportion the income.
Although they must still declare the full gain, the investor can claim TAR through their self-assessment tax return and reduce their tax bill accordingly.
Top-slicing relief is the next consideration, which can further lower the tax payable on the residual taxable profit.
Offshore Investment Bonds and Top-Slicing Relief
Top-slicing relief is available to taxpayers exposed to higher or additional rate tax bands after adding the chargeable gain to their other income – i.e. liable to pay income tax at 40% or 45% based on an annual income of over £50,271 or £150,000.
Policyholders with an offshore investment bond apply top-slicing relief to complete 12-month periods when they were a UK resident. Note that this works the opposite way to time apportionment relief and relies on the period spent in the UK rather than overseas.
Applying TAR necessarily reduces the amount of available top-slicing relief because the years used in this second tax calculation are reduced by the number of full years during the policy when the investor was a non-resident.
Example of Top-Slicing Relief
Top-slicing allows investors to reduce their exposure to higher rate taxes by spreading the gains made on their offshore investment bond over the years they have held it for.
Here’s how it works:
- To calculate the annual equivalent gain, the total return is split between the number of years the bond was held, during which the investor was a UK resident.
- That gain is added to the total income earned by the policyholder in each tax year to decide whether they would be exposed to an additional tax liability.
- The exact tax payable will depend on the investor’s tax bracket and their other earnings – but will often mean avoiding paying a much higher tax liability on the gain than if it were declared as one lump sum return within one tax period.
For this example, we will return to our investor, purchasing an offshore investment bond for £150,000 and achieving a gain of £100,000, reduced to £40,000 after applying time apportionment relief.
Of the total five years the bond was held, the policyholder was a UK resident for two full years. The gain is split between those two years to arrive at £20,000 per annum.
This total is added to the investor’s other income in those respective periods and taxed at the applicable rate.
If they were paying basic rate 20% tax on other earnings, and were not yet a higher rate taxpayer, some of the split gain will be taxed at 20%, and only the balance over and above £50,270 will be taxed at 40%.
The outcome is that investors can significantly reduce their tax liability on a chargeable gain, particularly if the overall return would have tipped them into the additional rate tax bracket.
Strategic Timing for Offshore Investment Bonds
As we have seen, significant tax efficiencies are available by apportioning the amount of the chargeable gain subject to tax and splitting that lower gain between tax periods to take advantage of lower tax brackets.
Another consideration is that you can approach encashment with professional guidance to ensure your apportioned gains coincide with beneficial tax years.
For instance, if there is a tax year where your income was lower, top-slicing could reduce your tax liability further by apportioning a share of the gain into that period where it will fall into a lower tax bracket. Offshore investment bonds that span several years may mean that top-slicing does not result in any higher or additional rate tax liabilities at all.
You can also plan encashment or surrender dates around whole years of residency or non-residency to maximise available benefits. Although time apportionment relief works on the number of days resident in each jurisdiction, top-slicing refers to complete one-year periods.
By bringing forward or deferring encashment to fit into those parameters, it may be possible to optimise your tax efficiency.
For more advice about the tax advantages of offshore investment bonds, claiming top-slicing or time apportionment relief, or incorporating other offshore investment products in your portfolio, please contact Chase Buchanan at your convenience.