Offshore Portfolio Bonds

The owner of the bond at the time of a taxable event (known as chargeable events) will usually be subject to income tax on any profits the bond investment has made.

Most investment bonds (excluding capital redemption bonds) are written on a life assurance basis. This means a small amount of life cover will be paid on the death of the life or lives assured, in addition to the investment value. The lives assured are not liable for tax on any bond gains unless they're also the owners.

Bond gains are not normally subject to CGT, but can have an impact on the rate of CGT applicable on the disposal of other assets. The rate of capital gains tax is based on the amount of an individual's taxable income, therefore chargeable gains from bonds can result in higher CGT for capital disposals in that tax year.

The main chargeable events (taxable to income tax) that can result in a tax liability are:

• taking more than the 5% tax deferred allowance (also known as an 'excess event')

• fully cashing in segments or the whole bond (full surrender)

• death of the last life assured

• maturity of a capital redemption bond

• assignment for consideration (money or money's worth)

The calculation of the taxable amount (also known as the 'chargeable gain') will depend on the event that triggers it.

Up to 5% of the amount invested can be withdrawn each policy year without creating a chargeable event. This tax deferred allowance runs from the start date of the bond.

If the tax-deferred allowance is not fully withdrawn in the policy year, any unused amount can be carried forward for future use.

If more than this cumulative tax-deferred amount is withdrawn, the excess is taxable as a gain, regardless of any actual growth or loss within the bond's investments. Any taxable amounts are assessed in the tax year that the 'policy year' ends. This may be a different tax year from the one where the withdrawal took place.

Once the cumulative total of tax deferred withdrawals (i.e. those within the 5% allowance) is greater than the amount invested, all future withdrawals will be fully taxable. For someone, who has been taking 5% withdrawals from the outset this will mean withdrawals taken after 20 years will result in a chargeable gain.

If the bond is incremented the added funds will have their own 5% allowance in addition to the allowance available to the original funds. This additional allowance will run from the policy year (based on the original investment) which the increment was made.

Example:

1. £500,000 is invested in a life assurance bond on 1 September 2020.

2. £80,000 was taken out the bond, when the bond was worth £490,000, in September 2023 as a part surrender.

3. The taxable amount was calculated on 31 August 2023 (the end of the 2022/23 policy year). Each year 5% could have taken of the total £500,000 investment. So an accumulated amount of £75,000 was available.

4. An excess gain of £5,000 was assessed in the 2023/24 tax year. This is despite the bond, being worth less than the initial investment.

When a bond (or individual segments) is fully surrendered, any profit the investment has made (known as the 'chargeable gain') will be assessed to income tax. The calculation of the gain will sweep up any additional amounts invested, plus any amounts previously withdrawn across the plan (including a deduction for any previous gains).

The tax charge will be assessed in the tax year of surrender.

Example:

• £1,000,000 was invested in an investment bond on 1 June 2017, by Mariam.

• In July 2019, a part surrender across the plan of £200,000 was taken. There have been no other withdrawals. This resulted in a gain of £100,000 (£200,000 - £1,000,000*5%*2)

• In June 2023, the whole policy was surrendered for £950,000.

• The chargeable gain = proceeds + withdrawals - amount(s) invested - previous gains

  = £950,000 + £200,000 - £1,000,000 - £100,000

  = £50,000 taxable amount in the 2023/24 tax year.

The chargeable gain is calculated in the same way as a full surrender, with the proceeds being the surrender value at the date of death, not the death benefit that's actually paid. This is assessed in the tax year of the death of the last life assured.

If the bondholder dies, but there are still surviving lives assured on the bond, this is not a chargeable event, and the bond can continue. When the last life assured dies, the bond must come to an end, and any gains on the bond will be taxed at that point. This is often why other people are added as 'lives assured', so that the investor's heirs will have the choice of whether to cash in the bond on the investor's death or to continue to hold it.

There is no chargeable event on death for capital redemption bonds as there are no lives assured. If the bond owner dies, the bond continues, ownership passes to any surviving joint owner or the deceased's personal representatives (PRs). If the PRs take ownership they can choose to surrender or assign ownership to a beneficiary of the estate.

A capital redemption bond has a guaranteed maturity value when the bonds ends, typically after a fixed term of 99 years. The chargeable gain is calculated in the same way as a full surrender with the proceeds being the higher of the bond cash-in value at the maturity date or the guaranteed maturity value.

The most common example of assignment is a gift either between individuals, or from trustees to an adult beneficiary. For example, an assignment from a SIPP or QROPS trustee into the name of the beneficiary. This type of assignment is not a chargeable event. Generally, for income tax purposes, the new owner will be treated as if they have always owned the bond, so they will keep the accumulated 5% tax deferral allowance.

Assignments for money are less common. These are chargeable events and there are specific rules around how the assignment is taxed.

If someone creates a chargeable gain while they're not resident in the UK, there is generally no tax charge in the UK. The bondholder will need to seek advice to determine what tax may apply in their country of residence.

There may be tax to pay on their return to the UK if someone becomes non-resident for a short period and creates a chargeable gain while non-UK resident.

The temporary non-residence rules will tax the gain in the tax year of return where;

• the bond was taken out before the period of non-residence,

• the bondholder was resident in the UK for a period of at least four of the last seven tax years, and

• becomes UK resident again within five years of leaving.

Time apportionment relief will be available for the period of non-UK residence.

Investment bonds are subject to income tax on any chargeable gains.

For onshore bonds, they pay corporation tax on income and gains within the fund. Therefore, they are taxed as the top part of income, so after dividend income. They benefit from a non-reclaimable 20% tax credit, reflecting the fact that the life company will have paid corporation tax on the funds.

This tax credit will satisfy the liability for non and basic rate taxpayers. Further tax is only payable if the gain when added to all other income in the tax year falls in the higher rate band and above.

Offshore bonds enjoy gross roll up with no tax payable on income and gains within the funds.

Offshore bond gains are aggregated with all other savings income and taxed after earned income but before dividends. As there's no UK tax on income and gains within the bond, there's no credit available to the bond holder. Gains are taxed 20%, 40% or 45%. Gains will be tax free if they're covered by an available allowance:

• personal allowance (2023/24 - £12,570)

• starting rate for savings (£5,000)

• personal savings allowance (£1,000 for basic rate tax payers or £500 for higher rate tax payers)

The 'personal savings allowance' is available for savings income including bond gains.

Individuals do not pay tax on their bond gains until a chargeable event occurs. The 5% tax 'deferral' is one of the popular features of bonds.

However, when a chargeable event does occur, a gain will be taxed in the tax year of that event. This can lead to a larger proportion of tax being paid at higher rates than would have been paid if gains had been assessed on an annual basis.

Top slicing relief is a remedy for this. It only applies when the full gain takes an individual into the higher rate or additional rate bracket. There is no top slicing relief given to keep a gain within the personal allowance. The relief is an amount deducted from the final tax liability and is based on the difference between the tax on the full gain and the 'average' gain (or 'sliced' gain).

Changes were included in the Budget 2020 which affected the availability of the personal allowance in the top slicing relief calculation. HMRC have agreed by that these changes will apply to all gains from 2018/19 onwards.

For gains which arose before 6 April 2018, HMRC's guidance is that the availability of the personal allowance will be based on adding the full bond gain to income in all stages of the bond gain calculation.

Where time apportionment relief is available, it's reduced by the number of complete years the individual has been non-resident.

For a full surrender or surrender of sull segments, you divide the chargeable gain by the number of complete years the bond has been in force, even if further premiums have been paid since the start of the bond.

Gains on death and full assignment for consideration also use the number of complete years.

For partial surrenders (in excess of the 5% allowance), the period used for top slicing will depend upon when the bond was taken out and whether it's an onshore or offshore bond.

• Offshore bonds established before 6 April 2013 will have a top slicing period dating back to the inception of the bond.

• All onshore bonds will have the top slicing period shortened if there have been any previous chargeable events as a result of taking more than the cumulative 5% allowance.

• This shortening also now applies to offshore bonds which commenced after 5 April 2013. The period used will be the number of full years between the current chargeable event and the previous one.

Gains on part assignment for consideration also follow these rules.

The Top Slicing calculation is relatively complex, and should be completed by an appropriate tax advisor, qualified to deal with this type of calculation. However, most people are more familiar with the 'shorthand' method.

This method calculates the amount of tax payable on the bond gain, rather the amount of relief, and gives the correct amount of tax in some circumstances. The 'sliced' gain is added to income to determine if any higher rate tax may be payable.

Gains below the higher rate threshold will be taxed at basic rate. For onshore bonds no further tax will be due as any liability will be covered by the non-reclaimable 20% tax credit for tax paid within the fund.

Offshore bonds will be subject to tax at 20% after deduction of any unused allowances.

If the sliced gain exceeds the higher rate threshold, higher or additional rate tax may be due. The excess above the threshold is taxed at 40%, or 45% on any part which exceeds £125,140 (£150,000 2022/23) and then multiplied by the number of policy years determine the tax on the bond gain.

However, this method does not work all the time, and therefore it's necessary to complete the full HMRC method to ensure the correct amount of tax (and top slicing relief) is calculated.

The sum of all chargeable gains is aggregated where there are multiple chargeable gains in the same tax year.

If the total gains plus the investor's other income exceeds the higher/additional rate tax threshold then top slicing may be used to reduce the exposure to higher/additional rate tax.

The payment of a pension contribution can help to reduce or eliminate any tax due on a chargeable gain.

Paying a contribution to a personal pension (including SIPP) has the effect of extending the tax bands by the amount of the gross contribution. If the top sliced gain when added to income is below the higher or additional rate threshold, there may be no higher or additional rate tax to pay on the bond gain.

A contribution made to an occupational pension scheme which operates a net pay arrangement will have a similar effect because, although the contribution won't extend the basic rate tax band, the contribution will reduce the individual's taxable income.

Gift Aid donations also have the effect of extending the tax bands by the amount of the gross payment. But unlike pension contributions, the extended basic rate band can't be used to calculate top slicing relief for an investment bond.

An investor who is UK resident when a chargeable gain arises but has been non-resident for part of the investment period can claim a reduction against the chargeable gain. This is known as 'time apportionment relief'.

This relief is available to all offshore bondholders and was extended to onshore bonds that start after 5 April 2013, or existing onshore bonds that are assigned or incremented after this date. The number of years used for top slicing relief will also be reduced.

TAR is not a tax reducer. The relief provides a reduction to the amount of the gain which is subject to tax, being based upon the number of days of non-residence over the relevant period.

Reduction in gain = chargeable gain x (number of days of non-UK residence) / (total number of days in the period)

The TAR rules changed from 6 April 2013 to include gains from both onshore bonds and offshore bonds (previously only offshore bonds could benefit from TAR).

These rules apply to bond chargeable event gains arising after 5 April 2013 where the bond is:

• an onshore or offshore bond taken out on or after 6 April 2013, or

• an onshore or offshore bond taken out before 6 April 2013 where the bond has been assigned since that date.

There's no change to the calculation of TAR if the individual has always owned the bond. The gain will continue to be reduced by the proportion of the days of non-residence over the term of the policy.

However, if there has been a change of ownership or who is assessable then TAR is calculated based on the period of non-residence since they became ‘owners’ and the residence period of the person who is responsible for paying tax when the gain arises. This period of ownership is also known as the ‘material interest period’.

The new rules mean TAR is available to a policyholder who was non-UK resident for at least part of what is known as the “material interest period” since the bond was taken out. This will be where they are either the:

• legal and beneficial owner of the bond

• settlor of a trust which owns the bond

• legal owner of the bond but have assigned it as security for a debt

This means TAR is only available for the period in which the current person has been assessable for gains on the policy. So where for example the bond was assigned, TAR is only available for the period following assignment.

The reduction in the chargeable gain is calculated as:

chargeable gain x (number of days of non-UK residence in the material interest period) / (number of days in the material interest period)

Example:

Caleb entered an offshore bond for £800,000 on the 10 June 2010. The bond was assigned to his son Barnabus on 6 April 2018. Barnabus surrendered the bond for £900,000 on 6 April 2023. Barnabus was non-UK resident 10 June 2017 to 10 June 2021.

1. The policy was assigned after 6 April 2016 therefore it will be subject to the new TAR rules.

2. Barnabus is now the legal and beneficial owner of the policy, therefore only his period of non-residence is relevant.

3. TAR is available to Barnabus only for the period in which he was a non-resident policyholder (from 10 June 2017).

Reduction in gain = £100,000 x (10 June 2017 to 10 June 2021) / (6 April 2018 to 6 April 2023)

Therefore reduction in gain = £120,000 x (1460/1,825) = £96,000

Assignments between spouses/civil partners living together continue to take into account the transferring spouse/civil partner’s period of non-UK residence. TAR is calculated on their combined period of ownership and residence.

The old rules only applied to offshore bonds. They continue to apply to offshore bond gains arising after 6 April 2013 where:

• the bond investment is made before 6 April 2013 and is owned by an individual,

• it hasn’t been assigned since 6 April 2013, and

• it has never been owned by non-UK resident trustees or an overseas company.

The gain is calculated in the normal way and then time apportionment relief is available to reduce the gain in proportion to the time spent as a non-UK resident throughout the period the bond has been in force:

Reduction in gain = chargeable gain x (number of days of non-residence in the UK) / (number of days investment bond in force)

Changes in ownership since 5 April 2013 on offshore bonds taken out prior to 6 April 2013 will result in bringing the calculation of TAR under the revised rules for post 6 April 2013 policies.

However, where there was a change in ownership of an offshore bond prior to 6 April 2013 TAR will be calculated on the policyholder’s period of non-residence over the full policy term and not just the period since the assignment.

For pre-6 April 2013 onshore bonds there is generally no TAR for onshore bonds taken out before 6 April 2013. However, they can become brought into the post 6 April 2013 TAR regime if they are assigned or incremented after this date.

Therefore, a pre-2013 onshore bondholder or their spouse who has been non-UK resident for any period while the bond has been in force may wish to consider assigning the bond to their spouse.

The assignment would bring the bond into the post 2013 TAR regime and mean a reduction to the onshore bond gain would be available for the period of non-residence.

Where the policyholder is eligible for TAR there will be a reduction to the amount of top slicing relief available.

The number of years used in the top-slicing relief calculation will be reduced by the number of complete years where the policyholder was non-UK resident.

Where there has been a change in ownership only the period of non-residence since the assignment is used. The exception is an assignment between spouses/civil partners living together where their residence status over the combined period of ownership may be used. In this situation the number of years for top slicing will be reduced by the combined period of non-residence during the policy term.

There's no relief for losses incurred because of investment performance. It's not possible to offset a loss on one investment bond against a gain on another or to offset the loss against any other income.

However, there is a limited form of loss relief for investment bonds where there's a loss on full surrender because of an earlier part surrender.

Corresponding deficiency relief reduces income subject to higher rate tax (not additional or basic rate tax) and can be claimed by individuals when:

• there's a loss on the full surrender (or death of the life assured) of a life assurance bond, and

• that same bond had gains in the past which happened when a partial surrender had been taken (across the whole plan and not by surrender of individual segments), and

• the owner of the policy is a higher or additional rate taxpayer.

The amount of relief is capped at the lower of:

• the amount of the previous excess gain(s) on the bond, and

• the amount of the loss.