This article looks at the taxation of a collective investment when held by a UK-resident bondholder (excluding companies) inside an offshore bond and considers any additional liability which may fall on the bondholder.
Although there are multiple asset classes available for clients to invest in, we have focused on collectives investing in UK equity, fixed interest and property. We will consider the taxation of income and gains, realised and unrealised.
Taxation of the collective investment when held as an asset of an offshore bond – income
Any income received (dividend or interest) within the offshore bond wrapper from the collective is deemed to be received gross.
Withholding taxes may apply on interest income that may not be reclaimed unless there is appropriate provision within a Double Taxation Agreement between the UK and the jurisdiction of the offshore bond provider.
The income will remain in the offshore bond provider's fund, untaxed. The value of the bond will reflect this income and remain untaxed until encashment from the bond by the bondholder.
Taxation of the collective investment when held as an asset of an offshore bond – capital gains
The collective would suffer no on-going capital gains tax within the offshore bond as the beneficial owner (the offshore bond provider) is non-UK resident.
The realised gains would remain in the fund, untaxed. The value of the bond will reflect the realised gains but remain un taxed until encashment from the bond by the bondholder.
Investment losses cannot be passed on to the bondholder, although any deficiency created on full encashment may be available to offset any higher rate (and where relevant additional rate) income tax suffered by the bondholder. This is providing that any excess gains included were also included in the individual's taxable income for calculating UK income tax.
Switches made within the bond will not generate a tax charge.
Principally, where a collective is held within an offshore bond, the policyholder is only liable to tax when a chargeable event occurs.
Encashment of the bond by the bondholder
On encashment, assuming a chargeable gain has been made, a chargeable event would occur and the policyholder would be liable to income tax on this gain of up to 45%, depending on the marginal rate of tax they are currently assessed against. However, the personal allowance, the personal savings allowance and the starting rate at 0% savings* would be available where earned income levels were sufficiently low. A basic rate taxpayer would be liable to tax at 20% provided the gain does not take their income into the higher rate income tax threshold. Top-slicing relief may be available.
* Offsore bond gains are deemed to be savings income.