This article explains how offshore bonds can be a suitable trust asset for a number of reasons.
Whilst the focus of this article is upon the suitability of an offshore bond it is important to consider the range of assets that are available.
Trustees are under a duty to ensure that they are acting in the best interests of the beneficiaries of a trust. There are a number of facets to this duty which include ensuring the performance of trust assets is reviewed regularly as well as diversifying the types of assets held within the trust fund.
Diversification of assets
As a result of the duty upon trustees to diversify, which in the UK is highlighted in the Trustee Act 2000, as well as a number of other factors, there has been a move away from holding a single traditional asset type such as shares.
However, only very large trust portfolios can fully utilise diversification of assets. An alternative could therefore be an offshore bond, which allows the trustees to hold a wide range of investments such as collective investments, in one place.
Simplified paperwork through diversification
The variety of assets that can be accessed through an offshore bond wrapper may not otherwise be accessible. With this come a number of other advantages where assets are held within one wrapper such as:-
- Reduced administration;
- Easier administration; and the
- Potential for reducing administrative costs.
It is also possible to buy and sell assets with great ease. Dealing transactions are co-ordinated by the life office rather than having to approach different fund managers. There is also the advantage of being able to buy and sell different assets without creating any immediate tax liability in the UK. However, there may be other taxation applicable at a later stage dependant upon the tax position in the jurisdiction, such as chargeable event taxation in the UK.
Since all of the assets are within one clearly identifiable product it could be an ideal investment to be placed into trust.
The taxation of trust assets must also be considered when fulfilling trustees’ duty to ensure that the asset type is suitable for the type of trust created.
Trust income is taxed differently in different jurisdictions and dependant upon which type of trust is created. The following is the position that applies in the UK.
In the case of interest in possession (IIP) trusts, savings income is taxed at source at the rate of 20%. The trustees have no further tax liability, although the beneficiaries to whom such income is distributed may have depending upon their marginal rate for income tax purposes.
For discretionary trusts, the income tax position is far less favourable. The tax rate is upon the trustees and therefore the trustees have an additional 25% tax liability on top of the 20% tax paid at source.
An offshore bond could be an ideal asset to ease this tax liability if the liability falls upon the trustees, since it is a non-income-producing asset. However, the chargeable event rules in relation to the bond need to be considered instead.
Offshore bonds have the advantage of ‘gross roll-up’ which means income is received gross of any income tax within the bond wrapper and will only suffer income tax upon any future chargeable events. In the UK, it is also possible to withdraw 5% tax deferred each policy year for 20 years without incurring an immediate tax liability.
A chargeable event for income tax purposes will only arise upon certain events occurring. An example of this is when the bond is surrendered. If the bond is surrendered and there is a chargeable event gain then there may be a tax liability, depending on whom the chargeable event is assessable on.
Another option that is available is to assign the bond to a beneficiary. The assignment would not constitute a chargeable event. The subsequent chargeable event gain arising upon the surrender by the beneficiary would be taxed at the beneficiary’s highest marginal rate.
In addition, there is also the availability of ‘top slicing’ to taxpayers who would usually be basic rate taxpayers but due to the gain arising on the chargeable event, they are higher rate or additional rate taxpayers. This usually results in a reduced tax liability.
It can therefore be seen how offshore bonds can be utilised as a trust asset. However, trustees should always ensure that they comply with the duties upon them and if they do not have the requisite expertise to assess the suitability of such assets, they should seek professional investment advice.