Offshore investment wrappers and offshore trusts offer savings as tax loopholes close

Tuesday, December 20, 2011 | Posted by: Naomi Smith
Categories: Protecting your wealth | Tags: tax, tax planning, offshore, inheritance tax, IHT, tax avoidance, tax havens, domicile, Naomi Smith, tax haven, non-dom, tax evasion, tax saving, discretionary trusts, IHT planning, offshore trusts, investment income, offshore investment wrappers

As HM Revenue & Customs (HMRC) steps up its mission to prevent British taxpayers illegally evading tax by holding their investments offshore and ‘forgetting’ to report them on their tax returns, we look at two legitimate opportunities to save tax through offshore set-ups: offshore investment wrappers and offshore trusts.

Offshore investment wrappers
Where suitable for their circumstances, some people may be able to benefit from investing in certain offshore wrappers which allow income and capital gains to accrue offshore without any immediate tax charge.

Where offshore wrappers are used, up to five per cent of the original investment can be withdrawn from the offshore wrapper each tax year without an immediate tax charge.

But beware, this does not mean that the profit is not taxed at all; just that the tax bill is deferred until a future chargeable event. This deferral can offer an excellent opportunity for those paying tax at 40% or 50% to delay the tax on the investment income until they are (potentially) paying tax at a lower rate. This could result in a tax rate of 50% on the investment being slashed to 20%!

Alternatively, it might be possible to assign the policy to a spouse who pays tax at a lower rate, thus achieving tax savings on the sale of the investment.

It’s important to consider the tax liability that may arise when planning to encash an investment. Deferred profits falling into charge in one tax year could result in a higher tax rate than expected. Local taxes in the offshore jurisdiction should also be taken into account. The implications of using offshore providers (and giving away control of assets) must also be considered.

Offshore wrappers are a highly complex area and anyone considering this type of investment should seek both financial and tax advice.

Offshore trusts
Most of the opportunities for tax planning using offshore trusts are only open to people who are non-doms, that is, not domiciled in the UK. (You’ll find an explanation of domicile in my previous post on bringing funds to the UK.)

If you are resident but not domiciled in the UK and you are considering retiring abroad, you may want to seek professional advice on setting up an offshore trust as part of your inheritance tax (IHT) planning.

This will typically be a good idea where you have UK beneficiaries in your will and you intend to cease UK tax residence at least three years in advance of passing away.

The benefits of leaving your estate in an offshore discretionary trust in these circumstances can be that:

• Assets can be left offshore outside the UK IHT net
• UK resident beneficiaries are only potentially exposed to IHT in their estates if the funds are distributed from the trust
• The income and capital gains of the trust can accrue offshore without an immediate tax charge – although UK income tax and capital gains tax becomes payable on the transfer of most trust funds to UK beneficiaries

It is important to consider taxes that may arise on the transfer of assets into trust and local taxes that may be payable. The implications of transferring control of assets to offshore providers should also be considered.

Take note that once someone who is domiciled abroad has been UK tax resident for 17 tax years out of the past 20 tax years, they will be deemed to be UK domiciled for IHT purposes, which means IHT is due on their worldwide assets at death. A solution to this problem can be to settle assets in an offshore trust before becoming ‘deemed domiciled’, which can mean that the assets fall outside the UK IHT net.

If you are domiciled outside the UK, you may want to seek professional tax advice on whether you would benefit from establishing an offshore trust.

Summing up
Offshore wrappers and offshore trusts can be a great way of saving tax for some people. If you think you might benefit from either of these ideas, please seek professional advice.

If you’d like to talk to a Grant Thornton tax specialist, contact your local office or read more about domicile, tax-efficient investments and other wealth management issues on our Private Client pages. 

Image: © Steven Straiton

You might also find these posts useful:

* Are trusts still the most tax-efficient option for family wealth transfers?
* What are the tax implications of bringing funds into the UK from abroad?
* Read more posts by Naomi Smith