Offshore/Onshore bond encashment

Gordon Pugh



The use and benefits of offshore and onshore bonds have long been known and for clients seeking a regular income, they can be a great planning tool.

The potential issue with investment bonds, whether offshore or onshore actually, is that upon death, Income Tax is payable on the profits and there is no planning that can be done post death to offset this tax (unless held on a multi-lives assured basis). Furthermore, what if the advice given previously is now obsolete as the client’s circumstances have significantly changed? This can often be the case, through no fault of their own, where there is a change in mainstream planning, such as has happened previously with pensions. However, there can be a significant problem if a bond is sold during the client’s lifetime.

Encashing a bond early can cause an Income Tax charge against any profits within the bond. Therefore, how does an individual deal with this and how can they encash their bond and not suffer a taxable event?

The short answer is that they cannot. However, when they do encash their bond (and if necessary repatriate the proceeds) then any Income Tax charge that becomes payable on the profits can be offset using a tax efficient investment vehicle such as an Enterprise Investment Scheme (EIS).

This of course has its own risks but it enables the investor to get tax relief on their EIS to offset the tax caused by encashing their bond and leaves the majority of the cash unencumbered to use as the client wishes.

FOR EXAMPLE:

£1 million bond is sold, this creates a chargeable gain and Income Tax becomes payable based on the individual’s circumstances. (The amount of chargeable gain is irrelevant with bonds as the important figure is the Income Tax payable for the individual.)

In this example, let’s assume the amount of Income Tax payable is £150,000. The client could potentially invest £500,000 into an EIS and benefit from 30% Income Tax relief of £150,000 which will negate the Income Tax liability on the sale of the bond. Having invested into the EIS, after two years this would qualify for 100% IHT relief through Business Relief (BR). After a period of around four years the EIS could be liquidated (subject to liquidity and the investment profile of the particular EIS) and invested elsewhere as it will have done its job of offsetting the Income Tax charge.

It could be reinvested into another EIS for another 30% Income Tax if relevant and/or invested into another BR qualifying investment (as this would retain the IHT relief gained under the EIS) or indeed left invested in the EIS. The reason for this is that it qualifies for Replacement Property Relief which means that you can reinvest one BR asset to another and it doesn’t restart the two-year clock. This then leaves the remaining £500,000 from the bond sale proceeds to invest elsewhere.

TO SUMMARISE:

  • Sell bond and trigger chargeable event
  • Client/accountant advises you of the Income Tax liability from the sale
  • Income Tax charge divide by 0.3 = investment needed in EIS to offset the Income Tax liability
  • Two years later attracts 100% IHT relief through BR
  • Four years later, liquidity expected and can withdraw to invest elsewhere if wanted
  • Client can leave invested, reinvest into another EIS or BR investment to retain the IHT relief
  • The remaining proceeds from the bond encashment can be invested elsewhere, even another bond and will be re-based at the higher level.

CAPITAL AT RISK

Click here to download this article