One of the huge advantages of an offshore bond is that time spent abroad can serve to reduce chargeable gains on the return to the UK.
This is generically called ‘time apportionment relief’ although HMRC refers to it as a ‘time apportioned reduction’.
HMRC has been considering changes to how the calculations are done for some time and published a consultation document on 13 August 2012 concerning possible changes to the rules.
This was, to in some extent, timed to coincide with the introduction of the new statutory residence test.
It was looking at ‘a more equitable approach to calculating time apportioned reductions’ and the outcome of their consultation has resulted in changes being included in the Finance Bill 2013.
The changes became law when the Finance Act received Royal Assent on 17 July this year, at which point the rules become effective from 6 April, 2013.
The two main changes are:
- Time apportioned reductions for chargeable g ains now also apply to investment bonds issued by UK insurers. Although a person knowing they will become non-UK resident would not usually have an investment subject to UK tax.
- Time apportioned reductions will be calculated by reference to the residence history of the person liable to income tax on the gains and not by reference to the residence history of the legal owner of the policy (for example, trustees).
They apply to investment bonds or capital redemption policies issued after 6 April, 2013 and to policies issued before that date if they are varied and benefits increased, they are assigned or they are held as security.
However, the Government is still concerned about what it perceives as abuses of the rules, such as when large partial surrenders are taken when overseas and reapplied as additional investments before the return to the UK.
It has said that “HMRC will continue to explore options for a more appropriate calculation method for time apportioned reductions with industry which is both pragmatic and not overly complex.”
So is the current calculation overly complex? You be the judge; to start with it looks really simple – you just multiply the chargeable gain on the investment bond by A/B and the answer is your time apportioned reduction of the chargeable gain.
A is the number of days during the policy term that are foreign days – when not UK resident plus any overseas days in a split year in which the individual is taxed as if non-UK resident.
B is the number of days overall in the policy term, overseas and in the UK.
To keep the figures as straightforward as possible, I will assume that the legal and beneficial owner of the policy has always been the same person, James.
James takes out an offshore bond on 1 May, 2005 while on a break in the UK from working in Germany. He was not UK resident for any of the tax years that he worked in Germany.
He returns to the UK on 5 May, 2009 and is still resident here when he fully surrenders the policy on 30 April, 2013, giving rise to a chargeable event gain of £50,000.
James is a higher rate taxpayer. And on the face of it, will also lose some of his personal allowance as his revised income will be over the £100,000 threshold.
But that is before the time apportioned reduction. The duration of the policy was 2,921 days of which 1,465 days were foreign days. So the reduction in the chargeable gain, using the A/B formula is:
£50,000 x 1,465 ÷ 2,922 = £25,068
James is, therefore, assessed on a gain of £24,932 which meant that he kept his personal allowance and paid less higher rate tax.
Although he still had a tax bill of £9,973.
A word of warning, however; in practice, the calculation can be different if the policy was issued or varied after 5 April, 2013.
But James is married and his wife is a basic rate taxpayer. Did he miss an opportunity to make use of his wife’s tax position? Compare his situation with that of a different client.
When Barry met Sally
I was recently speaking to an adviser who said to me ‘My client, Barry, took out an offshore bond on 1 May, 2005 while on a break in the UK from working as a chef in Dubai.
He returned to the UK on 5 May, 2009 and is a higher rate taxpayer. Because of this, he assigned his bond on 1 May, 2012 to his wife, Sally, who is a basic rate taxpayer.
Sally surrendered the bond on 30 April, 2013, giving rise to a chargeable event gain of £50,000.
Does Sally get any time apportioned reduction and what is the top-slicing position?
You will notice that, remarkably, the dates and amounts are identical to James’s situation, except for the assignment!
HMRC says that when a policy has been assigned between spouses or civil partners who are living together, any subsequent chargeable gain can be calculated by reference to the period of ownership of both individuals.
This means that periods during which the assignor was not UK resident are included in the calculation of the time apportioned reduction. This will be an advantage for Sally.
I will not repeat the calculation of the reduction, as it is the same as for James. So Sally ends up with a chargeable gain of £24,932 in her assessment for 2013/14.
But unlike Barry, she is a basic rate taxpayer – so top-slicing will be of benefit. And you do not include the years spent abroad in the calculation.
What you have to do is:
- Divide the number of foreign days by 365 and round down the answer. For Sally (albeit in respect of the time when Barry was overseas), this is 1,465 ÷ 365 = 4
- Work out the total number of full years for which the policy has run. For Sally, this is 2,922 ÷ 365 = 8
- The foreign days are subtracted from the full years, giving: 8–4 = 4 years.
So the policy was in force for eight years, but for only four of those was the beneficial owner UK resident. This means that the top-slice is £24,932 ÷ 4 = £6,233.
When this is added to her other taxable income, Sally is still within the basic rate tax band and so pays tax of 20% x £24,932 = £4,986 on her chargeable gain – half of that paid by James.
Also, Sally is under age 65 so the issue of higher age allowances being affected by chargeable gains is not relevant.
But what if Sally’s income was just a bit below the higher rate tax threshold and the top-slice straddled the basic rate and higher rate tax bands?
The way that HMRC calculates her tax liability is firstly to work out the tax payable on the whole reduced chargeable gain and then grant her top-slicing relief.
Say her income not including the gain is £3,000 shy of the higher rate tax threshold. So the tax on her chargeable gain of £24,932 before top-slicing is (£3,000 x 20%) + (£21,932 x 40%) = £9,372.80.
There are six steps to calculating the top-slicing relief due (see chart 1).
Sally will, therefore, have tax to pay on her chargeable gain of £9,372.80 less the top-slicing relief of £1,800, leaving tax payable of £7,572.80 – an effective rate of 30.4% on the whole chargeable gain.
This is quite a laborious calculation – and probably leaves you grateful you are not an accountant or the taxman – but in practice there are short cuts to getting to the correct answer.
But the message is clear; if a client is normally a UK resident but is spending time abroad, holding an investment bond throughout that period will avoid them being unnecessarily subject to UK tax.
That is not the case with some other investments. And it should be noted that assets may have to be reported to the authorities in some jurisdictions for wealth tax or other tax purposes.