In this detailed case study, Murphy questions how advisers can do financial planning in situations such as this one.
My clients are UK domiciled but have been tax resident in Spain for 10 years.
They have around £600,000 on deposit with a bank in the Channel islands and want to invest part of these savings. They do not require any income at present, but they want immediate access to the funds (without penalty) at any time in the future.
They have a good understanding of financial products and they approached us to see how we could them meet the following objectives:
1. Provide them with an investment that offers ease of administration (particularly in relation to their tax reporting requirements).
2. Be tax efficient (particularly in respect of Spanish IHT).
3. Provide the opportunity to earn returns better than those available from cash.
4. Be flexible enough to enable encashment at any time, without penalty.
They had spoken to advisers based in Spain, however, most of the solutions involved some form of Initial Commission to the adviser which meant the providers imposing heavy penalties on withdrawal within the early years.
We explained that we did not take commission, we charged fees, which could be paid from the investment or invoiced to them separately.
They liked this idea and asked us if we could research the market place and come up with a potential solution.
Expatriates resident in Spain can take out an ‘ordinary’ international offshore investments (for example from an Isle of Man or Channel Island life assurance company), however, such investments are regarded as ‘foreign’ policies and Spanish investment income tax is payable on an annual basis whilst the policyholder is Spanish tax resident.
With a non-Spanish compliant investment, there is no ‘fiscal representative’ available from the provider to calculate any tax that is due and the onus is fully on the investor to calculate the tax and pay what is due to the Hacienda themselves, regardless of their competence to carry out this requirement.
Income tax is payable every year on all investment gains, regardless of whether a withdrawal has been made from the investment!
This subsequently follows that tax might be payable on a gain made in a particular tax-year, but if the investment declines in value the following year, there is no way to offset the decline as tax has already been paid and cannot be reclaimed.
There are severe penalties for non-disclosure of non-Spanish compliant investments. Typically, there’s a fine of 5,000€ per item, with a minimum fine of 10,000€ imposed. In addition, policyholders may also become subject to penalties and interest for non-reporting, and these can range from between 50% and 150% of the tax due.
‘Hacienda’, (the Spanish tax office), has however granted certain taxation advantages for investment plans held by Spanish residents, if those plans fulfil certain conditions. The advantages can be considerable.
The Spanish Compliant Offshore Investment Bond, therefore provided the clients with some key benefits which link to their circumstances.
- No investment income tax is payable until they make a partial withdrawal or completely surrender their investment. This creates a tax deferred position, which gives them greater flexibility regarding when they want to realise their gains.
- The funds contained within the plan grow virtually tax free except for minimal, unrecoverable withholding taxes levied by the countries where the funds are based.
- When the time arrives, that tax must be paid, the amount of tax payable is calculated in a way that is extremely favourable for them and the treatment of the ‘Spanish Compliant’ investment by the Spanish authorities where tax is concerned, is far more favourable than might be expected in a recognised, tax advantaged, offshore centre.
- Any tax due is calculated by the provider company on behalf of the clients and paid direct to the Hacienda. This saves time and expense for them and will greatly simplify their admin.
- There will be no requirement for the client to list their investment on the Modelo 720 return.
We researched the Market Place and narrowed it down to two possible providers (we will call them Company A and Company B, to protect their confidentiality).
All was proceeding well, until we started to investigate the IHT situation of the Bonds…
We were working loosely with the client’s Spanish Accountant and we received a request from them to obtain clarification for clarification from Company A regarding a couple of points:
1. Where the Bonds was deemed situated.
2. The IHT treatment on 1st death, if the Bond was set up as a Joint Life, Second Death Bond.
The clients had both made Spanish and Jersey wills – the former covering their assets in Spain and the latter covering their assets elsewhere. For Spanish inheritance tax purposes, they had willed their respective shares in the jointly held assets in equal parts to the surviving spouse and to the surviving children.
Their accountants had advised that non-Spanish resident inheritors (neither of their sons are tax-resident in Spain) are able to inherit the non-Spanish portion of the estate free of Spanish Inheritance Tax. However, we needed confirmation that the Company A’s contract was deemed to be outside of Spain for this to work.
We approached Company A for their view on this and the situation on first death. They confirmed that in their opinion, the Bond would be deemed to be a Spanish asset for IHT purposes and that the non-resident beneficiaries would be liable for the payment of Inheritance Tax on the amount received as a death benefit.
They also advised that if the policy is set up as joint life, second death, the ownership of the policy transfers automatically to the remaining spouse, as within the bond no distinction is made between his and her share. Upon receipt of a certified death certificate they would simply remove the deceased spouse as an owner of the policy. The remaining policy holder would then assume control of the policy and the policy would only be subject to a death claim upon death of the last life assured.
Therefore, in their opinion, there would be no tax implications/reporting obligations for the insurance company since the policy reverts to the ownership of the surviving policyholder when there is more than one policyholder on the policy.
We asked Company B for their views on the 2 issues and they confirmed that they had recently taken legal opinion a leading firm of lawyers and their fiscal representative, who both confirmed that the Bond would NOT be a Spanish situated asset for IHT purposes.
This was obviously in direct contradiction with Company A – which is surprising, considering both Companies are situated in Dublin operate as an Irish Freedom of Services insurer to Spanish tax residents.
I therefore asked the client’s Spanish accountant to analyse the situation and paid them for their advice and they confirmed that in their opinion, the inheritance of the assets of a life insurance policy by a non-resident beneficiary would be subject to inheritance tax in Spain in the following cases:
1. When the policy documents are signed in Spain with an insurance company that is operating in Spain.
2. When the policy is expressly subject to the application of Spanish law.
The relevant articles of the Spanish inheritance tax legislation applicable to non-residents both state that, for non-resident beneficiaries, Spanish inheritance tax applies in the case of the inheritance of assets or rights that are situated, may be exercised or may be implemented in Spain and, in the particular case of insurance policies, they are taxable in Spain when the contract has been celebrated with a Spanish insurance company OR when the insurance contract has been subscribed in Spain with a non-Spanish insurance company that operates in Spain.
In conclusion, if both Company A and Company B have different views regarding if their life insurance policies are deemed to be Spanish assets, it may be because of their respective set up arrangements, terms and conditions. Some insurance arrangements may have avoided this problem and it must be borne in mind that not all life policies are the same.
Finally, from the review of all the previous correspondence received, both Company A and Company B also have conflicting comments and interpretation if on first death there is ISD payable by the surviving spouse on the receipt of the deceased’s shares in the bond.
How is an adviser meant to advise clients, in situations like these?