Example 5 - UK expatriate returning to UK

Having been based offshore for the previous 4 years, Mr Y was returning to the UK. In addition to a large portfolio of cash assets based offshore in various deposit accounts in Guernsey and Jersey, he had acquired over this period a portfolio of pension and savings arrangements, effected with various offshore financial services providers (including the offshore subsidiaries of large UK insurance companies). The savings schemes had been designed to run for 10 years.

Mr Y had been recommended to buy these investments on the grounds of "tax efficiency." Given the structure and, in particular, the exorbitant charges levied by the providers (described below), IAS saw no merit in the course of action which had been recommended. As a result of returning to the UK, there were now a series of tax implications for each savings plan (if these were left undisturbed) and these were all due to mature after Mr Y was due to return to the UK. It was essential, therefore, to set in train a course of action prior to his return.

IAS recommendations

Step 1 was to ensure all the interest earned on his various offshore deposit accounts was paid prior to his return to the UK. In this way interest earned since the last payment date (which amounted to over £5,000) would escape any liability to UK tax. As Mr Y was married to a non UK domiciliary, there were also ongoing advantages in a large part of the cash being transferred and retained in his wife's name offshore, to take advantage of the remittance rules which apply.

Step 2 was for IAS to undertake a full review of the portfolio of offshore investment vehicles including a review of the original terms and conditions and, most importantly, an analysis of the charges applying. Although the arrangements provided access to some good third-party fund links, the charges levied by the offshore insurance company were simply too high ever to make the savings plan a worthwhile option. In particular high initial charges were being incurred on every monthly contribution including bid/offer spreads of 6-7% on average and total annual management charges in some cases as high as 3%. (High costs are a feature of many offshore investment arrangements.) In addition, the charging mechanism applying to the savings plans also involved the application of "capital/initial units" under which investments purchased for the first 1-2 years were subject to additional annual charges over the term of the contract. In one case this increased the total annual management charge on part of the investments held to over 6% per annum (!) As some of the contracts were regular premium arrangements with ongoing investment these charges were still being incurred on new monies invested.

As far as the tax implications of each investment were concerned, although these had been presented as "tax -free," this freedom from tax only applied while the policyholder remained non- UK resident. As soon as the policyholder returned to the UK and became resident for tax purposes, the policies would lose their UK tax exemption (at least in part). Most offshore life policies of the type held will be subject to UK tax at the policies marginal tax rate (40% for a higher rate taxpayer) on a time apportioned basis, if they mature while the policyholder is UK resident.

On this basis, the "tax-efficiency" of such savings arrangements was largely irrelevant for UK expatriates who would be returning permanently to the UK within the 10 year term. Two of the savings arrangements in question were offshore insurance based contracts which had an option to "substitute" the original policy for an UK qualifying policy on the basis this would retain certain tax advantages. The problem with this option was that this would require ongoing contributions to continue to be paid on similarly unfavourable charging terms and while the policy benefits at maturity would have been paid free of UK tax in the policyholders hands, the underlying funds, in accordance with all UK insurance funds, would be subject to both income and capital gains tax under the rules which apply for these type of funds. For these reasons, therefore, the substitution option was not attractive.

For the majority of the policies held by Mr Y, we recommended encashment to ensure that the (barely discernible) growth achieved thus far would escape any UK tax liability. In the case of two of the policies, however, because of early surrender penalties or, in one case, a maturity bonus payable some 8 months after the policyholders return to the UK, there was a case for maintaining the policies while the policyholder was UK resident. In this way the policyholder would qualify for an additional bonus totaling over £10,000 although this would then be subject to some UK tax in addition to the other gains made, based on the time apportionment rules. IAS established that it would be possible to assign the benefits under the policy before maturity to the policyholders spouse on the basis the spouse was subject to a lower marginal rate of tax than the policyholder. In practice because of the availability of UK personal allowances it was possible for the plan to mature in the spouse's name and as the gain on the same time apportionment basis was identical to that in the policyholders name, tax on gains of approx. £2,000 at 40% was avoided.

IAS assisted with the deed of assignment, identifying and advising the client of the tax implications and undertook subsequently a restructuring and revised investment planning exercise, mindful of the couple's joint future career and investment objectives. This took advantage of UK tax shelters where relevant, as well as the non-domiciliary status of Mr Y's wife.