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Guide to Offshore InvestmentsQ. What are the pros and cons of going offshore?
The obvious primary benefit to using offshore funds is the fact that the reduced levels of tax paid within funds or the extra returns generated by rolling up tax liabilities in bonds should help to boost investor returns.
In a fund this benefit simply boils down to whether or not the more tax efficient nature of the underlying portfolio enables it to produce greater returns over the long term than an onshore peer.
The nature of the investments within the fund and its mandate are going to be key differentiators in the performance of the fund over and above these potential tax advantages and therefore offshore funds should be considered on the basis of their suitability for clients in the same way as for all other investments.
There is a significant difference in how investors are taxed on their income and gains from disposals depending on the fund’s status.
If a fund has ‘reporting status’, which is granted by HM Revenue and Customs for funds that disclosure income to UK tax authorities, income is taxed at the usual marginal rates but gains from disposals are charged at lower capital gains rates.
For non-reporting funds all income and gains are charged at marginal income tax rates, making it preferential from a purely tax planning perspective to use reporting funds.
For bonds the tax benefits lie in the fact that no UK tax is paid during the life of the bond, meaning interest accrues on a compound basis on all of the invested capital.
From a tax planning perspective, this can be particularly useful if an individual that is taxed at higher income tax rates is likely to see their marginal rate of tax drop in the future, for example when they retire.
Such investors could use an offshore bond to defer their income, thus paying a 20 per cent rate of tax on a larger accrued fund than if they invested in standard onshore vehicles that tax income on an ongoing basis.
On the downside, there are obviously doubts surrounding products that are not based in the UK in terms of the protection available to consumers.
To begin with, such funds are not covered by the Financial Services Compensation Scheme, which offers up to £50,000 protection on UK-based investments. Moreover, corporate governance is more questionable is many smaller jurisdictions, though this is less of an issue in established financial centres such as Luxembourg.
Advisers should also look into the charges and minimum investment thresholds of offshore products, as both can often be significantly higher than for onshore equivalents.
