Investment Bonds are collective investments in which the investments of many individual investors are pooled. This pooling enables relatively small investors to benefit from the economies of scale made available to institutional fund managers. Investment Bonds are technically single premium life assurance contracts and therefore normally have nominal life cover attaching. A wide choice of funds is available ranging from managed to specialist funds. A number of companies market offshore life policies, particularly single premium bonds. The most popular are those issued by subsidiaries of well known UK life offices in countries such as Luxembourg, the Republic of Ireland, the Channel Islands and the Isle of Man.
Unlike Onshore Bonds, which suffer corporation tax on most of their income and capital gains at the rate of 20%, the income and gains of an offshore bond fund will normally be free of tax in the relevant jurisdiction. Hence they are often referred to as benefiting from “gross roll-up”.
Whilst there will normally be no tax in the particular tax haven that the insurer is based, the fund is likely to suffer some withholding taxes on its underlying investments. There may be scope to reclaim some of the tax under double taxation agreements but it is unlikely that an offshore fund with equity content will ever be truly gross.
Investors can benefit from the ‘5% rule’ which allows them to withdraw up to 5% of the initial premium in each policy year (until such time as all of the original investment has been withdrawn, e.g. 20 years if 5% is withdrawn each year) with no immediate tax liability. At the start of each policy year, a tax deferred allowance is accrued of 5% of the premiums paid. If this allowance is not used it can be carried forward to use in future policy years (the cumulative allowance).
The ability to defer tax should have a greater effect under an offshore bond than an onshore bond as the longer it is held the greater the compounding effect of the tax deferment due to gross (or near gross) roll up. All things being equal an offshore fund should create a greater return than an onshore one over the longer term. However, the greater the level of withholding tax and management expenses (an offshore fund has no tax from which it is able to deduct management expenses) the less an individual will benefit from gross roll up.
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