Dividend tax and offshore bonds – taking the argument further
Following on from his article discussing investment bonds as a solution to the new dividend tax rules, Canada Life’s Jeremy Pearson looks further at where using an offshore bond becomes a ‘no brainer’ as an option
Following my previous article, we were asked recently what is the cross-over point at which an offshore bond becomes a no brainer with the introduction of the changes to dividend taxation? This article summarises the situation and then looks further into the subject.
As far as offshore bonds are concerned, if you assume the portfolio is entirely equity-orientated the situation is:
• If a basic rate taxpayer receives more than £5,000 in dividends now, post 6 April 2016, they will be paying more tax (7.5% on the excess) than they would have last tax year. So arguably, they could shelter part of their portfolio in an offshore bond and defer tax. However, if the client remains a basic rate taxpayer, chargeable gains will be taxed at 20% eventually, so this is probably not a ‘no brainer’. Actually, for basic rate taxpayers, they could be better off (technically) with an onshore bond (because currently there is no dividend tax in the fund – and as far as we know this situation will continue – and none on the chargeable gain.)
• For a higher rate taxpayer, paying 32.5% on dividends above the allowance next year, the allowance represents a saving of up to £1,625 (£5,000 x 32.5%). To end up with a bigger overall tax bill on their dividends, the 40% taxpayer would have to receive total dividends of over £21,667. If they were in this position, they could shelter part of their portfolio in an offshore bond and defer tax. Then exit strategies could be used to ensure the eventual chargeable gain is not taxed at 40% (assignment to spouse, retiring abroad, etc).
• For an additional rate taxpayer, the corresponding figures are 38.1%, £1,905 and £25,400. As before, if they were receiving dividends above this, they could shelter part of their portfolio in an offshore bond.
The ‘threshold’ calculation that gives the figures above is shown below. This shows that in 2016/17, any dividends above the amount stated in the second column are taxed at a higher rate in 2016/17 than they were in 2015/16.
So the conclusion is that on dividend taxation terms alone, at the higher end of a large equity portfolio, an argument can be made for moving part of it into an offshore bond. How large does that portfolio of equities or equity collectives need to be to breach the thresholds shown above? Assuming a yield of 3%, the answer is:
But to make a move would involve cost, asset selection and probably CGT when part of the portfolio is realised. A crucial factor is also how the client will eventually ‘exit’ the offshore bond and what will their tax position be at that stage.
Example case study
Mrs McRussell is a basic rate taxpayer who has £250,000 invested in a portfolio of UK equity income accumulation funds, yielding 3%. In the 2015/2016 tax year she paid no additional tax on this investment.
Now, she will be paying £187.50 tax a year. This is the reinvested dividends of £7,500 less the allowance of £5,000 taxed at 7.5%.
This is not a huge amount admittedly, but her professional adviser feels duty bound to explain the tax changes to her. In addition, he is not looking forward to having to explain to her why she suddenly has to pay tax when she is not actually receiving income (in this example).
Mrs McRussell could shelter £83,333 of her portfolio in an equivalent investment bond fund and avoid that bill, assuming the costs of the transaction and the CGT position makes such a switch viable.
In addition, her adviser will have to attempt to match the portfolio asset allocation with the investment bond funds. Something that may not be easy if the bond does not have open architecture.
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