Investment bonds

Investment bonds are a popular choice for investors. They are treated as a non-income producing investment that doesn’t attract capital gains tax (CGT). Instead, they are subject to taxation under the chargeable event regime as life assurance policies.

The chargeable event rules aid investors by enabling them to defer tax on withdrawals, utilise top-slicing relief and allow chargeable gains to be structured in a tax efficient way through policy segmentation and assignments.

Once a bond investment decision has been made, consideration will be given as to whether an onshore or offshore bond should be purchased. There are key differences that can mean onshore or offshore may be preferred by different investors.

Onshore and Offshore bonds – taxation

The main difference between an onshore or offshore bond is taxation. Gains on both are treated as savings income. However, onshore bonds are treated as having already paid 20% tax on growth within the bond, so come with a 20% tax credit on chargeable events. Offshore bonds are treated as having grown tax free, so will pay the full rate of tax on chargeable events.

At face value, this appears to produce the same result. For example, if a higher rate (40%) taxpayer invests £100,000 in a bond that grows by 5% (£5,000), the tax might appear to be identical as follows: 

However, the actual tax situation is far more complicated and nuanced. Reasons, together with a table showing when the position generally favours onshore or offshore bonds, include:

• Individual’s tax charge - For an individual holding an onshore bond, the taxable chargeable event is not 'grossed up'. This means that in the above example, the individual only pays 20% tax on £4,000 of growth for the onshore bond:
  
  

  	Onshore	Offshore
  Investment	£100,000	£100,000
  Growth	£5,000	£5,000
  Tax within bond	- £1,000 (20%)	-£0 (0%)
  Bond growth	£4,000	£5,000
  Tax dues on encashment	- £800 (20%)	£2,000 (40%)
  Total Tax	£1,800	£2,000

  
  
  

  Onshore
  Offshore

• Gross roll up – The off-shore bond benefits from ‘gross roll up’ within the bond. By deferring payment of any tax until the bond is encashed, the offshore bond can potentially grow faster over time (by earning a return on the tax that would otherwise be paid).
  
  

  Onshore
  Offshore

• Tax within the bond – Bonds are treated as already having paid 20% tax onshore and 0% tax offshore. However, the real tax situation within the bond can be very complicated and will depend on the underlying investments and the jurisdiction an offshore bond is located in. 
  
  In general, an onshore bond will have paid 20% tax on gains, but no further tax on dividends received. This means that the actual tax paid will typically be under 20%. Conversely, an offshore bond may have been subject to a small amount of withholding tax on dividends from non-UK equity funds.
  
  

  Onshore
  Offshore

• Tax status at encashment - On-shore bonds benefit from a 20% tax credit on encashment, which cannot be reclaimed if not used. If an individual’s chargeable gain (after top-slicing) is not subject to UK tax, the tax credit is lost, making the overall tax liability lower for the off-shore bond. 
  
  

  Onshore
  Offshore

Other differences

• Jurisdictions - Offshore bonds are outside the UK for tax purposes and will not come under the UK’s consumer protection rules. Any protection offered will depend on the jurisdiction where the offshore bond is based – typically low taxation jurisdictions such as Ireland, Isle of Man or Guernsey. They are unlikely to be protected by the UK Financial Services Compensation Scheme (FSCS) but may be protected by a similar scheme in the jurisdiction in which they are based.
  
  

  Onshore
  Offshore

• Investment choice – An offshore bond may offer a wider range of possible investments than an onshore bond, which can be partly influenced by the differences in taxation. However, this could also result in higher underlying charges, which will also be a consideration.
  
  

  Onshore
  Offshore

Conclusion

There are no set rules for choosing between an offshore or onshore bond and it will often come down to personal preference and product choice. 

An onshore bond may be preferred by investors who want to invest through a UK provider, do not plan to live/retire abroad and expect to pay at least basic rate tax at encashment.

Conversely, an offshore bond may have attraction for those who won’t pay UK tax at encashment, intend to move abroad (but perhaps not to the jurisdiction the bond is domiciled in) or are interested in a wider choice of assets to invest in.

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.