Conflict of views on offshore bond IHT rules vexes adviser

By Patrick Murphy

Added 7th September 2017

Two international life companies gave conflicting views on the tax treatment of offshore bonds to chartered financial planner Patrick Murphy, of Zen Wealth, in his quest to offer fee-based advice for his UK domiciled clients who have been tax resident in Spain for 10 years.

Conflict of views on offshore bond IHT rules vexes adviser

In this detailed case study, Murphy questions how advisers can do financial planning in situations such as this one.  

Background

My clients are UK domiciled but have been tax resident in Spain for 10 years.

They have around £600,000 on deposit with a bank in the Channel islands and want to invest part of these savings. They do not require any income at present, but they want immediate access to the funds (without penalty) at any time in the future.

They have a good understanding of financial products and they approached us to see how we could them meet the following objectives:

1. Provide them with an investment that offers ease of administration (particularly in relation to their tax reporting requirements).

2. Be tax efficient (particularly in respect of Spanish IHT).

3. Provide the opportunity to earn returns better than those available from cash.

4. Be flexible enough to enable encashment at any time, without penalty.

They had spoken to advisers based in Spain, however, most of the solutions involved some form of Initial Commission to the adviser which meant the providers imposing heavy penalties on withdrawal within the early years. 

We explained that we did not take commission, we charged fees, which could be paid from the investment or invoiced to them separately. 

They liked this idea and asked us if we could research the market place and come up with a potential solution. 

Options

Expatriates resident in Spain can take out an ‘ordinary’ international offshore investments (for example from an Isle of Man or Channel Island life assurance company), however, such investments are regarded as ‘foreign’ policies and Spanish investment income tax is payable on an annual basis whilst the policyholder is Spanish tax resident.

With a non-Spanish compliant investment, there is no ‘fiscal representative’ available from the provider to calculate any tax that is due and the onus is fully on the investor to calculate the tax and pay what is due to the Hacienda themselves, regardless of their competence to carry out this requirement.

Income tax is payable every year on all investment gains, regardless of whether a withdrawal has been made from the investment!

This subsequently follows that tax might be payable on a gain made in a particular tax-year, but if the investment declines in value the following year, there is no way to offset the decline as tax has already been paid and cannot be reclaimed.

There are severe penalties for non-disclosure of non-Spanish compliant investments. Typically, there’s a fine of 5,000€ per item, with a minimum fine of 10,000€ imposed. In addition, policyholders may also become subject to penalties and interest for non-reporting, and these can range from between 50% and 150% of the tax due.

‘Hacienda’, (the Spanish tax office), has however granted certain taxation advantages for investment plans held by Spanish residents, if those plans fulfil certain conditions. The advantages can be considerable.

The Spanish Compliant Offshore Investment Bond, therefore provided the clients with some key benefits which link to their circumstances.

  • No investment income tax is payable until they make a partial withdrawal or completely surrender their investment. This creates a tax deferred position, which gives them greater flexibility regarding when they want to realise their gains.
  • The funds contained within the plan grow virtually tax free except for minimal, unrecoverable withholding taxes levied by the countries where the funds are based.
  • When the time arrives, that tax must be paid, the amount of tax payable is calculated in a way that is extremely favourable for them and the treatment of the ‘Spanish Compliant’ investment by the Spanish authorities where tax is concerned, is far more favourable than might be expected in a recognised, tax advantaged, offshore centre.
  • Any tax due is calculated by the provider company on behalf of the clients and paid direct to the Hacienda. This saves time and expense for them and will greatly simplify their admin.
  • There will be no requirement for the client to list their investment on the Modelo 720 return.

We researched the Market Place and narrowed it down to two possible providers (we will call them Company A and Company B, to protect their confidentiality).

The Problem

All was proceeding well, until we started to investigate the IHT situation of the Bonds...

Continued on page two..

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Spanish Accountants Rule 2

Am I missing something or is it not the case that point 2 of the Spanish Accountants' reply would also mean IHT payable by the remaining spouse in Spain on first death no matter where it were signed? If it is the case that a bond receives specific 'Spanish Compliant' status for income tax purposes, it must surely follow that that investment is 'subject to the application of Spanish law'? I have always expected 'Spanish compliant' bonds to be subject to IHT for this reason. Another point is that when clients are more interested in avoiding IHT in Spain and the UK because they do not need withdrawals, then even though the downside is extra 'income tax' payments on 'growth' a non Spanish 'international' bond may actually be a better option?

Posted by: Gerard McShera, 07 Sep 2017

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