Offshore investing is often seen as a means for the mega rich to keep their millions far away from the prying eyes of tax authorities or a place for shady deals on the margins of legitimate business.
Deposits in numbered Cayman Island accounts are a staple of countless spy and gangster films.
This is by no means the case. With increased vigilance from law enforcement authorities throughout the West in the wake of various terrorist attacks, traditional offshore centres such as Switzerland, Lichtenstein and the Isle of Man are being forced to become more open in their dealings.
The recent "tax amnesty" offered by the Inland Revenue for holders of offshore bank accounts is part of this process. They were giving people a chance to come clean before the Revenue found out for themselves.
Changes in the global economy have also changed perceptions of what constitutes "offshore". For a UK resident investor the normal offshore investment centres have been the Channel Islands, Isle of Man or Gibraltar.
For a Russian oil billionaire, Britain makes an ideal offshore tax shelter with no tax to pay on his worldwide earnings and no inheritance tax on assets held outside the UK. This has been of great benefit to the London housing market and a certain West London football club.
For an investor with a UK domicile who is resident here, the tax benefits of offshore investing amount to a deferral of tax. That is to say tax is often not paid on offshore investments until the money from those investments is returned to the UK. With careful planning, a diversity of savers can put offshore investments to good use.
The most common form of offshore investment is offshore investment bonds offered by offshore branches of British life assurance companies. These allow investment in a huge range of investment funds based in the UK or abroad in a tax-efficient wrapper.
Growth or income generated within the bond is not liable to UK income or capital gains tax as it would be if invested in the UK.
This gives rise to the concept of "gross roll-up" where the investment grows free of tax, greatly enhancing investment growth. Tax is only payable when the investment bond is encashed in the UK.
Offshore bonds can be very useful for investors have already exhausted other tax-efficient savings schemes, such as pension allowances and individual savings account allowances. They are also great for those who are planning to move or retire abroad.
So who specifically could benefit from offshore investing? Almost anyone who currently pays higher rate income tax who is likely to be paying at a lower rate in the future. Ideally, the investor would be in a position where they won’t pay any UK income tax at all.
The classic scenario is a higher rate taxpayer saving for retirement when they know they will become a basic rate taxpayer. Rather than pay higher rate tax now on the investment, it grows with gross roll-up, free of tax, and can be cashed in with only basic rate tax to pay.
This can be even more beneficial if the investor plans to retire abroad. The bond can be encashed free of UK tax as well as benefiting from the tax-free growth. Certain countries, such as Cyprus, will not even levy tax on the investment if you cash it in while resident there. The whole investment is basically tax free.
Offshore bonds can also be an excellent way of investing a lump sum to pay for a child’s university education. The parents would take out the bond and then assign it to the child when needed. Most students don't pay tax, so there would be no tax due on encashment.
A UK citizen who is currently working full-time abroad but who intends to return to the Britain can also benefit. Any growth accrued in the offshore bond during the period of residence overseas is not liable to UK income tax.
Finally offshore bonds can come in very useful in mitigating against inheritance tax (IHT). By placing the bond in trust, it’s possible to remove money from your estate, enabling you to pass it on the next generation without incurring any IHT. Many insurance companies will provide the trust deeds to go with their offshore bond.
As with onshore bonds, holders of offshore bonds can receive five per cent of the original investment as tax-free "income" each year as the Revenue treats this as return of capital.
Another advantage of offshore investing has traditionally been access to a number of investment managers and financial instruments which are not available onshore.
While there are a huge variety of funds available within the UK it is still the case that offshore investors have access to an even wider range, including deposit accounts with offshore banks.
So why isn’t everyone doing it? Well, the charges are usually higher than for an equivalent onshore investment. On average, an offshore investment bond would need to be held for around nine years before the benefits of gross roll-up outweigh the costs.
Basic rate taxpayers with money to invest do not generally benefit from offshore investment bonds. They would be better off investing in an onshore bond or unit trust. It is also important that offshore bonds are encashed at the right time and in the right way to utilise the tax advantages properly.
This can lead to quite complex arrangements and reduce flexible access to your investment.
Overall, offshore bonds can form an important part of an investor’s portfolio in the right circumstances . But it is even more important than usual to get specialist advice to get the most out of offshore investing.
* Trevor Law is a director with Montpelier Group (Europe) Ltd, the privately-owned independent financial advisers located at Barston near Solihull. E mail: TILaw@montpeliergroup.com