Discretionary trusts and offshore bonds

by **Duelstone** on Sat Apr 23, 2011 10:33 pm

Hello, I would be very grateful if you would help me out regarding the taxation of an offshore investment bond held in a discretionary trust. I am looking to invest about £50,000 in an offshore bond for the benefit of my childrens' university fees (approximately 10 years away) and would like this within a discretionary trust. I understand that these offshore bonds pay no income tax or CGT within the fund and income tax is only due when the bond is encashed. I'm also aware that the bondholders (the trustees) would be allowed to withdraw 5% per year, which can be accumulated if necessary, without any immediate tax liability. I am a higher rate taxpayer but I'm wondering what the situation would be regarding the taxation of the proceeds if the bond was assigned to the children at the age of 18 before it was encashed? Would this reduce the tax liability? Thank you for any pointers you can give.

by **maths** on Sun Apr 24, 2011 8:32 pm

I assume the trust is a UK resident trust.

No income tax charges arise re the bond unless a chargeable event arises eg maturity; surrender; assignment for value.

If the bond is assigned to the children (ie beneficiaries under the discretionary trust) by the trustees no income tax charges arise so long as the assignment is for no consideration. It appears unlikely that an IHT exit charge would arise (unless you have already made significant chargeable gifts in the last 7 years).

Any gain arising on a chargeable event whilst you are alive and the bond is in the trust is charged on you at your marginal rate of income tax subject to top-slicing relief; any income tax charge may be recovered from the trustees by you.

As the bond is offshore basic rate income tax is also chargeable on a chargeable event.

Neither you nor your wife should be beneficiaries under the trust.

Segmentation of the bond is usually preferable.

by **Duelstone** on Mon Apr 25, 2011 12:50 pm

That's great, thank you for your reply, it is very helpful. Yes, it would be a UK resident trust.

Would you please clarify what "assignment for no consideration" means - is it that I have no interest in the proceeds of the bond and they are for the benefit of my children only? If so, that's fine.

I haven't made any chargeable gifts within the last 7 years so IHT isn't an immediate issue.

Therefore,to clarify,if I put the offshore bond into the discretionary trust purely for the benfit of my children and leave it there for 18 years before the trustees assign it to my children, at which point it is encashed (so a chargeable event arises) there would be NO income tax payable? That sounds too good to be true! Is it not subject to top slicing based on the childrens' tax position at the time(which is likely to be non or basic rate taxpayers if they have a part time job)?

If this is the case, is there any tax benefit to drawing the accumulated 5% allowance in year 18, either before or after it is assigned to the children? Thanks again for you help, it is much appreciated.

by **maths** on Mon Apr 25, 2011 4:50 pm

Would you please clarify what "assignment for no consideration" means - is it that I have no interest in the proceeds of the bond and they are for the benefit of my children only? If so, that's fine

It means that the transfer (ie assignment) of the bond is made for no money; thus, if the trustees appointed the bond out to the children for no monies no chargeable event for income tax purposes arises.

Therefore,to clarify,if I put the offshore bond into the discretionary trust purely for the benfit of my children and leave it there for 18 years before the trustees assign it to my children, at which point it is encashed (so a chargeable event arises) there would be NO income tax payable?

No, incorrect. If the trustees assign the bond to the children who subsequently surrender it then at the date of surrender an income tax charge arises at both their basic rate and higher rates (albeit top sliced if appropriate).

If this is the case, is there any tax benefit to drawing the accumulated 5% allowance in year 18, either before or after it is assigned to the children? Thanks again for you help, it is much appreciated.

No. The 5% withdrawals represent partial surrenders which are taken into account as and when a chargeable event occurs (eg encashment).

by **Duelstone** on Mon Apr 25, 2011 9:00 pm

Thanks maths, I knew it was too good to be true! So any gain is taxed at a minimum of 20% & then top slicing applies, based on the childrens' tax position at the time? Effectively by doing this I am reducing the tax liability from 40% (my highest marginal rate) to realistically 20% (unless the bond does incredibly well and pushes them into the higher rate tax bracket even after top slicing - but let's be serious)!

by **tax_schmax** on Tue Apr 26, 2011 11:00 am

This is something I personally do quite a lot of. You should be able to safely assume that as students, your children will have no income and therefore an unused personal allowance. I would imagine that the gain on this would probably fall completely within the £10,000 personal allowance we are promised, and therefore you have shifted from 40% taxes to nil in the case of the student. Probably. The future is uncertain, but as things stand, this would be a good tax planning move.