Bloomsbury Financial Planning

BIG firms have long been attracted to Ireland’s favourable tax regime but now individuals are being advised to put their savings there, too, following little-noticed changes in Alistair Darling’s first budget.

Firms such as Yahoo, eBay and Google have set up shop in Dublin, where the corporate tax rate is 12.5% compared with Britain’s 28%. Last week, Shire Pharmaceuticals became the first FTSE-100 company to relocate there.

Dublin-based offshore cash funds have become more attractive following the chancellor’s March budget, as they have the potential to save middle and high-income earners 15% off their income tax bills.

Jason Butler, of Bloomsbury Financial Planning, said: “The turmoil in equity markets means that cash is becoming more attractive to investors. The income from offshore cash funds is classed as a dividend, and so not subject to the 40% you would pay on a savings account. Since the budget, however, the position has become even more favourable.”

RELATED LINKS

• At a glance: tax changes for 2008/09

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Opportunities for investors have also arisen out of government changes to capital gains tax, with advisers working overtime to ensure clients benefit from the cut in the CGT rate from 40% to 18%, and the increase in the allowance to £9,500.

On an investment paying out an annual income of £10,000 a year, making sure you pay CGT rather than income tax could save £3,910 in tax.

David Kilshaw at accountant KPMG said: “This is the latest game in town. It is early days yet, but it’s a logical next step.”

We look at how the super-rich are paying less income tax, and how you can too.

1 The offshore cash fund

Cash funds invest in a portfolio of bank deposits. In Britain, interest from cash funds is taxed as income at 40% for higher-rate taxpayers and 20% for those in the lower band – the same as if you were investing in a standard deposit account.

However, certain offshore funds are set up to distribute dividends, not interest, subject to higher-rate tax at 32.5% or 10% at the basic rate. Historically, this made investing in offshore cash funds an attractive proposition for the super-wealthy, but the costs involved were not worth it for those with smaller deposits.

Following changes unveiled in the budget, dividend income sourced overseas became eligible this month for a tax credit worth 10%, taking the tax rate fora UK resident higher-rate taxpayer to 22.5% or 0% for a lower-rate taxpayer.

Butler said: “This is substantially more attractive than receiving income from a UK cash fund or savings account, which will still be taxed as interest income. If a fund yields 5.1% in Dublin, a higher-rate taxpayer would need to find an equivalent savings account yielding consistently more than 6.30%.”

The principle applies to all offshore accounts, but Butler likes Dublin “because we can get decent funds in sterling”.

Smith & Williamson Investment Management offers cash funds with a rate of about 5.1%. Rates change daily and are not guaranteed, but you can take your money out at any time.

Better rates are available on higher deposits – for example, Goldman Sachs, the investment bank, offers about 5.7% on deposits over £1m.

For a higher-rate taxpayer with £1m invested, the difference between an investment in an Irish cash fund and the best-buy savings account is £5,250 a year. A higher-rate taxpayer with a £20,000 investment, would pay £245 less tax a year with an Irish fund. In most cases, funds will spread deposits across at least 10 financial institutions, Butler said.

If you invested £20,000 in a savings account at 6.25% you would receive a net return of £750 a year, after paying £500 tax. If you invested in an offshore cash fund paying 5.7% you would receive a net return of £855 after paying just £285 tax – £105 more.

2 Investment bonds

UK insurers usually own an international arm based in Dublin or the Isle of Man, including Axa Isle of Man, Royal Skandia, Clerical Medical International, Prudential and Friends Provident. Investors can buy offshore bonds from these providers, and benefit from an added tax perk. They can withdraw up to 5% of the capital invested in the bond with no tax to pay until the entire bond is cashed. So those who expect to move from a higher-rate tax band to a lower rate or plan to retire to a low-tax country benefit from being able to defer their tax.

Your returns are also likely to be higher with an offshore bond because they can grow tax free. If you invested £50,000 in an onshore bond, you would have a lump sum of £72,294 after 10 years with growth of 7% a year, according to SG Hambros.

If you invested the same amount in an offshore bond, you would have £72,833 at the end of the term – an extra £539 as your gains would have rolled up gross. The figures assume higher-rate tax is paid.

However, fees and charges are usually higher and advisers do not recommend them for investments of less than £100,000, and less than five years. With onshore bonds, cash rates are often guaranteed.

3 Zero dividend shares

Much-maligned “zeros” could be about to make a comeback, thanks to Darling’s CGT changes, which mean a portfolio of zeros structured to provide a regular income is taxed at 18% rather than 40%.

Zeros aim to return a target sum to shareholders on a set date and were widely used as a “safe” way to save for retirement and school fees before the stock market dived in 2001. Following the collapse, split-capital investment managers were alleged to have colluded to prop up the sector by issuing new shares bought by other splits managers. The Financial Services Authority ordered firms to pay £350m in compensation.

It is understood firms are again playing up the tax advantages of zeros. Technically zeros do not pay out any income – they offer a predetermined return when the trust is wound up, provided it achieves a stated minimum return – so all of gains are subject to CGT.A higher-rate taxpayer taking an annual “income” of £10,000 from a portfolio of zeros would be liable to tax on the sum over the annual CGT limit – £9,500 this year. That’s 18% on just £500, or a tax bill of just £90.

4 Get some of your CGT back

Did you pay capital gains tax at 40% within the past three years? You may be able to claw back the tax previously paid if you “reinvest” the same amount as the gain into a “qualifying investment” such as an enterprise investment scheme (EIS). You could also choose to reinvest the money into your own business.

Butler said: “Darling’s proposed new flat-rate CGT regime shines a rather different light on reinvestment relief and opens up a lot of opportunities for individuals who have made substantial capital gains on property in the past.”

If you made £250,000 from the sale of an investment property that was subject to CGT at 24% as a higher-rate taxpayer, you would have paid £60,000 in tax.

If you reinvested the £250,000 into a EIS, though, you could claim back the £60,000 previously paid on your tax return, then get a cash refund or a deduction from any other tax owed. When you eventually came to sell the EIS, you would only be taxed at 18% under current rules – so would make between £15,000 and £55,000 on the capital gains tax relief.

5 Halve your tax in retirement

At retirement you are allowed to take 25% of your pension fund as tax-free cash. However, if you invest that in a standard savings account or fund you will pay tax on any income it produces, so it is not tax-free at all. If you put the money in an offshore bond, though, you can withdraw 5% a year without paying tax.

The investments also grow tax-free until there is what is known as a “chargeable event” – when you cash the bond and bring the funds back into Britain or take out more than 5% a year.

Jason Hemmings at Albannach Financial Management, an adviser, recommends combining income drawdown, an alternative to buying an annuity at retirement, and offshore bonds. That way even when you bring the funds into Britain you can keep tax to a minimum.

With drawdown, your fund remains invested with the option of drawing an income each year, which you can stop at any time. If you have a £400,000 fund at retirement, he suggests you take £100,000 as tax-free cash and place it in an offshore bond. The remaining £300,000 should then be placed in income drawdown, from which you would take an income of £15,000 a year.

When the offshore bond grows to £115,000 you reduce the drawdown income to nothing and surrender your bond. This is a chargeable event, but because you don’t have any other income in that tax year this is your only liability. You therefore pay basic-rate tax on the £15,000 gain at 20% – £1,732. Had you kept drawing the income from drawdown your tax bill would have been more than double that, at £4,732.

You restart taking drawdown payments in the following tax year and reinvest the £100,000 in a new offshore bond, repeating the process.

IN SEARCH OF LEGITIMATE BREAKS

For the past 10 years Keith Bennett of Surrey, a self-employed health and safety consultant, has invested in offshore bonds with Skandia.

Bennett, a higher-rate taxpayer in his early sixties, has started to think about possible retirement, when he will encash the bond as a lower-rate taxpayer.

‘I feel I should be able to reduce my income tax bill legitimately,’ he said.

‘I will pay more capital gains tax when I come to sell my business under the government’s changes to CGT so I rely on my accountant, Menzies, to find legitimate tax breaks. I want to make sure I can take advantage of any relief that is out there. I also use Isas and save into a pension.’

Penny Bates of Menzies said: ‘There are legitimate tax breaks out there for middle-class workers – if they know where to find them.’

HOW THE FUNDS WORK

— They invest in a portfolio of deposit accounts from leading financial institutions

— They distribute dividends, taxed at 32.5% for higher-rate taxpayers, against 40% on UK savings, which are taxed as income

— However, UK cash funds also pay company tax, which means in effect you pay 40%

— Changes in the March budget also mean that dividend income from offshore funds is eligible for a 10% tax credit, cutting the tax to 22.5%

— Basic-rate taxpayers are taxed at 10% on dividend income – or 0% on overseas dividend income now that they get a tax credit.