Friday, February 16, 2007

Insurance Wrapper Tax Play

Few of us would consider carrying around our personal possessions in a black plastic bin-liner but that effectively is what many of us are doing with our financial possessions. This is because most of us hold our investments directly as 'naked owners'. The use of an appropriate wrapper to hold our financial possessions is analogous to using a suitcase or trunk for our personal possessions, which can be safely stored in the aeroplane's hold while we travel, unhindered, in comfort. We can, of course, carry on a limited amount of baggage with us on to the plane but that should be for immediate use only, for example, our transaction banking account.

The use of a wrapper to hold property effectively disconnects the property from the individual and the fact of this disconnection can bring about tax advantages, especially if an offshore-based wrapper is used, because the property no longer vests in the individual but in the wrapper. As a result, tax authorities view wrappers with suspicion and are constantly (it is an ongoing process varying from country to country) introducing anti-avoidance legislation to attack the tax efficient use of wrappers. This is unfortunate because the utility of wrappers for individuals extends beyond their tax efficiency, which is how unhappily they have been marketed in the past.

tax regime

The portfolio insurance bond (PIB) provides tax efficiency and has the marked advantage of being viewed, because it is an insurance product, as a privileged transaction by most onshore jurisdictions. Most countries have well established taxing regimes for insurance policies and these regimes are usually applied with certain modifications to offshore policies. It is therefore usually possible to obtain definitive tax and estate planning advice in respect of such policies in most countries where individuals are likely to live, work or retire. In an environment of full disclosure, certainty of tax treatment must be viewed as a sine qua non of tax and estate planning solutions going forward and the PIB is relatively unique in this respect. Civil law countries, for instance, do not prima facie recognise trusts but they do recognise insurance policies since these are in the nature of a commercial contract. If there is a problem with insurance per se in a particular jurisdiction then a capital redemption policy can be used instead.

From a UK perspective it is probably safe to assume that the PIB tax regime is now settled and will enjoy the same stability as the UK's tax regime for collective investment schemes and provides a reliable basis for long-term planning. The insurance companies have considerable financial clout in the UK and have successfully resisted in the past draconian anti-avoidance legislation proposed by successive UK governments. That clout can also be used to obtain best execution and discounts on directly-traded securities and collective investment scheme transactions, which would not be available to individuals investing directly on their own account.


PIBs can also ease the reporting headache for both individuals and trustees. The asset that is owned by the individual is the insurance policy, not the underlying securities. All transactions in the underlying securities are therefore irrelevant from a reporting point of view for the owner of the PIB who is only concerned with additions to and withdrawals from the PIB for his tax return. Nevertheless, full details of the transactions and the valuation of the holdings in the PIB are regularly reported by the insurance company and a current valuation is usually only a telephone call away or available on the internet. The bookkeeping for individual securities transactions is performed entirely by the insurance company who will also account for dividends and corporate events. In the UK, insurance companies are to be required to provide calculations of gains so that they provide the figure to be entered on the investor's tax return without further computational work by themselves or their advisor. If the PIB is held in trust this can mean substantially reduced trustees' fees since the trustee does not have to account for and value the underlying securities transactions.

The use of a PIB also avoids an individual getting caught up in disclosure regimes such as the US qualifying intermediary regime which became effective from 1 January 2001 or the EU Savings Tax Directive. QI type regimes can be expected to be widely adopted by other OECD countries over the next decade. Trustees also fall within this regime and the use of a PIB avoids them having to disclose to revenue authorities details of the trust's settlor and beneficiaries. A PIB can hold cash as well as investments and from 1 April 2001 the UK's banks have reported to the Inland Revenue interest paid gross to individuals not ordinarily resident in the UK. Details of the interest will then be reported to the tax authorities of the individual's country of residence.

While PIBs are often marketed as welded investment products, and in the past the insurance companies have only offered their linked in-house funds as the underlying investment, it is now common for a wide variety of underlying investments to be available including direct equities, indices and cash. It is also possible to switch between investment types without incurring switching fees. The naïve investor can therefore begin by investing in a with-profits type fund and as they mature and their savings accumulate they can move into more exotic investment types.

PIb benefits

There are family unit trusts available in the market for which the minimum investment is usually in the order of £1m. The primary benefit of these funds is that the family can appoint its own investment adviser for its investment cell within the unit trust and change the adviser without triggering a tax charge. But this arrangement can be easily provided using a PIB for much lower value portfolios. The usual minimum entry for direct investment is £100,000 and for linked investment £15,000. The insurance companies are introducing competitive pricing structures for PIBs, which become more cost effective the longer the bond is held.

A PIB has the advantage of being both a tax deferral mechanism and providing tax free withdrawals. For an individual whose residence position changes over time this means that during a period of residence, funds can continue to be withdrawn from the PIB tax free and accrued income and gains can be 'bed and breakfasted' during a period of non-residence. Since gains realised on a chargeable event are taxed as income gains and not capital gains the more generous UK income tax split-year concession can be used and only a period of one year's non-residence is required. If investments with accrued gains were directly held then an individual would have to break their residence for five years to be able to realise the gains which have accrued during a residence period tax free.

PIBs can also be used for employee benefit and pension schemes when held in trust. The trustees can unitise the PIB in their records (not account for the underlying units or securities in their records, which they must never do) and allocate interests to the various employees and, if necessary, their dependents. If an offshore PIB is used the policy can be written on the multiple lives of the employees to avoid an unwanted chargeable event affecting the other employees.

If it is required to transfer the PIB into trust at some point this can be done without triggering a chargeable event for UK tax purposes so long as the PIB is gifted into trust and not sold to the trustees. The PIB can also be assigned to another individual as a potentially exempt transfer for UK inheritance tax purposes. This is a considerable advantage since transferring directly held assets or collective investment schemes to another individual or into a trust or company usually triggers a capital gains tax charge. The use of PIBs, trusts and life insurance policies in combination opens up a large number of short and long-term tax and estate planning possibilities.

If you would like to discuss how you may use such an insurence wrapper/ portfolio bond, then please get in touch.

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