Offshore investment
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Dubai: Are you looking for medium to long term investment where underlying assets grow free of tax? Offshore bonds have been offering one such investment alternative, particularly for expats living in the UAE where income is not taxed.

“With many expatriates in the UAE and elsewhere earning salaries in tax free jurisdictions, offshore bonds have long been an ideal investment for individuals looking to make the most of the tax mitigation strategies they offer,” said Masher Suleiman, an overseas tax planning associate based in Dubai.

“However, investors must be aware of the tax regime of the country in which they are resident of when they encash their bond. Choosing the provider and location of your offshore bond is therefore important, as this will dictate many of the rules surrounding taxation and access to your savings.”

How do offshore bonds work?
An offshore investment bond is a tax-effective investment ‘wrapper’ that can hold a variety of assets, like stocks, mutual fund, among other investments. (A ‘wrapper’ is means of consolidating and managing an investor's investment portfolio and financial plans - services that are offered for a fee.)

Also referred to as ‘portfolio bonds’ and ‘tax wrappers’, they are provided by global life insurance firms to enable investors to grow capital often without attracting any tax. Within an offshore investment bond, investments benefit from growth that is largely free of tax – referred to as ‘gross roll-up’.

Because the bond in most cases act as an insurance product, it provides both a tax and legal shield to the investments held within. “While most offshore bonds available are low cost and efficient tax planning structures, great care must be taken considering such a tax wrapper,” added Suleiman.

How can offshore bonds bring you tax benefits?

“As offshore bonds are primarily being domiciled or based in a jurisdiction or country with a favourable tax regime, insurers can offer avail this scheme on a tax-deferred or tax-free basis,” explained Zubair Shakeel, an Abu Dhabi-based asset manager and wealth advisor.

“Also, regular withdrawals give investors access to tax-free capital as well. What this means is by enabling the withdrawal of up to five per cent of each investment amount every year as tax-deferred income, you save on taxes as opposed to being in a country that levies taxes on any income earned.”

However, experts reiterate that how you decide to withdraw your offshore bond investments will depend on individual circumstances, your investment’s performance and how long you stay invested. This will in turn also help you determine the most suitable offshore bond, they add.

Countries with the most favourable tax environments

Offshore bonds are not always beneficial to expats

“Offshore investment bonds are getting negative reviews given their complex nature as financial products and how these investments are taxed. Also, majority of offshore bond investors still jump into offshore bonds directly without taking appropriate advice first,” added Suleiman.

“Also, even though UAE-based expats aren’t subject to any special tax regime as investment gains are not taxed, it remains a diversified investment alternative. But perks may be comparatively limited and moving cash to an offshore bond may often deem largely unnecessary from a taxation point of view.”

When implemented correctly, however, they can be a great investment opportunity, but on the flip side they can be abused and there have been a number of instances that end up costing expats a lot of money.

Expats face new risks when investing in offshore bonds

• Offshore bond investment plans lack transparency

“While offshore bonds can be an excellent option for financial planning if used correctly, there has been a rising trend. While more investment plans advertise the use of the tax benefits offered by such offshore products, it covertly benefits asset management companies – albeit partly,” added Shakeel.

“Offshore plans are now known to hide commissions and these practices are still relatively frequent. Such practices can significantly reduce the investor’s investment, while also making the long-term costs for the investor significantly higher than they believed when they originally made the investment.”

• Complex products for ‘sophisticated’ investors

Due to its new-found complexity, those who invest in offshore bonds are classified as ‘sophisticated’ investors, i.e. those who have vast knowledge and experience in investment matters, alongside high net worth that allows them to go for high-risk investment opportunities.

“As some offshore investments are limited to highly experienced investors only, and available to those who have significant capital or are able to self-certify as knowing what they are doing, this can cause newbie investors to lose interest right off the bat rather quickly,” explained Suleiman.

• Subject to home country’s income tax laws

“There are also some highly complex offshore bonds that incur tax as high as 45 per cent on withdrawal (when you access the funds) when the investor returns to the home country. Any income taken from the bond will be subject to tax according to the rules of the country of residence of the investor.”

The type and range of underlying investments available through offshore bonds will depend on the provider and the country in which the bond is based out of. “The jurisdiction of the offshore bond will also define the exact tax rules that may apply to the bond itself and the client,” Suleiman added.

“With offshore investing grappling with intricate regulatory frameworks of foreign jurisdictions as each country operates under its own set of laws, rules, and compliance requirements. Navigating these complexities can be daunting, leading to potential misunderstandings, legal and compliance breaches.”

What’s the fix? Know the charges, fees, commissions

While investment bonds can offer some excellent advantages, it is important to understand the charges, fees and, potentially, commissions which will be charged. The minimum investment for an offshore bond will depend greatly on the providers.

The investment provider’s recommendation will depend on a number of factors, including the level of control and diversification required, as well as the level of acceptable risk against an investment. In all cases, it is important to seek advice before making any decision on provider and investment amount.

“The costs associated with investment bonds can occur when the investment is originally made, while there is also possibly an ongoing annual fee. You may also be charged a management fee by the adviser, which may be fixed or a percentage of the investment amount under management,” agreed Shakeel.

Are offshore bonds useful as advertised? Not for all investors!
• Offshore bonds are sold frequently to those with lump sums to invest, but they are not always sold with transparent fee structures, and that can be the undoing of an otherwise excellent solution.

• Therefore, the answer to this question is – yes, offshore bonds work well for many investors for whom they are suitable, but only when they are not subject to commission charges and high ongoing costs.

• For this reason it is vital to seek independent advice from someone who can analyse your full situation, including where you are likely to live in the future.

Key takeaways

Offshore bonds provide a tax effective investment option for expats as the bond will not be subject to capital gains tax and income tax deferred. This means that the investment grows free of tax, substantially increasing the value of the investment itself.

Even if the investor returns to his or her home country, the investment will continue to grow free of tax, provided the correct offshore bond is in place. However, offshore investment bonds are not for everybody and advice should always be sought before making any decision.

For the investors who meet the above investment-related conditions, offshore bonds can provide significant benefits and be a cost effective, tax efficient way of increasing capital. However, if an offshore bond is incorrectly sold or is not suitable for the investor, they can be incredibly expensive and result in the investment amount reducing over time through fees, charges and tax penalties.