In the UK, scandals such as the Panama Papers in 2015 have done little to reverse the long-standing image of offshore funds as investments used solely to squirrel away money from the taxman. However, many argue that offshore funds offer legitimate tax planning benefits and investment opportunities. 
 
Sam Instone explains what offshore funds are and looks at the tax implications that lead many investors to use them. AES International is a global wealth management firm that’s involved in offshore banking.
What is an offshore fund? To UK investors, it is a collective investment vehicle that is not domiciled in the UK.  It is typically based in low-tax jurisdictions like the Isle of Man, the Channel Islands, Luxembourg or Dublin.

Most UK onshore funds have identical offshore counterparts to cater for different savers. This means offshore funds broadly fall into categories that investors are already familiar with. These include open-ended investment companies (known as SICAVs in the offshore world), investment trusts and unit trusts. 

Like onshore investment products, offshore funds can be accessed directly, through a fund platform or by using an intermediary.
Why do people use offshore funds?This depends on several factors, but they are mainly employed for tax purposes.

Offshore funds are not necessarily tax free; there are often withholding taxes applicable that cannot be reclaimed, depending on the nature of underlying investments. 

For UK resident investors, the benefits of an offshore fund chiefly relate to its reporting status, which determines whether income tax or capital gains tax (CGT) is paid on the returns made on any investment. For tax purposes, offshore funds are divided into reporting and non-reporting products. 

Much like onshore funds, reporting funds must disclose all the income they make to UK investors and HMRC. These gains are then taxed regardless of whether or not they have been distributed to investors.

If a UK investor is holding a reporting offshore fund outside a tax wrapper, like an individual savings account (ISA) or self-invested personal pension (SIPP), gains beyond the current annual exempt amount of £11,300 will be subject to CGT rates of up to 28%. Losses can be offset against future CGT bills.  

On the other hand, a non-reporting fund is not required to report details of its income, which means gains are only taxed when they are distributed to investors. This delay can be useful for higher rate taxpayers who think they could qualify as a lower rate taxpayer by the time they cash in. For example, clients who are planning to retire or move to a low tax jurisdiction. 

However, when returns are received on non-reporting funds they are classified as ‘offshore income gains’ and are liable to income tax rather than CGT, which can come in at up to 45%. Furthermore, losses cannot be offset against future capital gains. 
Taxation of returns for 2017/18 tax year on onshore funds and offshore funds held outside an ISA or SIPP 

		Onshore fund	Offshore fund with reporting status	Offshore fund without reporting status
Gains below the £11,300 annual capital gains tax exempt amount	Basic rate taxpayers	None	None	20% (income tax)
	Higher rate taxpayers	None	None	40% (income tax)
	Taxpayers earning over £150,000	None	None	45% (income tax)
Gains above the £11,300 annual capital gains tax exempt amount	Basic rate taxpayers	10% (capital gains tax)	10% (capital gains tax)	20% (income tax)
	Higher rate taxpayers	20% (capital gains tax)	20% (capital gains tax)	40% (income tax)
	Taxpayers earning over £150,000	20% (capital gains tax	20% (capital gains tax)	45% (income tax)

Source: Tax positions explained: Direct investors

For UK expatriates, tax benefits vary widely depending on the country of residence, but can include keeping money outside their home country’s tax jurisdiction. Offshore funds can also effectively be used to benefit estate planning. 

A non-domiciled UK resident who does not intend to remit income or gains to the UK could potentially look at non-reporting offshore funds. However, it is important not to fall foul of any regulations or other taxes that may become due.

Aside from the tax implications, offshore versions of onshore funds can give UK investors exposure to their desired investments in an alternative currency. This is useful during periods of sterling volatility, but it may backfire if the alternative currency also drops in value. 

Furthermore, some offshore funds give investors access to a niche investment sector or highly specialised hedge fund strategy unavailable onshore due to the stricter rules in the UK governing where investments can be made.
What’s available?As offshore funds are often replicas of onshore counterparts, there is a wide variety on offer covering all asset classes and geographies. 

Many international advisers or financial planners offer reviews and recommendations of funds to help investors pick the best opportunities. The UK government also posts a regularly updated list of reporting offshore funds, with nearly 60,000 currently listed. 

Historically, offshore reporting funds that levied performance fees, such as hedge funds, had a performance advantage over their onshore counterparts. Investors in these products were able to subtract performance fees before calculating how much UK income tax they owed, helping to mitigate their bill. 

This accounting loophole was shut in April 2017. Aside from that, the performance of onshore and offshore versions of the same fund is usually similar.
How much to invest?Whether or not an investor is suited to an offshore fund depends on individual circumstance, attitude to risk, other taxable income and a product’s investment mandate.

The funds are typically aimed at sophisticated clients and investments are usually larger than those made by UK investors with a stocks and shares ISA. For example, the infamous Blairmore offshore fund set up by former UK prime minister David Cameron’s father had a minimum initial investment of $100,000 .

We have seen offshore hedge funds and absolute return funds being used as a satellite position in a wider portfolio. However, this has often not been beneficial due to the opaque nature of these funds and their charging structures, which have eroded returns.
About the expert

Sam Instone is founder and chief executive of AES International, a global financial firm whose UK company provides services in offshore wealth management, cross-border investment advice, and financial planning to expatriates around the world. 

Sam is a former British army officer in the Household Cavalry Regiment. Liquidity and protectionAs always, liquidity depends on the nature of the fund’s underlying asset. For example, property is a lot harder to sell than shares in a FTSE 100-listed firm when investors look to exit. Most offshore funds are daily dealing rather than exchange-traded and some funds are weekly dealing if the underlying assets are more illiquid.

Unfortunately, if an investor puts money into an offshore fund that subsequently collapses due to mismanagement, there will be little to no protection on offer. However, if a UK-based company or adviser encourages an investor into a fund, it may be possible to receive compensation from the UK Financial Services Compensation Scheme (FSCS). This pays out fully on losses of up to £50,000.
Are charges typically higher?As they are usually smaller than onshore funds, fixed costs like reporting and administration make up a larger portion of offshore funds, meaning ongoing charges can look higher. In theory, this means wealth managers using offshore funds may need to take a less defensive approach across a client’s investment portfolio to replicate onshore returns. Index funds from firms such as Dimensional Fund Advisors, Vanguard Asset Management and BlackRock’s shares are just beginning to gain traction as lower cost options within the international market-place. 

Seen a blog, news story or discussion online that you think might interest CISI members? Email eila.madden@wardour.co.uk.