Tax Tips: The lure of offshore gains

As ISAs with their pounds 50,000 cap loom, investors are sending their savings into exile.

Sales of offshore bonds and insurance policies are booming as the Budget looms. With the prospect of personal equity plans (PEPs) and tax-exempt special savings accounts (Tessas) being scrapped in 1999, the lure of these investments is strong. But savers tempted by the prospect of tax-free gains are putting cash into investments designed for expatriates.

Peter Nightingale, of accountants Deloitte Touche, warns "many of these offshore vehicles pay high commission to intermediaries, and offer little real saving to anyone living here. They are sold as a substitute for good tax planning".

A number of British insurance companies, like Allied Dunbar and Scottish Widows, have set up offshore arms based in the Channel Islands, Dublin and Luxembourg. These havens levy tax on fund income of 20 per cent or less, with no charge on capital gains.

But UK taxpayers are still liable to tax on encashment of such policies, after deducting the original amount invested. The key difference is that because these funds roll up free of tax, they allow its deferral and should give better performance than UK based equivalents.

Clerical Medical International estimate the net gain for a basic-rate taxpayer in an offshore bond could be as much as 10 per cent of the amount first invested, but only after holding the bond for15 years or more. The gain for a higher-rate taxpayer is even greater, but early encashment brings heavy penalties.

Better value can be found in FSA recognised offshore funds, mostly run through Luxembourg. These are similar to unit trusts.

Nigel Davies of Arthur Anderson suggests "These can be useful for those with capital but no income. Funds pay only a 15 per cent withholding tax. Using both your personal allowance on income tax and annual exemption on capital gains means that you can realise up to pounds 10,545 tax free."

Many UK banks and building societies also run offshore accounts, paying interest gross. Abbey National (Jersey) return 6.2 per cent gross for deposits of pounds 10,000 or more on instant access. Onshore, their 30-day account yields just 4.98 per cent gross for the same amount.

Income tax is payable on interest received but for non taxpayers, rates can equal those from Tessas. If you have no other source of income, your personal allowance of pounds 4,045 means you can hold over pounds 50,000 in an account paying 7 per cent gross.