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Saving tax is a good policy

By John Hayward - Topics: Bonds, insurance bond, Investments, Saving, spain
This article is published on: 9th October 2017

09.10.17

Having recently written about the benefits of using a well-established investment or insurance company to manage your savings, within a Spanish compliant insurance bond, with the benefit of your money growing by more than inflation and far more than any bank has offered in recent years, I want now to explain how brilliantly tax efficient a Spanish compliant insurance bond is. I will do this by telling stories of two married couples. Mr and Mrs Justgetby and Mr and Mrs Happywithlife. Both couples are retired and tax resident in Spain. Also, both couples have two adult children in the UK.

Story 1 – Mr and Mrs Justgetby
Mr and Mrs Justgetby have lived in Spain for 10 years. They had sold up in the UK in 2007 and bought a property on the Costa Blanca (Valencian Community). This is valued at €300,000 and owned jointly. They each receive pensions from the UK in the form of State pensions and both have small company pensions. These cover their expenses but do not allow them to do much more. From the sale of their property in the UK, they were left with £200,000. They exchanged £50,000 before moving to Spain when the exchange rate was 1.45 euros to the pound. This gave them €72,500. They have had to eat into this because they needed a new car, they have done a bit of work on their house, and they have had to supplement their pension income. The exchange rate has also gone against them by about 20%. They are now left with €50,000 in their joint Spanish bank account. This does not pay any interest. The remaining £150,000 is in the UK in a variety of investments made up of premium bonds, ISAs, and fixed term savings accounts. The accounts have been split so that each holds exactly the same in individual accounts so that they each hold £75,000.

INCOME/SAVINGS TAX
“ISAs and premium bonds are…..not tax free for Spanish residents”!
Whilst no interest is being paid on their Spanish bank account, at least there is not a tax concern there. However, some of the money in the UK is in tax free accounts. ISAs and premium bonds are tax free for UK tax residents but are not tax free for Spanish residents. Therefore, any income or gains from these investments should be declared to Spain. Mr and Mrs Justgetby have not been declaring any of the prizes they have received from neither the premium bonds nor the interest from the ISAs believing this not to be necessary. With automatic exchange of information that has come into force, Mr and Mrs Justgetby may be in for a nasty shock for unintentionally evading tax.

INHERITANCE TAX
On the death of either Mr or Mrs Justgetby, there are some significant tax issues. As they are tax resident in Spain, the surviving spouse will be liable to Spanish inheritance tax (known as succession tax in Spain) on 50% of both the property value and the bank account as well as 100% of the assets owned by the deceased in the UK. The inherited amount in euro terms, based on an exchange rate of 1.13 euros to the pound, is €150,000 (property), €25,000 (bank account), and €84.750 (UK investments). This totals €259,750. The Spanish inheritance tax on this, after allowances, could be around €11,500.

On the death of the other spouse, the children in the UK would have a liability of around €5,000 each based on current rules and on the assumption that their pre-existing wealth is not over certain limits.

Story 2 – Mr and Mrs Happywithlife
By coincidence, Mr and Mrs Happywithlife were in the exactly same position as Mr and Mrs Justgetby in terms of when they sold their UK property and they had exactly the same amount of money as Mr and Mrs Justgetby in cash. They also have a property in Spain worth €300,000. Instead of investing in ISAs, premium bonds, and deposit accounts in the UK, from the £200,000 property sale proceeds, they put £175,000 into a Spanish compliant insurance bond in joint names. The policy will pay out on the request of Mr and Mrs Happywithlife or when the second of them dies. They felt that it would not be necessary to hold so many euros in a low or no interest bank account in Spain. They kept £5,000 in a UK bank account to cover the times that they pop back to the UK to see their children and the remaining £20,000 they exchanged into euros and deposited almost €30,000 with their local bank.

INCOME/SAVINGS TAX
“……tax is only due when withdrawals are made.”
Once again, the interest in the bank account in Spain has paid little interest and so has not created a tax problem. However, the Spanish compliant insurance bond has increased in value but has not created a tax liability to date. This is because tax is only due when withdrawals are made and then only on the gain part of the withdrawal. This has allowed the plan to increase on a compound basis as tax has not been chipping away at the growth. They have decided to take regular amounts from the bond now. Each time the money is paid out, the insurance company deducts the appropriate amount of tax and pays this to Spain. As mentioned, the amount of the tax will be determined by the gain portion. In the early years, this is generally little or nothing due to the special tax treatment afforded to these types of savings plans. Longer term, the tax payable is likely to be a fraction of that payable by those who own non-compliant investments.

“….tax that they saved has gone towards a cruise….”!

Unlike Mr & Mrs Justgetby who would have had to pay €1,980 on the €10,000 gains they made, Mr and Mrs Happywithlife would not have had to pay anything. Instead, the €1,980 tax that they saved has gone towards a cruise they are going on next year.

INHERITANCE TAX
On the death of either Mr or Mrs Happywithlife, using the same assumptions as with Mr and Mrs Justgetby, the surviving spouse will inherit 50% of the property value (€150,000), 50% of the Spanish bank account (€15,000) and 50% of the UK bank account (€2,825). This totals £167,825. The Spanish inheritance tax on this, after allowances, could be around €3,500, €8,000 less than Mr and Mrs Justgetby´s position.

On the death of the other spouse, the children in the UK would have a tax liability of closer to €4,500 each as their parents had less money in the Spanish bank than Mr and Mrs Justgetby.

The difference the Spanish compliant bond makes
As the bond was set up on a joint-life, last survivor (second death) basis, there is no “chargeable event”, as it is known, on the death of the first spouse. Nothing is paid out on the first death as the insurance bond was taken out to pay out when the second party dies. This will have saved either Mr or Mrs Happywithlife thousands of euros in tax.

Words of warning
Tax rules change regularly and the figures quoted are estimates based on our knowledge at this time. The allowances assumed are those applying to the Valencian Community at the time of writing.

Brexit could have an effect on the benefits received by the children in the above cases. Allowances apply currently to the children as they live in the UK and are part of the EU. The allowances may not be there after Brexit.

There are a number of other ways to reduce taxes by distributing wealth appropriately. Everyone is an individual and we all have different needs. Therefore, a financial review is the first part of the solution.

It is vital, from a compliance point of view, to take a look at all our financial arrangements and more importantly to review them on a regular basis. What we may have once bought many years ago, and which complied then, may now have become obsolete and could cause tax questions later.

Reviewing existing contracts and investment arrangements has become much more important with the open border tax sharing arrangement, the Common Reporting Standard’ which has now been fully implemented.

It might just be the right time to start looking at your existing arrangements to ensure they comply before anyone starts looking.

Fun Financial Fact
The Latin for head is caput. In ancient times, cattle were used as a form of money and each head of cattle was a caput. Therefore, someone with a lot of cattle had lots of caput or capital

How to be compliant…..

By Gareth Horsfall - Topics: Bonds, Investments, Italy
This article is published on: 3rd October 2017

03.10.17

What an interesting couple of weeks. Organising a protest in Firenze to fight for the protection of citizens’ rights in the EU, to being interviewed across multiple news channels around the world and being joined by about 100 people who turned up on the day and got an equal amount of press attention. And now, to slip back into normal life again and a work/life pattern. It all seems a little surreal.

But whilst the amazing memories are still clear in my mind, the ever present obligations of financial life continue and in this article I am going to elaborate on one which is an extremely useful financial planning tool in Italy.

I haven’t written about the benefits of the Italian compliant Investment Bond for some time and the details have moved on a little since my last musings on this topic. In this article I just want to take a look at the Investment Bond contract, the things that make it compliant for Italian tax purposes and why they can help with long term tax planning in Italy.

WHAT IS AN INVESTMENT BOND?
In short, an Investment Bond is a life assurance contract, but the life assurance part is stripped to a minimum and your money is allocated exclusively to investments. Its other name is an Investment Bond. The life assurance part is normally offered by a company as an additional 1% of the value paid out by the company on death or a minimum protection of the original investment, determined by you. Under these terms the contract qualifies as an Investment Bond and therefore is treated preferentially for tax in Italy.

Typically these companies are based in Dublin, Ireland, and due to its place in Europe and standing as a financial centre, can design products exclusively for different EU markets. In this way the money is not located in Italy but complies with local laws.

WHAT IS THE TAX TREATMENT?
Any invested monies, whilst held in an Italian compliant Investment Bond will NOT be immediately liable to capital gains tax or income tax on distributions/dividends etc.

This means that for the larger portfolios, where active management of a portfolio is taking place, the money can be moved around and invested in any way possible without incurring an immediate tax liability. Administratively, this has huge advantages as each taxable event (income or gains) do NOT have to be reported and taxed in the year in which they occur, and neither does the arduous task of calculating everything, pro rata, from the UK tax year to the Italian tax year or vice versa, for example, and/or converting all those events to EUR from other currencies on the day in which they occurred at the official Banca D’Italia EUR exchange rate. A large task even for the more monetary minded.

The monies are only taxed when a withdrawal is made and ONLY on the capital gain element of the withdrawal, not the whole amount.

This can be a highly effective tax planning tool for those seeking growth and/or income from investments. It can literally mean an income stream with very little liability to tax in the early years.

COMPLIANCY IN RECENT YEARS
In recent years the Italian authorities have been looking into the higher value arrangements that qualify under the definition of Polizza Assicurativa Unit Linked / Investment Bond to ensure that they comply. If not, tax penalties and redefinitions of the policies can arise (more on that below).

The more recent developments are as follows:
1. The policy must have the opportunity to insure a certain level of the principal investment. (But this option does not necessarily have to be taken up).

The theory here is that these vehicles are clearly being used for investment purposes as the main driver and the life assurance element is secondary. The Italian authorities now expect to see that the option to protect a specified amount of the investment, on death, is included in the policy, rather than just the historic additional 1% paid out on death.

2. ‘Self investment’ and ‘advised’ investment options are NOT unlimited.

In the past it has typically been the case that you could invest in any traded investment funds in the world. However, the Italian authorities started to look at this more closely, and rightly in my opinion.

Their argument is that monies in an Investment Bond should be invested in the ‘approved funds’ of the company OR the money should be managed by a professional asset manager (our preferred partners are Rathbones, Tilney Investment group and Prudential). In this way the investor, you and I, are at arm’s length from the investment decisions. That is, it should not be managed exclusively by ourselves when the money is in the hands of the Assurance company. In reality, the investor has quite a lot of power to restrict and allow investment decisions, but they must be within the parameters laid down above.

And lastly on this point, the ability for rogue advisers to recommend investing in offshore registered funds, unregulated investments or merely investments that pay the adviser extra commissions for finding more subscribers, are much more restricted with the Italian authority decision. This has to be viewed as a good thing, in my opinion.

3. One size does not fit all

The last point is one that affects many British holders of these investment vehicles where they may have been advised to take out an investment because an adviser in the UK, for example, recognises the tax effectiveness of the assurance structure but does not understand the details required for full compliancy under each EU member state.

The typical type of policy issued under these terms is one which is located in the Isle of Man, Luxembourg, or Switzerland. A lot of these contracts, although generically correct in structure, lack the detail for it to fully comply with the requirements for an Italian Investment Bond.

If you are a holder of a contract in one of these jurisdictions, it is worth checking the terms and conditions.

WHAT HAPPENS IF MINE DOESN’T MEET THE CRITERIA?
Of course, the big question is what happens if you own or are thinking of starting an investment contract of this type without the necessary conditions mentioned above.

In recent years there have been some notable cases where the Italian authorities have looked through the structure and ruled that the portfolio was nothing but a classical investment portfolio and that the preferential tax treatment never applied. As a result, all historical taxable liabilities; capital gains and income payments, have had to be calculated and paid immediately to the authorities.

The ruling was made on the basis of one or more of the elements mentioned above not being complied with, from too much control over investments to too little life assurance protection being offered to the client.

Therefore, it is vital, from a compliance point of view, to take a look at all our financial arrangements and more importantly to review them on a regular basis. What we may have once bought many years ago, and which complied then, may now have become obsolete and could cause tax questions later.

Reviewing existing contracts and investment arrangements has become much more important with the open border tax sharing arrangement, the Common Reporting Standard’ which has now been fully implemented.

It might just be the right time to start looking at your existing arrangements to ensure they comply before anyone starts looking.

If you hold assets directly or through historic contracts of this type and would like to review them, you can contact me below or call me on +39 333 6492356.

Is lending money to a government still low risk?

By Peter Brooke - Topics: Bonds, France, Investment Risk, Investments, wealth management
This article is published on: 26th July 2017

26.07.17

If you buy a government bond, sometimes called GILTS (UK), BUNDS (Germany) or T-Bills (US), as an investment, then you are effectively lending that government money. Most portfolio managers say investors should have some bond exposure in their investment portfolios as they diversify away from other assets like shares.

How do Bonds work?
You start by buying a bond on ‘issue’ for a set issue price with a ‘promise’ to pay you back the same amount in a date in the future. In the meantime, the bond pays you a ‘coupon’ or interest in payment for you lending your money. The bonds are also traded on a ‘secondary bond market’ where the price fluctuates according to supply and demand but the coupon remains the same… this means that your interest rate changes depending on what price you pay for the bond.

You can also invest in ‘funds’ of government bonds which are managed by professional managers using new issue and secondary market bonds around the world to build a diversified portfolio… but are they as low risk as they are made out to be?

Traditionally these forms of investment have always been viewed as low risk, as governments, unlike companies or individuals can always ‘print money’ and so can always pay you back. This also means that the interest rate you receive (the coupon) will be lower than company bonds.

If we consider that RISK is the chance of loss then I would argue that these investments are no longer low risk. Right now, we are in an environment where interest rates are at all-time lows around the world, inflation is starting to bite and so the chance of an interest rate increase by central banks is high; even though the rate increases may be low.

If you are holding any bond and interest rates go up, then bond values will drop, therefore I would argue that at some point you are risking a capital loss by holding government bonds. Some analysts believe that a 1% increase in interest rates could lead to a 10% capital loss on most bonds. If this is the case are you now being compensated for this risk of loss? Well, no… interest rates on government bonds are around 1% now and so with inflation higher than 1% in most countries you are losing money on an annual basis too.

So, what can you do about it? The first option is to take a little more risk and swap your government bonds for high quality corporate bonds… the coupon will be greater and as long as the companies are in good health then they should be able to repay you at the end of the term… there are also funds of corporate bonds which diversify risk.

The corporate bond market is segmented by credit rating so be aware of the level of risk this can bring to your savings… “high yield” (Europe) or “junk bonds” (US) tend to behave more like shares.

Another option would be to diversify away from western government bonds into emerging market government bond funds… there is some extra currency risk, though this can help performance too. Finally, you can outsource the choice of the bonds you buy by using a Strategic Bond fund… this will invest in corporate, government and emerging markets bonds on a strategic basis and would be very diversified.

This article is for information only and should not be considered as advice.