Offshore cash isn't off limits to the Revenue

As UK residents with Irish accounts are probed, Simon Hildrey looks at legal ways to save ta

British residents with offshore bank accounts were told last week to check they are compliant with tax laws if they want to avoid heavy penalties. The warning, from accountants KPMG, comes as the Inland Revenue investigates whether UK residents with bank accounts in Ireland, in particular, have declared them on their tax returns.

The Revenue says it is carrying out an "ongoing investigation into offshore bank accounts held by people residing in the UK". According to KPMG, this includes bank accounts in Ireland held by UK-based individuals, trust accounts with the Bank of Ireland in Jersey and offshore accounts held through other Irish and UK banks.

The inquiry should act as a reminder that it is not legally possible for British citizens to hold money offshore without declaring it to the authorities and therefore without paying tax.

However, while you have to pay tax, there are ways to defer it. For example, interest earned on offshore bank accounts is paid gross and the tax bill has to be settled only once a year via your tax return, says Jonathan Crowther, head of investment services at Abbey National Offshore. The tax saved during the year can in turn earn extra interest.

Those residents who do not have UK domicile have greater room for manoeuvre in limiting their tax bill. Domicile is a legal concept and is usually decided by where an individual's father was born. It is also determined by how long the individual has spent in Britain and whether he or she intends to live here permanently.

For example, a foreign banker working in the City for two years would be taxed only on money earned here or brought into the UK. He would not be taxed on money held in offshore accounts before he moved to London.

The Revenue investigation was sparked by a probe by the Irish tax authorities that began two years ago. This focused on 70,000 people holding accounts with 23 institutions in Ireland who had not paid an estimated €570m (£386m) in tax on the interest earned. Some people have been imprisoned as a result of this investigation.

Derek Kelly, a member of KPMG's tax investigation department, says the Inland Revenue has been given a list of people who told the Irish tax authorities that as UK residents they did not have to pay taxes in Ireland.

The Revenue is now checking to see whether these individuals have declared their Irish accounts on their British tax returns.

"The seriousness of this issue is demonstrated by the fact that it has been given to the Special Compliance Office as a project. They usually only become involved when accounts of at least £100,000 are concerned," says Mr Kelly.

He adds that the Revenue can levy a penalty of 100 per cent of the interest earned on undeclared offshore bank accounts. This can be reduced to between 60 and 70 per cent if account holders admit to the Revenue that they have money in offshore accounts.

"It is good pub chat for people to say you can put money into offshore bank accounts without having to pay tax," adds Mr Kelly. "But this is not the case. It has to be declared on the self-assessment form and tax paid on the interest."

But this does not mean that residents who are UK domiciled cannot put money offshore to defer tax. The most common measure is to use offshore bonds, which are offered by the international arms of a number of life insurers, such as Scottish Equitable, Skandia, Scottish Life, Clerical Medical and Aviva.

Offshore bonds offer gross roll-up of interest, so gains can be reinvested to defer the tax until the products are encashed. This is attractive to higher-rate taxpayers who know they will encash their bonds when they retire and become basic-rate payers, or who plan to become non-resident in the UK, says Margaret Jago, technical manager at Scottish Equitable.

These bonds also allow policyholders to withdraw 5 per cent a year as income for 20 years and defer the tax until they are encashed.