Floating your funds

Reports that Zimbabwe's President, Robert Mugabe has allegedly used bank accounts in the Channel Islands to move £10m out of his country in the past few weeks have done little for the reputation of offshore banking.

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Let the taxman wait

Reports that Zimbabwe's President, Robert Mugabe has allegedly used bank accounts in the Channel Islands to move £10m out of his country in the past few weeks have done little for the reputation of offshore banking.

But Mr Mugabe is not the first high-profile leader facing trouble at home to use the islands' banking facilities, in this case through "front" companies. Nor, despite ever tighter measures to clamp down on money-laundering and other dubious practices, will he be the last. Jersey's Financial Services Commission is investigating transactions linked to Mr Mugabe, who is suspected of preparing a nest egg in case he decides to flee Zimbabwe after this weekend's presidential elections.

But for all the publicity cases like this attract, for the most part offshore banking is a perfectly legitimate part of the financial landscape. Anyone putting money in the Channel Islands, the Isle of Man or Dublin will face money-laundering and other security checks very similar to those operated by banks at home. Within the European Union, at least, their money will also enjoy very similar levels of protection, should a bank run into trouble.

Banks operating offshore accounts admit a minority of customers move their money out of the UK to avoid prying eyes. But this is more likely to be to keep the money out of reach of interested relatives or even divorce lawyers than from the tax authorities. Banks on Jersey will reveal details of an account only if they are presented with a court order. What they will not do is hide money from the Inland Revenue.

There is no doubt about the legal position. Every UK resident who pays tax has to pay tax on money held offshore. The Inland Revenue works out the bill by asking taxpayers to declare the interest they get on their annual tax return. Hoping the Revenue will not notice if you "forget" is not a realistic option: the financial authorities in Jersey, Guernsey and the Isle of Man exchange information with their onshore counterparts.

For savers with large cash sums to put away, there are advantages to offshore savings and bank accounts. Unlike in the UK, tax on interest is not deducted at source. This means savers gain compound interest on their (untaxed) interest. This means their money grows more quickly, even if they do have to pay the tax later.

There is also a time lag between earning the money and paying it to the Revenue. In most cases, interest on savings will not need to be paid until the January following the tax year when it was earned. Again, the benefit is relatively limited unless the sums involved are very large. Where large sums are involved, the Revenue can ask for payments of tax on account, in the January and the July during the tax year. For non-taxpayers, there is no advantage in holding money overseas: applying for gross interest in the UK is merely filling in the Revenue's form, R85.

But there is a time factor: people paying 40 per cent income tax now can shelter that and pay tax on their savings when they are retired and may be paying only 22 per cent tax. Time will have magically made the extra 18 per cent vanish.

Many banks and building societies, including the offshore arms of well-known UK companies, offer offshore investment bonds. The lowest-risk bonds are, in effect, cash savings with a small life assurance element. The bonds are structured so they pay no income or interest, but roll it up so it is paid when the bond matures. Tax is due when the investor brings the money back to the UK, and that's usually when the bond matures.

"As long as you take no income from these bonds, they will grow and have no effect on your tax position," says Louis d'Espagnac, of the specialist independent financial adviser Financial Explorer. "If someone retires, they can bring the money into the UK, and pay a lower rate."

This form of tax planning is accepted by the Inland Revenue. Mr d'Espagnac says more clients are interested in using it to plan for inheritance tax, with the bond written in trust. "But it is for medium to long-term tax planning of at least five years," he says.

Most bonds require an investment of at least £10,000 and a term of at least a year. Rates compare favourably with onshore savings accounts, and the larger the sum and the longer the term, the better the rate. Offshore bonds do raise tricky tax and inheritance law questions, and professional advice is a must.

But for people who are still some way from retirement, the attraction of an offshore account could be convenience rather than interest rates or tax. Banks also say more people are opening offshore accounts before they take on an overseas posting, or as part of a plan to retire overseas.

"Generally, our customers are expatriates or people living in the Isle of Man or the Channel Islands," says Joanna Lawrence, manager for Alliance & Leicester International on the Isle of Man. "We have long-term expatriates working in industries such as oil and gas, and people on shorter contracts. While they are non-resident, they use an offshore account to save for a car or a property."

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