If you are resident and domiciled in the UK, you must declare to HMRC the income from any offshore bank accounts you have. If reminders were required, they arrived through letters that HMRC began sending to some account holders in July 2005.

HMRC said the letters were part of its investigations into tax evasion. Recipients of the letters were only given 30 days in which to reply and asked the holder why there was no tax liability from their offshore bank account. This may have been for perfectly legitimate reasons such as because some individuals were non-domiciled.

If you are UK resident and domiciled, you have to include income from offshore accounts on your self-assessment return and then pay tax on the interest earned every year. There is a marginal cash flow benefit in holding offshore bank accounts, however, particularly where you have large balances. This is because interest on offshore accounts is paid gross compared to net for onshore accounts. If you elect to pay a withholding tax under the European Union Savings Tax Directive (see below) then this mitigates this particular advantage.

If you receive interest after 5 April, for example, you will not pay tax on it until the following year. Every year, offshore account holders can earn interest on their interest until the tax is paid. Therefore, if you have a large amount of money and it is kept offshore for many years, there will be an advantage by keeping it onshore.  

An attraction of offshore banking for international investors is the greater availability of different currency accounts and the ease with which money can be transferred between them and thus into dollars, euros and other denominations. Such transfers will create capital gains and losses, however.

Non-domiciled individuals have the greatest advantage in using offshore bank accounts. Income from these accounts does not have to be reported to HMRC. As long as you do not remit interest from your offshore accounts to the UK then you do not pay UK tax on the interest earned. Non-domiciliaries are also exempted from the European Union Savings Tax Directive where it is non-remitted to the UK.

European Union residents became subject to a new tax on offshore bank accounts on 1 July 2005 through the EU Savings Tax Directive. The Directive was intended to reduce tax evasion by requiring banks and financial institutions in one EU member state to exchange information with tax authorities of an EU citizen account holder’s home member state. This was extended to include Dependent and Overseas territories of the UK and Netherlands and five third-party countries. In total, 40 countries are subject to the Directive.

If you have accounts in certain countries, including the Channel Islands, the Isle of Man and Switzerland, however, you have the choice of either paying a withholding tax of 15% or having your details passed to HMRC by the bank. The withholding tax will increase to 20% in 2008 and 35% from 1 July 2011. You have to elect whether to choose the withholding tax or information exchange option. If you do not contact your offshore bank then the default position is the imposition of the 15% tax.

There are four main categories of savings income that are treated as interest payments and therefore subject to withholding tax or exchange of information. These are interest paid on bank accounts; interest earned from debt instruments such as government securities, corporate bonds and debentures; distributions by unit trusts and other collective investment funds where at least 15% of assets are invested in debt; and accumulated income when investors redeem from a fund which has at least 40% of its assets in debt claims.

Unsurprisingly, investors will have complicated circumstances that do not fit neatly into set definitions. For example, there will be interest payments made to joint accounts where one of the holders is an EU resident and the other is not. The tax due may be determined by the proportion of the interest going to the EU resident and tax it appropriately.

Certain instruments and structures are not caught by the directive and are thus not subject to the withholding tax or exchange of information. These include ordinary shares in companies, insurance policies and corporate structures such as offshore companies.

The Directive does not mention trusts. The most common view is that trusts are excluded from the Directive unless the beneficiary of the trust concerned is entitled as of right to the savings income. This is the case where it is an interest in possession trust and the beneficiary has the immediate entitlement to any savings income. Nominee and bare trust arrangements are included within the Directive as it is the same as interest arising directly to the beneficial owner of that interest.

Another group of individuals who are not subject to the withholding tax or exchange of information are investors with savings in bank accounts outside the 40 countries included within the Directive. They include Singapore, Hong Kong, Mauritius and Bermuda. The last country should have been included but the Directive referred to Overseas Territories in the Caribbean. Bermuda then pointed out that it is not in the Caribbean!!