Investing Offshore With Portfolio Bonds

Specifically, the investor closes a contract in his name with an insurance company, usually domiciled in an offshore tax haven. The insurance company opens an account with a bank selected by the investor, who in turn receives a policy from the insurance company. Legally, the investor is the client of the insurance company and the insurance company is a client of the bank. The investor can maintain full control of his assets as the policyowner or may choose to have the bank or an investment adviser manage the account. The policy value consists precisely of the value of the assets placed there by the insurance company on the investor's behalf and grows as managed. Legal entities and natural persons can be designated as beneficiaries. With certain annuities and insurance companies, the policyowner may be a legal entity. The person insured, however, must in all cases be a natural person.

Overview of benefits

A Portfolio Bond provides the important benefits of an offshore account with a private bank: confidentiality and privacy, professional and individualized asset management, personal attention. As an insurance investment, a Portfolio Bond also provides the following substantial benefits:

Asset Protection Properly structured and established in the right jurisdiction, Portfolio Bonds enjoy legal protection from creditors. The laws applicable to asset protection with life insurance under Swiss law have been discussed by this author in detail in a previous issue of this Journal. Interestingly, Liechtenstein's laws on the protection accorded life insurance policies and annuities is directly taken from the relevant Swiss laws. To summarize, where a person not residing in Switzerland or Liechtenstein (the “policy owner”) purchases an insurance policy from a Swiss or Liechtenstein insurance company and designates his spouse or his descendants as beneficiaries of such insurance policy, or irrevocably designates any other third party as beneficiary (e.g., a legal entity such as a Trust), this insurance policy will be protected by law against any debt collection procedures instituted by the creditors of the policy owner and will also not be included in any Swiss or Liechtenstein bankruptcy procedure in this regard. Even where a foreign judgment or court order expressly decrees the seizure of such policy, or its inclusion in the estate in bankruptcy, such an insurance policy may not be seized in Switzerland or Liechtenstein or included in the estate in bankruptcy, except where it is considered a fraudulent conveyance.

In case of bankruptcy of the owner, protection is also guaranteed since the ownership is transferred to the beneficiaries automatically. Any instructions from the original policy owner which are forced upon him can no longer be acted upon; only his beneficiaries, as the new owners can give instructions to the insurance company.

The Swiss insurance company can only act upon orders of the owner if his actions are deemed not to have been made under duress. If there is any evidence that an order has been forced upon the owner, such as in the case where the owner revokes in writing the beneficiary designation prior to a bankruptcy declaration, the insurance company cannot follow the instructions so issued. In such a case, it is important that the beneficiaries inform the insurance company.

Separate and Simple Estate Planning Device Although a legal entity such as an estate planning trust can be named as irrevocable beneficiary of the Portfolio Bond, this type of investment is also well-suited for making distributions separate from the policyowner's estate. However, depending on his home jurisdiction, some compulsory portions for legal heirs may be reserved. Neither power-of-attorney, nor last will nor certificate of inheritance is required for payments to be made upon the owner's death. Beneficiaries get immediate access to the funds according to the payment method chosen by the policyowner.

Confidentiality and privacy In addition to the confidentiality provided by a bank account in the name of the insurance company, a second layer of confidentiality is provided by insurance confidentiality. In certain jurisdictions insurance companies treat client information as would their banking counterparts. No information can be provided to any third party (natural person or legal entity). In Liechtenstein, for example, a separate insurance secrecy law protects the privacy of policyowners. This law subjects not only persons affiliated with or acting on behalf of insurance undertakings to professional secrecy but also representatives of public agencies.

With the introduction of U.S. withholding taxes on U.S. assets held in foreign accounts and with the tough reporting requirements for investments made through offshore trusts, offshore insurance vehicles, if correctly structured and from the right jurisdiction, can add strong privacy to your existing investments in a trust or a bank account.

Tax advantages Unlike many offshore investments and structures, Portfolio Bonds are, in certain jurisdictions, completely free of local taxes. As far as income, capital gains, estate or withholding taxes are concerned, the law of the investor's tax domicile is decisive. In many countries insurance policies enjoy substantial tax benefits if correctly structured, i.e., the Portfolio Bond can be tailor-made to fit the legal requirements for privileged tax treatment. For U.S. persons this includes:

* Tax deferral during the insured's life. The inside build-up of the Portfolio Bond is generally income and gains tax-free. For U.S. individuals and corporations with assets abroad, using a Portfolio Bond as a holding structure for these assets provides an efficient mechanism for sidestepping the new 31% withholding tax on income and gains from U.S. assets held in foreign accounts.
* No income taxes on insurance proceeds. At the policyowner's death, the insurance proceeds are generally income tax exempt.
* No estate taxes on insurance proceeds. With proper planning (such as through the use of an irrevocable trust under which the insured has no control or benefits) insurance proceeds can avoid estate taxation at the death of the insured.
* No U.S. excise taxes under certain conditions. Unlike many other foreign insurance policies, Swiss policies are not subject to the 1% U.S. excise tax on the purchase of foreign insurance and insurance premiums. This is a by-product of the adoption in 1998 of a revised Swiss-U.S. Double Tax Treaty and applies for premiums paid by a US citizen to an insurance company domiciled in Switzerland. Liechtenstein insurance companies are not "favored" by a similar tax treaty; Liechtenstein annuities are therefore subject to the excise tax. On the other hand, they are not subject to provisions with respect to disclosure of tax information, even where crimes have been committed under Liechtenstein law. The U.S. treaty with Switzerland, moreover, provides that the tax exemption applies "only to the extent that the risks covered by such premiums are not reinsured with a person not entitled to the benefits of this or any other Convention which provides exemption from these taxes." The proof required to overcome this limitation -- of whether the premiums are reinsured and, if so, whether the reinsurer is entitled to the exemption -- could possibly defeat the privacy aspects of the policy, assuming the insurance companies would be willing to provide the information.

The Portfolio Bond qualifies as a life insurance policy for U.S. income tax purposes:

* If it is based on a segregated investment account and the segregated account is adequately diversified, i.e.:
o No more than 55% of the value of the total assets of the account is represented by any one investment;
o No more than 70% of the value of the total assets of the account is represented by any two investments;
o No more than 80% of the value of the total assets of the account is represented by any three investments; and
o No more than 90% of the value of the total assets of the account is represented by any four investments. To make certain that the segregated accounts comply with this "diversification rule", the portfolio needs to be re-balanced at the end of the first policy year and on a quarterly calendar basis thereafter.
* If it satisfies Internal Revenue Code rules on death benefits. These ensure that the insurance protection meets certain minimum requirements from the inception of the policy.
* If it is not self-directed, i.e., the policyowner must be deemed to have surrendered ownership or control of the assets. The income from Portfolio Bond is tax-free if the owner (or his adviser) is not managing the investments himself. Conversely, the insurance company is deemed to be the beneficial owner of the segregated account. Policyowners are permitted to choose investment categories, but they may not choose the actual investments. If they do, they are treated as the beneficial owners of the underlying assets, not the insurance company, and the income generated by those assets would be taxable. Similarly, policyowners are not permitted to appoint an investment adviser to make the investment decisions on the underlying assets nor to control the adviser in such decisions. The insurance company as beneficial owner is permitted to appoint an independent investment adviser.

Trust compatibility A Portfolio Bond is not necessarily a structure to replace offshore trusts, rather it can be used to complement a trust and to strengthen its protection. For example, assigning investments to an offshore trust is much cheaper and easier if they are grouped together under one Portfolio Bond. This greatly simplifies the tax treatment of the structure, and consequently, the reporting requirements, either through a reduction in the number of assets to be listed or through the fulfillment of the conditions for tax deferral. Assets held within a portfolio bond are considered to be held by the insurance company. This allows an investor or a trust to hold assets privately also under the new regulations on U.S. withholding taxes on U.S. assets held in foreign accounts.

Insurance coverage Depending on the investor's own needs and requirements for his heirs, additional insurance coverage can be provided in case of death. Coverage can also be adjusted during the term of the contract. This feature can be very important if a remaining spouse is forced to pay off a mortgage or if heirs need cash to buy out business partners.

Flexibility Apart from being able to choose the amount of insurance coverage, the policyowner can choose to receive an annuity as well as choose to pay several premiums or a single one. As the underlying investments can be freely selected from a global palette of investments not available to the general public, the policy owner or his investment advisor (the latter for tax deferral) can optimize performance through wide diversification or hedging strategies.

Conclusion

Either in combination with offshore or domestic planning structures or alone, a Portfolio Bond is a useful and cost-effective tool to upgrade an existing portfolio of investments. A portfolio's features can be added or improved with regard to asset protection, confidentiality, reporting burden, insurance coverage, and flexibility, reducing costs and taxes, including transfer taxes as wealth passes from one generation to another. Whether they are concerned with taxes or the threat of litigation or are looking to diversify assets globally, with the Portfolio Bond, wealthy individuals can address those concerns as well as have access to leading investment managers and to investments otherwise not available to the public.

Marc Sola is Managing Partner of NMG International Financial Services Ltd., Switzerland, which develops products for the international market in insurance and banking. Mr. Sola obtained a law degree at the University of Zurich.