International debt financing is critical for the development of emerging economies because it provides access to more liquidity, a larger investor base, and more effective rules and regulations for EM enterprises. However, the late-nineties financial crisis, along with recent rapid expansion in corporate debt in emerging markets, caused policymakers to reconsider the danger of offshore financing and its role in EM development. The bonding/signaling effect of offshore finance on domestic market financing is investigated in this article, as evidenced by improved information disclosure and creditability.
We discovered the following using a comprehensive database covering Chinese enterprises’ bond issuances in local and overseas markets from 2010 to 2015:
1) The issuer’s funding conditions in subsequent domestic bond issuances improve as a result of the offshore bond issuance, with longer corporate issuance maturities and reduced funding costs.
2) The shift in financing arrangements is particularly substantial for domestic issuance by companies that have previously issued bonds in the public market or with an investment-grade rating.
3) Offshore loan financing boosts long-term firm performance, particularly for cash-strapped businesses.
4) In comparison to other offshore locations, offshore bonds issued with a registration domain in Hong Kong, under Hong Kong legislation, or traded on the Hong Kong exchange market have larger signaling implications in subsequent domestic issuance.
Our research emphasizes the importance of offshore financing in fostering the local market’s institutional environment and company growth, as well as policy recommendations for building a comprehensive offshore corporate bond market in emerging nations.
What are the benefits of investing in an offshore bond?
An offshore investment bond offers both benefits and drawbacks. Tax-free investment fund growth, fund swaps within the bond that do not result in a CGT or income tax penalty for the investor, and no tax reporting requirements are among the benefits. The offshore investment bond can be given as a gift without incurring income tax (even if given to a trust), and the 5% withdrawals are not counted as income for the age allowance.
However, there are drawbacks, including chargeable event gains that can be taxed at up to 50% on encashment of a bond; no means to utilise a capital gains tax allowance because gains are subject to income tax; and inheritance tax and income tax may be due upon the death of the last life guaranteed.
Why do firms issue foreign currency bonds?
The necessity for foreign currency financing is the key motivation for issuing Eurobonds. Because bonds are fixed-income products, investors typically receive a fixed interest rate.
Assume a US corporation wants to break into a new market and is planning to build a huge factory, say in China. Large sums of money will have to be invested in local currency, the Chinese yuan. Because the company is new to the Chinese market, it may have difficulty obtaining loans.
In the United States, the corporation opts for yuan-denominated Eurobonds. The bonds will be purchased by investors with yuan in their accounts, and the cash will be used to fund a new facility in China. If a new factory is profitable, the cash flow will be used to pay interest to bondholders in the United States.
What is a foreign bond?
International Bonds are another name for offshore bonds. They’re a tax-advantaged option to put money aside for the medium to long term. This normally occurs over a period of five years or more.
You can invest a flat sum or make regular payments with an Offshore Bond. When you invest your money, it can grow tax-efficiently over time because you don’t pay tax on investment growth, which means you can save more for the future.
When you’re ready, you can use the money you’ve saved as a regular source of income to fund your retirement. You can either keep it or pass it down to your family. At any point, an International Bond can be entirely or partially relinquished.
Is it wise to invest in offshore bonds?
To various people, bonds have different meanings. The reason for this is that bonds cover a wide range of investments. Building Society bonds, bank bonds, government bonds, business bonds, and investment bonds, to name a few, are all available.
Investment bonds are what I’m going to focus on today. Only insurance companies can issue such bonds. Non-qualifying single premium whole life insurance plans are the full formal name for them. As a result, they are effectively insurance plans, even if the real amount of life insurance is usually only a notional 1% of the single cost. To all intents and purposes, investment bonds are just investments that are governed and taxed by insurance company legislation.
Investment bonds aren’t the most tax-efficient way to invest. ISAs and pensions, for example, receive significantly larger tax advantages. Taxes are deducted at the point of sale. Internal taxation of investment bonds is actually taxation of the insurance company itself, which largely refers to Corporation Tax but also covers all linked insurance company taxes such as VAT and so on. Surprisingly, insurance companies often pay less than 20% tax on their overall income. Individual investors in UK investment bonds are presumed to have paid basic rate income tax on their gains. This is the basic taxing aspect of bonds. Everything else about individual investment bond investors’ taxation is convoluted.
There are both onshore and offshore investment bonds, for starters. Non-UK insurance businesses typically situated in tax countries such as the Channel Islands, the Isle of Man, or Dublin issue onshore bonds, while UK insurance companies issue offshore bonds. These offshore corporations are identical to the offshore subsidiaries of big UK insurance firms and use the same names.
The fundamental distinction between offshore and UK investment bonds is that offshore bonds are largely tax-free at the point of sale, with the exception of a tiny amount of withholding tax on certain overseas dividends. As a result of the significantly lower taxation paid on offshore insurance businesses, investors’ profits on offshore bonds are projected to be bigger than those on UK bonds. Because offshore corporations cannot claim tax relief on their expenses, the tax reduction isn’t as large as 20%. Nonetheless, the taxation differences are big enough to give offshore bonds a distinct tax benefit over UK bonds for investors.
Individual investors will be taxed on gains on both UK and offshore bonds at some point, although taxation on so-called chargeable events (gains) occurs only when the bonds are fully or partially encashed. Despite this, due to the 5% rule, no Income Tax can be imposed right away.
Basically, investors in both UK and offshore bonds can relinquish (encash) up to 5% of their original investment amount each year without having to pay Income Tax on the chargeable gain right away. This is due to the fact that such a gain can be delayed for up to 20 years if no more than 5% of the original investment is withdrawn each year. If no money is taken out each year, the allowance can be saved and used later.
For example, if no encashments have been made for ten years, up to half of the original investment amount (5 percent x 10) may be relinquished without incurring an immediate tax charge. Of fact, if less than 5% of the original investment is removed each year, the tax deferment period could be extended even further.
For instance, if an investor withdraws 2.5 percent per year, the tax postponement may run for 40 years (2.5 percent x 40). The tax deferment might last for 100 years if they just withdraw 1% per year (1 percent x 100).
The interesting thing about such investments is that you can invest in an offshore bond for a hundred years or more and pay virtually no tax on the gains even after withdrawing the entire amount originally invested, leaving your heirs with a substantial sum far in excess of the original investment amount.
Unlike UK bonds, well offshore bonds allow minors to be specified as lives insured. The insurance legislation controlling offshore bonds becomes highly intriguing at this point. You see, insurance policies have policyholders, who are the owners, and lives assured, who are a group of people who are covered by the policy. Importantly, the lives guaranteed and the owners do not have to be the same person. As a result, a couple might buy and own an offshore bond. They will be immediately identified as policyholders and assured life. However, it’s important to note that the same couple can name their children and even grandkids as additional lives guaranteed. The bond is still owned by the couple, not their heirs.
The purpose of adding young lives is to simply extend the life of the ties. Because the bonds will be automatically relinquished on the last of the couple’s deaths unless the young lives are guaranteed, which could result in a significant tax penalty. A bond does not have to be redeemed until the last of the lives guaranteed has passed away. This offers the bond’s beneficiaries complete control over when the bond is encashed, allowing them to plan the most tax-efficient method to surrender it. In other words, the bond profits will be taxed at the lowest feasible rate, which may even be nothing!
The fascinating thing is that, over the next 20 years, human life expectancy is expected to rise to 120 years, thus adding grandchildren as lives secured may potentially prolong the life of an offshore investment bond to more than a century!
When you consider that, unlike ISAs and pensions, there is no limit to how much you may put in an offshore investment bond other than the life insurance company’s own maximum investment limit, you could effectively create your own tax deferred investment for more than 100 years. This is an exciting prospect.
Furthermore, unlike pensions, which are susceptible to frequent legislative change, investment bond legislation is largely benign, which means it doesn’t change very often and, when it does, it usually just makes minor modifications, tinkering around the margins. This is excellent news for investors in investment bonds.
I plan to write more on the different ways you can lawfully avoid Income Tax on both UK and offshore investment bonds in the coming weeks and months.
What makes offshore bonds tax-friendly?
The underlying fund selection can be changed without triggering a personal capital gains tax liability because the change is made within the bond itself, according to the tax regulations for offshore bonds. Any dividend income from UK equities received by a fund is tax-free.
Why do governments only issue bonds?
A government can raise cash by issuing debt in its own currency when it needs money to run its operations. And if a government has trouble repaying the bonds when they come due, it can simply print more money. While this idea has potential, it will most likely lower the value of the local currency, which will disadvantage investors in the long run. After all, if a bondholder earns 5% interest on a bond but the value of the currency declines 10% owing to inflation, the investor loses money in real terms. As a result, countries may decide to issue debt in a foreign currency to assuage investor concerns about currency depreciation decreasing profitability.
Why do governments purchase bonds?
Any government that engages in free trade with others is likely to purchase foreign sovereign debt. A country can have any two but not all three of the following economic policies: a fixed exchange rate, independent monetary policy, and free capital flows. Foreign sovereign debt provides a mechanism for governments to achieve their economic goals.
The central bank’s first two functions are to make monetary policy decisions. To begin with, sovereign debt typically makes up a portion of foreign exchange reserves held by other countries. Second, central banks purchase sovereign debt as part of their monetary policy to keep the exchange rate stable and avoid economic instability. Third, central banks and other financial actors alike find sovereign debt appealing as a low-risk store of capital. Each of these functions will be briefly explored.
Foreign Reserves
Any country that is open to international trade or investment must have a certain amount of foreign currency on hand in order to pay for imported commodities or foreign investments. As a result, many countries hold foreign currency reserves to cover these costs, insulating their economies from fluctuations in international investment. Central banks are frequently required by domestic economic policies to maintain a reserve adequacy ratio of foreign exchange and other reserves for short-term external debt, as well as to safeguard a country’s capacity to service its external short-term debt in a crisis. The International Monetary Fund (IMF) issues guidelines to help governments determine acceptable levels of foreign exchange reserves based on their economic circumstances.
Exchange rate
A monetary policy decision is a set or tied exchange rate. This choice aims to reduce the price volatility that comes with variable capital flows. Such circumstances are particularly evident in emerging markets: Argentine import price hikes of up to 30% in 2013 prompted opposition leaders to label wages as “inhumane.” “It’s like there’s water streaming through your fingers.” Policymakers manage exchange rates to limit price volatility, which is economically and politically damaging. Few countries’ exchange rates are totally stable on a global scale “Currency markets determine whether a currency is “floating” or not. A country may choose to purchase foreign assets and preserve them for the future, when the currency may decline too quickly, in order to manage local currency rates.
A low-risk store of value
Because sovereign debt is backed by the government, commercial and public financial institutions consider it a low-risk investment with a high likelihood of repayment. Some government bonds are considered to be more risky than others. A country’s external debt may be deemed unsustainable in comparison to its GDP or reserves, or it may default on its debt. However, even if earned interest is not high, sovereign debt is more likely to yield value and hence more safer than other forms of investment.
What is the purpose of issuing dollar bonds?
- A dollar bond is a bond issued by a foreign firm or government outside of the United States that is denominated in US dollars rather than the local currency.
- Dollar bonds are utilized to appeal to a wider range of investors because U.S.-based creditors will face less currency risk.
- For international issuers, however, dollar bonds offer a bigger risk because they are exposed to currency risk in addition to the usual credit risk.
- Dollar bonds are municipal bonds that are valued in terms of their dollar price rather than their yield.
What are bonds, and why do businesses use them?
A bond, like an IOU, is a debt commitment. When investors purchase corporate bonds, they are effectively lending money to the firm that is issuing the bond. In exchange, the corporation agrees to pay interest on the principal and, in most situations, to repay the principal when the bond matures or comes due.