‘How can we maximise our capital gains to mitigate tax on interest and dividends?’

Lewis and his wife are 80 and 71, respectively, and have lived in Cyprus since 1999. Before retiring, Lewis spent three years doing consultancy work in the Middle East, and also lived and worked across Africa for 33 years. The couple have an annual income of £75,000 a year from sources including Lewis’s former workplace final-salary pension of £63,000 a year, which includes some inflation protection, and UK state pension of £7,500 a year.

Lewis and his wife have two children who live in the UK and one who lives in Australia. Their home is worth about £450,000 and their holiday home in the UK is worth about £270,000. Both properties are mortgage-free.

“We want to go on long-haul holidays, while preserving some capital to fund possible care costs and an inheritance for our children,” says Lewis. “As a tax resident in Cyprus, we pay tax of 30 per cent on interest and 17 per cent on dividends, but nothing on capital gains. So we aim to maximise our investments’ capital gains and reinvest dividends.

“I would say that I have medium to high investment risk tolerance, and would be prepared for the value of our investments to fall by up to 20 per cent in any given year. I plan to diversify our investments by geography and sector by holding investment trusts, and will also add direct equity holdings when opportunities arise.

“I have been investing for over 50 years, and my wife and I hold the investments in our joint names.”

Lewis and his wife’s portfolio
Holding	Value (£)	% of the portfolio
Holiday home	270,000	40.76
Ruffer Investment Company (RICA)	23,408	3.53
Cash	23,000	3.47
Pacific Assets Trust (PAC)	19,502	2.94
Scottish Mortgage Investment Trust (SMT)	18,906	2.85
Edinburgh Investment Trust (EDIN)	17,214	2.6
AstraZeneca (AZN)	17,007	2.57
WisdomTree Physical Gold (PHAU)	15,991	2.41
WH Smith (SMWH)	15,002	2.26
Fidelity Special Values (FSV)	14,839	2.24
Renewables Infrastructure (TRIG)	14,746	2.23
Barclays (BARC)	14,678	2.22
JPMorgan American Investment Trust (JAM)	13,967	2.11
Harmony Energy Income Trust (HEIT)	12,400	1.87
JPMorgan Emerging Markets Investment Trust (JMG)	12,207	1.84
City Of London Investment Trust (CTY)	12,021	1.81
SSE (SSE)	10,960	1.65
Allianz Technology Trust (ATT)	10,890	1.64
Causeway Securities FTSE 100 Kick-Out Plan August 2021	10,025	1.51
Hilbert 3-Stock Defensive Autocall Issue 12	10,000	1.51
Shell (SHEL)	9,929	1.5
National Grid (NG.)	9,755	1.47
Causeway Securities FTSE 100 Kick-Out Plan March 2022	9,345	1.41
IDAD Ultra Defensive Callable Supertracker Plan – Issue 2 – July 2022	9,030	1.36
Personal Assets Trust (PNL)	9,030	1.36
Causeway Securities ESG Green Bond Step Down Kick-Out Plan February 2022	8,932	1.35
BlackRock Greater Europe Investment Trust (BRGE)	8,442	1.27
Fidelity Asian Values (FAS)	8,362	1.26
Spire Healthcare (SPI)	7,937	1.2
iShares MSCI India UCITS ETF (NDIA)	7,851	1.19
F&C Investment Trust (FCIT)	7,510	1.13
Entain (ENT)	4,883	0.74
Ashtead (AHT)	4,628	0.7
Total	662,397

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS’ CIRCUMSTANCES.

 

Jason Porter, business development director at Blevins Franks, says:

Residents of Cyprus are taxable on their worldwide income and gains, although certain sources may be exempt. There are no personal allowances, but individual deductions may be available. 

Interest from bank accounts and dividends are exempt from income tax, and there is no capital gains tax (CGT) in Cyprus except when you dispose of Cypriot real estate. But as you have been residents of Cyprus for more than 17 years, you are liable for the defence contribution on interest and dividends of 30 and 17 per cent, respectively.

Cyprus is a good place to reside if you have pension income. The UK-Cyprus Double Tax Treaty gives Cyprus the taxing rights on both your former workplace and UK state pensions. It is taxed at a flat rate of 5 per cent on amounts in excess of €3,420 (£2994.42) – the exempt amount – or added to your annual income and taxed at the normal scale rates. I assume that you have chosen the first way as it would result in a liability of €3,294 while the second one would be more than four times this figure.  

Dividends from your UK-listed investment trusts and direct equity holdings are subject to the defence contribution, although any gains on disposal are tax-exempt. One way to potentially avoid paying defence contributions is to invest via a single premium life assurance contract. The life company holds your premium as an investment portfolio, for which you have selected the manager and risk profile. As the income generated by an insurance organisation is a combination of several types of income and gains, some of which are not subject to defence contributions, there is no provision in Cyprus to charge these on withdrawals from the policy.

Or instead of investment trusts, hold the accumulation units of open-ended investment companies (Oeics). These roll up and accumulate dividends so are free from defence contributions, as is the case with any unit disposal regarded as a capital gain.

Around half of your investments are in large UK-listed companies and investment trusts that invest in UK equities, with further exposure to the FTSE 100 via structured products. There is also a degree of duplication across some holdings, which is not good. And about a quarter of your general investment account is in just five UK companies, which heightens the level of unsystematic risk and means that the investments’ overall performance is heavily impacted by these companies.

Your investments are not very diversified globally, especially as the UK equity market only accounts for around 4 per cent of global equity indices such as MSCI AC World Index. Although some of these UK companies have geographically diverse earnings, to increase the chance of maximising capital gains in a risk-adjusted manner, you need a more global approach. You could invest more in global multi-asset investment trusts or accumulation units of open-ended funds, or add to existing non-UK regional holdings. 

Having greater exposure to other asset classes, meanwhile, could provide more downside protection while still maximising gains within your volatility constraints. Your investments’ equity bias is high-risk and potentially not compatible with your desire for their value not to fall by more than 20 per cent in a single year. This and the large UK overweight leave the portfolio particularly exposed to a change in sentiment on and/or lacklustre growth in UK equity markets.

The investments have a particularly noticeable underweight to the US market compared with global equity indices. Diversifying the equity component of the portfolio would reduce concentration risk and reliance on a single geography to deliver returns consistently. Although US equities had a difficult 2022, their valuations are now at more attractive levels and, arguably, they have more exciting long-term growth prospects compared with defensive ‘old economy’ UK large-caps. The US has more disruptive companies in sectors such as healthcare and technology that reinvest their earnings rather than pay dividends, and could deliver growth that is more likely to lead to capital gains.

As long as they are compatible with your investment time horizon and risk tolerance, smaller companies could help to achieve capital growth. You could invest in them via an investment trust or fund that invests in smaller companies globally across multiple sectors to mitigate volatility. Smaller companies tend to outperform larger companies over time because they’re able to grow more rapidly and have greater potential upside for investors. 

You could also have a more global, multi-asset allocation via an investment portfolio held through a single-premium life assurance contract or by directly holding Oeic accumulation units. Both of these approaches should mitigate defence contribution tax and be exempt from CGT. 

You may be liable to succession rules in both the UK and Cyprus if you have both retained your UK domicile of origin, particularly as you have a property in the UK. While it is hugely beneficial that Cyprus doesn’t have any estate or succession taxes, it is just as important to know how and to whom you can pass your assets on death. Cyprus has adopted the UK concept of domicile in its succession law but not our concept of testamentary freedom. Cypriot succession rules derive their main principles from the continental tradition of protecting the right of inheritance of certain heirs. The law expressly states that if a person dies leaving a spouse and one or more children, three-quarters of their net estate is equally reserved for them. The remaining quarter can be disposed of freely, by will.

And even if assets are held jointly, the deceased’s portion does not automatically pass to the surviving joint owner, as in the UK, but falls into their estate.

In 2015, the European Union (EU) tried to reduce member-state cross-border succession conflicts and to unify the law that applies to estates across the EU. Although the UK opted out of EU Regulation 650/2012 (Brussels IV), UK nationals owning assets or living in the EU can benefit from the new rules. The default position is that the succession law of the country in which the deceased was habitually resident can apply.

So if you elected for the law of the UK to apply in your wills, you are free to leave your respective estates to whoever you choose, with the Cypriot forced heirship rules set aside. In most cases, it is advisable to have a UK will for the non-Cypriot assets and a Cypriot will, with the Brussels IV clause included if required, for those sited there.  

Also review the position of your child who lives in Australia as a beneficiary of your estate.

 

Robert Salter, director at Blick Rothenberg, says:

Your domicile position impacts your liability for UK inheritance tax (IHT). UK IHT rules mean that if you have a UK domicile, even if you are living overseas when you die, you are liable to UK IHT on your worldwide assets. But if you don’t have a UK domicile, you are only liable for IHT on your UK-located assets. UK IHT is charged at a rate of 40 per cent on the value of assets over £325,000, although in some cases there are reliefs and the threshold for married couples can be £650,000. 

From a tax perspective, domicile doesn’t refer to where you live at present. Rather, it assesses where your deepest links are, what is, in effect, your permanent home and in some respects the place where you want to die. And if you have been living outside the UK for many years, the common law rules of domicile that have been developed over many decades apply.   

Although you might have a UK domicile of origin because you were born in the UK of UK parents, check whether this is the case. In this regard, you usually acquire the domicile of your father, assuming your parents are married, and typically retain this domicile of birth throughout life. This is unless there are clear changes that result in you, for example, acquiring a domicile of choice in an alternative jurisdiction.

Husbands and wives can have separate domiciles even though they have been married for many years. We assume that you both have the same domicile status. You can also only have one domicile at any specific point in time, so if you are Cyprus-domiciled you can’t be UK-domiciled at the same time.

And if you are Cyprus-domiciled, any non-UK assets you pass to your children would automatically be free of UK IHT.

It’s important to know whether you have a UK domicile of origin or a domicile of origin in another country which you have retained. Also consider whether any domicile you acquired as children has been superseded by a domicile of choice in Cyprus. Although the concept of domicile is not clear cut as it is based on common law case decisions rather than modern legislation, if you regard Cyprus as your permanent home and the place, for example, where you expect to spend the rest of your lives and be buried, you may have acquired a domicile of choice in Cyprus.  

Factors that can indicate that you have acquired a domicile of choice in Cyprus or another location can include where your closest social and economic ties are, whether you have acquired nationality in that location and if you have a will based on the laws of that jurisdiction. Given the complexity around domicile, seek specialist advice on this point. 

If you believe that you are now Cyprus-domiciled, ensure there is as much documentary evidence to back up this assertion as possible. For example, ensure that your wills are written in accordance with Cypriot law and, if applicable, clearly state that you wish to be buried in Cyprus.

Then consider whether, based on the chance of being non-UK domiciled, you wish to minimise possible liability to UK IHT. For example, you could invest in non-UK assets which would fall out of UK IHT liability if you are able to show a Cypriot domicile. Investing in EU-based assets, for example, might also mean that your capital gains accrue in euros, which might be helpful as you live in the eurozone.