Boxed in, ticked off

Professionals and clients should note the recent costly mistake of an investor who decided not to seek financial advice, says Scott Gallacher

Solicitors, accountants and financial advisers are often asked to justify the cost of advice. As surgeons would say: "It's not how long the operation takes, it's knowing where to cut."

It's a point illustrated in the case of Joost Lobler (TC2539), who is facing bankruptcy because of 'not knowing where to cut'. He simply ticked the wrong box on an investment bond withdrawal form. On the advice of HSBC Private Bank, Lobler invested US$1,406,000 (part funded by a US$700,000 loan from HSBC) into a Zurich Life offshore investment bond in 2005.

Ignoring the potential pitfalls of borrowing to fund investment, Lobler's problem started when he decided to withdraw some money from his bond to repay the loan. It has been reported that Lobler assumed he did not need any advice about this.

He withdrew just under US$750,000 from the bond in February 2007, which was used to repay the HSBC loan. A year later he withdrew a further US$690,000. The bond is understood to have made a profit of US$70,000 overall.

Unfortunately for Lobler, withdrawals from an investment bond can be made in one of two ways: by encashing 'whole segments of bond', essentially cashing in whole parts of the bond and having to pay the appropriate income tax on any profit made on those segments, or by making a 'partial surrender across the whole bond', which is the normal approach for using the '5 per cent annual withdrawal allowance'.

Outrageously unfair

Had Lobler chosen the first option, that is ticking the correct box, he would have faced a legitimate tax bill of about US$28,000 (if a higher-rate taxpayer).

However, he ticked the wrong box. Because of a quirk in the tax rules, this means that any withdrawals in excess of the annual 5 per cent limit are regarded as profit (even if the bond is not in profit). And that deemed profit is subject to income tax. Lobler was dealt an unnecessary and artificial tax charge of US$560,000.

Unsurprisingly, he felt that this tax bill on a gain of only US$70,000 because of simple ticking the box was more than a little unfair and appealed against HMRC's decision. The tribunals agreed that it was "outrageously unfair", but they decided that HMRC had followed the rules. So the tax liability stood.

Simple mistakes

As a chartered financial planner, I am particularly aware of the potential problems that could arise from using the wrong method when making withdrawals from investment bonds. I would suggest, in this case, the cost of advice (had Lobler sought it at the time) would have been much less than the value of that advice, that is saving approximately US$532,000 in unnecessary and unfair tax.

Other advisers, such as solicitors or accountants, may think that Lobler's problem is not their concern. Of course, we would all hope that no professional adviser would have made Lobler's mistake. But it is easy to foresee situations where a client's decision to make a bond withdrawal would have been directly or indirectly the result of other professional advice.

For example, a client may have to share assets because of a divorce, or they could be acting as an executor settling an estate. In these scenarios their solicitor or accountant might have simply told them to 'take the money from the bond' or failed to recommend that they should 'get independent financial advice'. Had this been the case for Lobler, I would suggest that the ridiculous tax bill was not his problem but the professional adviser's.

The moral of the story is clear: clients should always take professional advice when dealing with any financial matter. And our fellow professionals should always recommend clients obtain independent financial advice, even if it appears as simple as completing a withdrawal form.

Scott Gallacher is a director at Rowley Turton