UK: Certainty About Trustee Residence?

In response to widespread concern among practitioners to the modernised trustee residence rules introduced by the Finance Act 2006, and to HMRC's recent guidance note on the subject, the Society of Trust and Estate Practitioners (STEP), the Institute of Chartered Accountants of England and Wales (ICAEW) and the Chartered Institute of Taxation (CIOT) have jointly released their own guidance note in agreement with HMRC (the STEP guidance).

Although it was hoped that this additional guidance would completely allay concerns in the industry that uncertainty in this area of the law may discourage off shore providers from using UK advisers, there are still a number of matters upon which HMRC seems unwilling, or unable, to provide certainty. UK advisers will therefore continue to have difficulty advising in relation to non-UK trusts in some cases, despite this new guidance.

The legislation

Prior to the introduction of the updated legislation, the definitions of trustee residence for CGT and income tax were sufficiently distinct that trustees could find themselves resident for CGT but not income tax, and vice versa. Trustee residence is not a factor in considering liability for IHT, which is ascertained by reference to the domicile of the settlor and the location of the trust assets.

Section 69 of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) and ss475-476 of the Income Tax Act 2007 (ITA 2007) set out the rules establishing whether or not the trustees of a settlement are resident, or ordinarily resident, for the purposes of CGT and income tax respectively. The relevant sections came into force on the 6 April 2007 and also include deeming provisions which treat a non-resident trustee as resident if they fulfil, or perhaps fall foul of, various conditions. The relevant sections are set out in full in the boxes on pp8-9.

For the purposes of determining residence, trustees of a settlement shall, unless the context otherwise requires, together be treated as if they were a single person (distinct from the persons who are trustees of the settlement from time to time): see s474(1) ITA 2007 and s69(1)(3) of the TCGA 1992.

The residence rules require that the residence of each individual trustee be considered in order to establish the residence of the notional 'single trustee', and the trustee shall be considered to be resident if:

(a) all of the trustees are UK resident; or

(b) at least one of the trustees is UK resident and the settlor was either UK resident, ordinarily resident or domiciled at the time that the settlement was made.

If all of the trustees are non-UK resident then the trust will be non-UK resident. However, a single UK resident trustee will make the trust resident if the settlor was UK resident or domiciled when the trust was established.

The question of who a settlor is for these purposes follows normal principles, and this includes both a person who has made the settlement or a person whose property has become comprised into a settlement.

A person may also be treated as settlor in other circumstances, such as entering into a reciprocal arrangement with another person. A trust may have more than one settlor and care should be taken not to 'taint' trusts with mixed residence settlors. A settlor may also cease to be a settlor of a particular settlement if, at a given time, there is no longer any property settled by them in the settlement. The updated legislation has introduced a deemed residence provision and, in essence, the rules treat as resident any trustee who:

(a) is carrying on business in the UK through a branch, agency, or permanent establishment; and

(b) acts as trustee of the settlement concerned in the course of that business.

It is these deeming provisions that have caused most concern as, although widely used, the term permanent establishment is not defined, and difficult to apply.

There are two important exceptions provided in s148(3) of the Finance Act 2003, which exclude agents of 'independent status' acting in the ordinary course of business; investment managers are deemed in most circumstances to be independent agents.

The effect of becoming UK resident

The effect of a trustee becoming UK resident could be disastrous from a tax planning perspective.

There are two main consequences of a trust becoming UK resident for CGT purposes:

(a) The trust's worldwide gains would be subject to UK CGT on an arising basis, subject to any treaty relief (no remittance basis being available because this is only available to 'individuals' (s12(1) TCGA) and trustees are not 'individuals' (s65(2) TCGA)).

(b) If the trustee subsequently becomes non-UK resident they will be deemed to have disposed of the trust assets and reacquired them at market value giving rise to tax on any deemed gain (s80 TCGA). This is a particularly important consequence because it means that if a trust has even inadvertently become UK resident, curing the position by becoming non-UK resident will give rise to a deemed disposal and reacquisition of trust assets, and a likely consequent charge to CGT. Before 6 April 2007 the rule was mitigated, because a trust would not become UK resident for CGT if a trustee became resident for one year only. That defence is no longer available, heightening the need to be certain about trustee residence.

For income tax, the effect would be that the worldwide income of the trust would become subject to UK income tax, again, subject to treaty relief being available. However, the remittance basis of taxation has traditionally been available to trustees who are UK resident but non-UK domiciled. Since trustees are, for income tax purposes, treated as a single person, one would have expected the legislation to provide for a way of determining the domicile of a trust – it does not, although the domicile of a company is its place of incorporation.

HMRC guidance

In relation to considering the deemed residence rules, HMRC's guidance narrows the issues down to three core questions:

(a) Is the trustee carrying on business in the UK?

(b) If so, is it carrying on that business through a branch, agent or permanent establishment in the UK?

(c) If so, is the trustee carrying on the activity of being a trustee of the particular trust in the course of its business through the branch, agent or permanent establishment?

The first question is who is the trustee? In the ordinary course of events this will be straightforward and include a validly appointed trustee of a properly constituted trust. Ordinarily, as long as their powers are not so wide that it could be argued that a protector is an agent of the trustee, a UK resident protector will not have adverse tax complications or affect the trustees' residence.

In relation to part (a) above, it is generally accepted that the carrying on of a business has a somewhat wider meaning than that of carrying on a trade: see American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1978]. In the case of a trustee carrying on a business, HMRC have confirmed that it views the core activities of a trustee to be:

(a) The general administration of the trust;

(b) Determining the investment strategy;

(c) Monitoring the performance of those investments; and

(d) Making decisions on how trust income will be dealt with and whether distributions should be made.

The guidance says that HMRC will not include in the above activities things which are not core to the conduct and management of the trust, such as preparatory or auxiliary meetings, information gathering or meetings with independent agents.

In respect of whether or not that business is carried on through a branch, agent or permanent establishment, the position is more complicated. It should be noted that HMRC specifically say that the words 'branch' or 'agency' apply only to non-corporate trustees, and so in respect of corporate trustees it is only a permanent establishment that might be relevant – however, there is no statutory basis for this statement. Perhaps it is an implicit acceptance by HMRC that it agrees with the interpretation that a non-resident company, which is not controlled or managed in the UK, is only subject to corporation tax if it is trading through a UK permanent establishment and therefore a corporate trustee could only be considered UK resident if trading through a permanent establishment. The guidance may be a tacit agreement by HMRC not to take points where the legislation is unclear, which is a pragmatic approach, albeit possibly ultra vires.

Permanent establishment

The term 'permanent establishment' has two possible definitions. The first is derived from domestic law and the second from the OECD Model Treaty. In the context of corporation tax, the UK domestic law provides that an off shore company has a UK permanent establishment if:

The OECD Model Treaty definition is somewhat narrower than the UK legislation, with the first limb of the test being substantively similar to that of the UK test, but with a second limb that requires the agent acting on behalf of the company to have 'authority to conclude contracts in the name of the enterprise', which would be clearer than the UK position of having and habitually exercising authority to do business on behalf of the company. It might be expected that it is the UK test that HMRC will seek to impose, although it is the OECD model that is referred to in the HMRC guidance. However, s148(4) FA 2003 states that a company is not likely to be regarded as having a permanent establishment merely by having an agent of independent status acting in the ordinary course of business. A fixed place of business includes a place of management, a branch or an office.

Particular care should therefore be taken by organisations that have affiliated, or group companies within the UK, to ensure that any business carried out by an affiliated company in the UK is on an arm's length basis. In a letter by HMRC to STEP dated 18 July 2007, HMRC noted its position to be:

• maintaining the financial or accounting records;
• preparation of accounts; or
• preparation and submission of tax returns for any settlement by a separate entity within the organisation contracting at arm's length terms.

HMRC will not only consider where the core activities are physically being carried out, but also the nature and significance of each activity and the frequency of such activities.

Branch or agency

Although HMRC's guidance sets out that the test to apply for non-corporate trustees are the branch and agency tests, it does not set out the basis for this or indeed what the definitions relative to these are. The terms 'branch' and 'agency' are not defined in the income tax legislation, and in the CGT legislation they are defined as including 'any factorship, agency, receivership, branch or management...' (s10(6) TCGA). Giles Clarke in Off shore Tax Planning (16th ed, Butterworths 2009) considers that general guidance on this can be obtained from Hoffman J's judgement in IRC v Brackett[1986], where he found it difficult to consider that a non-resident could be carrying on any trade in the UK with any degree of continuity without it being through a branch or agency. When considering their residence, individual trustees should thus be referred back to again considering whether they are carrying on any form of business from within the UK.

HMRC examples

The HMRC guidance notes that a trustee is likely to be deemed resident if:

(a) an employee or director of the trust carries out regular meetings at the offices of a group company;

(b) if work carried out in the UK by a group company is not at arm's length – so for less then commercial rates, and in particular where that group company has authority to make investment decisions on behalf of the trust; and

(c) where meetings with professional advisers, beneficiaries or general administration are carried out and substantive decisions are taken in the UK with only short 'rubber stamping' meetings being carried out off shore.

STEP guidance

In their introduction, STEP, ICAEW and CIOT note the general concern in the industry that the legislation may act to discourage settlors and off shore trustees from using UK-based advisers. It was hoped that the STEP guidance would clarify the application of the legislation in practice by further developing the examples in HMRC's guidance.

The STEP guidance is set out in much the same way as HMRC's guidance, and contains a number of example scenarios. Below each scenario is an analysis by the three technical bodies followed by HMRC's response. The technical analysis of each scenario should prove useful to professionals advising trustees and is well worth reading. Unfortunately, the HMRC responses fall short of providing adequate certainty in some difficult areas. The scenarios set out are reasonably straightforward; however, the HMRC responses are still heavily interspersed with 'unlikely' and similarly qualified phrases. That said, the situation is an improvement for advisers and the technical institutions confirm that they are continuing to work with HMRC to provide further clarification and possible improvements to the legislation.

There is useful clarification from HMRC in the STEP guidance, which confirms that, in relation to a trust business in the UK, 'it may be a dependant agent of the trustee, but that it still needs to be habitually acting in this way so a one-off event is unlikely to create a dependent PE [Permanent Establishment].' This position applies to a number of scenarios whereby auxiliary meetings with advisers such as investment advisers, and other meetings with beneficiaries, are held in the UK and are 'unlikely' to cause a residence problem. Advisers should ensure that detailed records are available of both on and off shore meetings in order to be able to provide evidence to HMRC should it be required to confirm non-residence.

Examples 13 and 14 concern beneficiaries of non-UK resident trusts acting on behalf of the trustees in certain onshore matters (in these examples the general maintenance and running of investment properties). In neither example is the beneficiary remunerated, however, in example 13 the beneficiary's assistance is only infrequent whereas in example 14 the beneficiary keeps an eye on the properties and reports back to the trustees on a more regular basis. HMRC note that occasional small tasks are 'unlikely' to create a permanent establishment, but if the assistance is anything more than occasional then the trustees should consider remunerating the beneficiary on an arm's length basis to 'put the matter beyond doubt.' Additional guidance in this common scenario would be useful.

Example 19 confirms the application of the independent agent exemption to only corporate trustees rather than individual trustees. The scenario involves a Jersey corporate trustee and an individual Jersey trustee who together appoint a UK investment manager. The STEP analysis discusses how the application of the legislation would potentially leave the trust in a more difficult position than if only a corporate trustee had been appointed, and that there is a potential disparity between the application of CGT and income tax in this context. HMRC only provides limited guidance confirming that the position is not immediately clear and that they will clarify it. Advisers should err on the side of caution pending this confirmation.

Section 2 of the STEP guidance provides some comfort to professional advisers in being able to hold meetings at their offices and HMRC confirm that, so long as there is no right by trustees to use particular rooms, then this should not lead to there being a permanent establishment. Interestingly though, HMRC indicated that if, as was posed as an example, the trustees were requested to pay for the use of the meeting room, it would strengthen the possibility of there being a permanent establishment. HMRC was challenged on this point as in all other examples they have confirmed that using a hotel room, which could be argued is analogous, was unlikely to create a permanent establishment because of its lack of permanence. HMRC attempted to clarify this by saying that the repeated use of a particular hotel (or if it generally became known that the trustees would be available at a particular hotel) over a period of a few years may create the requisite permanence for that hotel to become a permanent establishment, but not otherwise. On the other hand, payment for use of an office meeting room might indicate a right to use of the room and permanence.

Conclusion for practitioners

In the high proportion of cases where UK-based advisers are contracted on an arm's length basis, on commercial terms, there will not be a threat of inadvertently creating UK residence. However, there may be difficulties where a corporate trustee is represented in the UK by UK-based directors or employees and where the representatives' dealings in respect of a particular trust could be said to be more than preparatory or auxiliary. Further, there are difficulties in scenarios involving individual trustees where the independent agent exemption does not apply, and for which adequate guidance has not yet been provided.

UK-based advisers still maintain a reputation such that international trustees are likely to continue to instruct them. However, it is now vital that advice is taken in relation to residence and that the advice is followed with all procedures carefully documented. The HMRC and STEP guidance papers are of assistance, but it would be extremely welcome if HMRC could clarify (with amending legislation if necessary) some of the remaining uncertainties.

Guidance notes

www.hmrc.gov.uk/cnr/trustee-res-guidance.pdf

www.step.org/news/press_releases/2010/trustee_residence_guidance.aspx

The Taxation of Chargeable Gains Act 1992

Section 69

Trustees of settlements

(1) For the purposes of this Act the trustees of a settlement shall, unless the context otherwise requires, together be treated as if they were a single person (distinct from the persons who are trustees of the settlement from time to time).

(2) The deemed person referred to in subsection (1) shall be treated for the purposes of this Act as resident and ordinarily resident in the United Kingdom at any time when a condition in subsection (2A) or (2B) is satisfied.

(2A) Condition 1 is that all the trustees are resident in the United Kingdom.

(2B) Condition 2 is that:

(a) at least one trustee is resident in the United Kingdom,

(b) at least one is not resident in the United Kingdom, and

(c) a settlor in relation to the settlement was resident, ordinarily resident or domiciled in the United Kingdom at a time which is a relevant time in relation to him.

(2C) In subsection (2B)(c) 'relevant time' in relation to a settlor:

(a) means, where the settlement arose on the settlor's death (whether by will, intestacy or otherwise), the time immediately before his death, and

(b) in any other case, means a time when the settlor made the settlement (or was treated for the purposes of this Act as making the settlement); and, in the case of a transfer of property from Settlement 1 to Settlement 2 in relation to which section 68B applies, 'relevant time' in relation to a settlor of the transferred property in respect of Settlement 2 includes any time which, immediately before the time of the disposal by the trustees of Settlement 1, was a relevant time in relation to that settlor in respect of Settlement 1.

(2D) A trustee who is not resident in the United Kingdom shall be treated for the purposes of subsections (2A) and (2B) as if he were resident in the United Kingdom at any time when he acts as trustee in the course of a business which he carries on in the United Kingdom through a branch, agency or permanent establishment there.

(2E) If the deemed person referred to in subsection (1) is not treated for the purposes of this Act as resident and ordinarily resident in the United Kingdom, then for the purposes of this Act it shall be treated as neither resident nor ordinarily resident in the United Kingdom.

(3) For the purposes of this section, and of sections 71(1) and 72(1), where part of the property comprised in a settlement is vested in one trustee or set of trustees and part in another (and in particular where settled land within the meaning of the Settled Land Act 1925 is vested in the tenant for life and investments representing capital money are vested in the trustees of the settlement), they shall be treated as together constituting and, in so far as they act separately, as acting on behalf of a single body of trustees.

(4) If tax assessed on the trustees, or any one trustee, of a settlement in respect of a chargeable gain accruing to the trustees is not paid within 6 months from the date when it becomes payable by the trustees or trustee, and before or after the expiration of that period of 6 months the asset in respect of which the chargeable gain accrued, or any part of the proceeds of sale of that asset, is transferred by the trustees to a person who as against the trustees is absolutely entitled to it, that person may at any time within 2 years from the time when the tax became payable be assessed and charged (in the name of the trustees) to an amount of CGT not exceeding tax chargeable on an amount equal to the amount of the chargeable gain and, where part only of the asset or of the proceeds was transferred, not exceeding a proportionate part of that amount.

Income Tax Act 2007

Section 475

Residence of trustees

(1) This section applies for income tax purposes and explains how to work out, in relation to the trustees of a settlement:

(a) whether or not the single person mentioned in section 474(1) is UK resident, and

(b) whether or not that person is ordinarily UK resident.

(2) If at a time either condition A or condition B is met, then at that time the single person is both UK resident and ordinarily UK resident.

(3) If at a time neither condition A nor condition B is met, then at that time the single person is both non-UK resident and not ordinarily UK resident.

(4) Condition A is met at a time if, at that time, all the persons who are trustees of the settlement are UK resident.

(5) Condition B is met at a time if at that time:

(a) at least one person who is a trustee of the settlement is UK resident and at least one such person is non-UK resident, and

(b) a settlor in relation to the settlement meets condition C (see section 476).

(6) If at a time a person ('T') who is a trustee of the settlement acts as trustee in the course of a business which T carries on in the United Kingdom through a branch, agency or permanent establishment there, then for the purposes of subsections (4) and (5) assume that T is UK resident at that time.

Section 476

How to work out whether settlor meets condition C

(1) This section applies for the purpose of working out whether a settlor ('S') in relation to a settlement meets condition C at a time.

(2) If:

(a) the settlement arose on S's death (whether by S's will, on S's intestacy or in any other way), and

(b) immediately before S's death, S was UK resident, ordinarily UK resident or domiciled in the United Kingdom, then S meets condition C from the time of S's death until S ceases to be a settlor in relation to the settlement.

(3) If:

(a) the settlement is not within subsection (2)(a), and

(b) at a time when S made the settlement (or is treated for the purposes of the Income tax Acts as making the settlement), S was UK resident, ordinarily UK resident or domiciled in the United Kingdom, then S meets condition C from that time until S ceases to be a settlor in relation to the settlement.

(4) Further, if:

(a) there is a transfer of property in relation to which section 471 applies,

(b) S is a settlor in relation to settlement 2 as a result of that section, and

(c) immediately before the disposal by the trustees of settlement 1, S meets condition C as a settlor in relation to settlement 1 as a result of subsection (2) or (3) or this subsection, then S meets condition C as a settlor in relation to settlement 2 from the time S becomes such a settlor until S ceases to be such a settlor.

(5) 'Settlement 1' and 'settlement 2' are to be read in accordance with section 470(1).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.