UK: NZ Trust Plan

Last Updated: 24 September 2002
Article by Michael Reason

1. The Orwellian Play

Offshore trusts have traditionally been resident in the British Channel Isles and Caribbean states.

In recent years, the "Zero Tax" jurisdictions have come under attack from the OECD and other international bodies on the grounds of "unfair tax competition" and due to the threat of money laundering and misuse. Non-disclosure of beneficial ownership to assist a foreign revenue authority is being superseded by exchange of information between the Inland Revenue departments of onshore and offshore jurisdictions.

"All Crimes" criminal laws have been enacted in certain offshore jurisdictions. One aim is to prevent terrorism and to prevent the corporate services providers, their lawyers, accountants and bankers from assisting terrorists, drug traffickers and those who retain the benefit of criminal conduct. In the Isle of Man under the Criminal Justice (Money Laundering Offences) Act 1998, it is an offence to "pass on information to anybody, knowing or suspecting that it is likely to prejudice an investigation into money laundering. "Criminal conduct" includes conduct, which would be criminal, if it occurred in the Isle of Man. If the Isle of Man has been involved in some way with the committing of a crime in another state, the crime will be treated as though it had been committed in the Isle of Man.

Although it is not a crime to arrange your affairs in such a way as to minimise tax, this new law has been enacted to satisfy international organisations such as the OECD, the EU and the UN. Their perception has been, whether right or wrong, that the Channel Islands have been exploited by criminals wishing to launder money and use it for illegal purposes. Consequently due diligence requirements of offshore banks have become stricter there and costs, already high, have been forced up.

Is this a case of Orwellian government in which the unfair tax competition argument cannot be won directly by forcing another sovereign state to introduce income and corporation tax so it is being won indirectly by making the use of the jurisdiction uneconomic?

2. New Zealand

New Zealand is not known as an "offshore Zero Tax Jurisdiction" but the trust is a useful device, which New Zealand can safely offer to worldwide trust and estate planners.

A New Zealand resident trustee does not by itself attract NZ tax. As long as "settlors, beneficiaries, and income are all foreign, the residence of the trustee is in principle not relevant to the New Zealand tax system."1

When income has a foreign source, liability to taxation in NZ depends generally on the residence of the beneficiary, if the beneficiary derives the income, or on the residence of the settlor (not the trustee) if the trustee derives the income and accumulates it.2

Foreign source income is not taxable in NZ to non-resident beneficiaries, even if the trust has a New Zealand connection such as a resident settlor or trustee.3

The taxation of the accumulated income of the trustee depends on the residence of the settlor. If the settlor is non-resident, then, ordinarily, the income is not taxable in NZ, even if the trustee is resident.4

A trustee company incorporated in NZ will be resident there wherever its management is situated 5 unless practical management is situated in a state with which NZ has a double tax treaty and residence provision treated the company as resident in the other state.

New Zealand does not have a comprehensive capital gains tax. On a number of occasions in 2000, the Minister of Revenue has reiterated the present government policy not to introduce a capital gains tax.6

3. Non Domiciled UK Residents

The text of Magna Carta 1215 contains the following paragraph:-

"All merchants may enter or leave England unharmed and without fear, and may stay or travel within it, by land or water, for purposes of trade, free from illegal exactions, in accordance with ancient and lawful customs." 7

Almost 800 years later leading authorities on the UK tax system are able to write as follows in relation to the position of non-domiciled individuals (the modern interpretation for Foreign Merchants and others) resident in the UK:-

"..with care and foresight and the adoption of an appropriate tax planning strategy, United Kingdom tax may be largely avoided." 8

4. What is Domicile?

When a child is born he or she acquires a domicile of origin. This is the domicile of his father (or if illegitimate of his mother). On attaining the age of 16 it is possible for him or her to shed their domicile of origin and acquire a domicile of choice. The individual may retain their domicile of choice indefinitely; alternatively they may acquire a new domicile of choice or may abandon their domicile of choice without acquiring a new domicile. In that event the domicile of origin will revive.

If an individual were to go to the UK and wished to retain their foreign domicile (and associated tax privileges) the initial advice is should be clear; he of she may live in the UK as long as he or she wishes from year to year but he or she should not form the intention to settle in the UK permanently. Unless he or she does so, the essential condition for the acquisition of a new domicile will not be satisfied. He or she should take such practical steps as are possible to broadcast the absence of any intention of residing in the UK permanently and to manifest the intention to return elsewhere in due course. The individual should retain their ties with their country of origin including regular visits, local business interests, bank accounts and investments, membership of local social, political and religious organisations and the execution of a will taking effect under local law. The will should include a declaration that the individual intends to return home in due course or the circumstances in which this will occur. 9

The retention of the foreign domicile of origin is not dependent on establishing a positive desire to return home; rather, it is determined negatively by the absence of an intention to stay in the UK, whether to the country of origin or elsewhere.

5. Inheritance Tax

The inheritance tax code modifies the definition of domicile so that seventeen years residence in the UK will give the foreign domiciliary the status of a UK domiciliary for most inheritance tax purposes. In fact this rule is illusory. A foreign domiciliary who puts his or her inheritance tax affairs in order in good time will continue to reap tax advantages even after he or she becomes deemed a UK domiciliary.

Non domiciliaries resident in the UK are taxed on their income arising outside the UK income on a remittance basis. 10 This relief regarding income tax applies where an individual who is domiciled outside the UK receives a benefit but it does not receive the benefit in the UK. UK non-resident person may use the foreign income outside the UK or to make a gift. It may be accumulated abroad tax-free and the part that the person requires may be brought into the UK and be subjected to UK taxation, the rest remaining outside to accumulate. Trust capital as opposed to income may be safely introduced into the UK.

6. Transfers

The foreign domiciliary with assets in the UK does not need to sell them and take the proceeds abroad for inheritance tax purposes (subject to UK CGT rules referred to at para 8 below). He of she might give them to a foreign registered company owned wholly by him or her. The gift would not be a transfer of value because the donor's estate would not be reduced in value. The shares of the foreign company should remain with the offshore directors or company secretary as excluded property of the non-domiciliary resident in the UK. Their transfer to the trustees of the non-domiciliary could then be completed without the gift attracting UK IHT. 11

Reporting conditions section 5A if said were ordinarily resident. Section 218 IHTA reporting obligation on legal advisers.

7. Use of residential property in the UK

The use of residential property held abroad by the beneficiaries of a trust could give rise to tax due to the use of the property being deemed to be a benefit in kind. 12

8. UK Capital Gains Tax

Section 222 of the Taxation of Chargeable Gains Act 1992 provides for relief from Capital Gains tax in the case of the disposal by an individual of a dwelling house which "is or has been… in his period of ownership, … his only or main residence"

The relief applies in full when the dwellinghouse has been used throughout the period of ownership as the owners main residence. Where the house has been so used for only a part of the period of ownership, partial exemption applies by apportioning the overall gain by the period of ownership as a main residence. The last three years of ownership is treated as owner occupation, whether so occupied or not, provided that the house has at some time been the only or main residence.

Non-UK residents are outside the scope of UK GGT, unless they conduct a trade in the UK through a branch or agency in which case disposals of the assets of the branch or agency are subject to CGT.

In general a non-UK domicilliary resident, including trusts and personal representatives in the UK who disposes of assets outside the UK is only chargeable to tax on gains "remitted" to the UK. If income is held in one offshore account, the capital gain in another account and the capital which did not arise from a gain but merely from a disposal and conversion to cash in a third account, the sum in this third account could be remitted to the UK without suffering UK CGT.

Generally, assets should be acquired by an offshore trust. Anti avoidance provisions relating to offshore trusts do not apply to foreign domiciled beneficiaries.

9. NZ domiciles

An individual resident in the UK may be NZ domiciled and when the determination to gift real property situated in the UK to a wholly owned company in another jurisdiction, the question of NZ Gift Duty must be considered.

The concept of a gift would include the creation of a trust described above which would have the effect of diminishing the donor's own estate and increase the value of the estate of another. One specific exception is that a disclaimer of an interest under a disposition made inter vivos or by will does not constitute a disposition of property. This is not helpful to a transferor wishing to set up a trust situated outside the UK.

A "dutiable gift" is a gift of property wherever situated that is the subject of a gift made by a donor domiciled in New Zealand (or body corporate situated in NZ) or property situated in NZ when the donor is not domiciled in NZ or is a body corporate incorporated outside New Zealand.

Gifts of NZ$27,000 or less and made in a 12-month period are subject to a "nil" duty rate. The solution for the NZ domiciliary then is to sell assets to a trust at market value and forgive at NZ$27,000 per annum.

10. Interaction of Loan and gift back with UK tax provisions

One means by which the value of the gift may be diminished would be for the NZ domiciliary's UK situated property the be mortgaged by way of a loan from an unconnected third party such a foreign bank on commercial terms. The borrowed funds could then be placed into a offshore bank account the individual in the event of his death before the gift may be completed because the borrowed funds being abroad, for inheritance tax purposes, the borrowed money will be an asset of his or her estate for inheritance tax purposes but will be excluded property. The liability could reduce to zero the value of his or her UK estate immediately before his or her death.

The charge in favour of the foreign bank will contain a term, which prevents the transfer of ownership of the mortgaged property without the consent of the mortgagee. Thus mortgaged the property's net value would be the market value of the property less the sum of the mortgage. If the net value is less than NZ $27,000, the consent of the mortgagee may be obtained and the mortgaged property transferred to the trustees. The individual could then repay of the mortgage. This method would not appear to offend s 69 of the Estate and Gift Duties Act 1969 (NZ) as the bank loan is made at all times to the NZ domiciled individual and the trustee to whom the property is transferred is not entitled to any "right of contribution or of indemnity" regarding the loan and mortgage. The NZ domiciled individual could transfer the "rump" of the property to the trustee subject to the mortgage and loan in the bank's favour. If the loan was not repaid the bank would only be able to sue the individual and would have no cause of action against the trustee with whom it had not legal relationship.

The same above method does not offend s 70 of the same NZ act because the mortgage is not a "benefit or advantage" to the donor.

11. Investment Portfolio of Trust Collective Investment vehicle

Smaller investors might wish to invest into UK situated capital appreciating assets. It would be proposed that the trust me in possession of the shares of companies holding investors cash which when the required sums are collected is used to acquire property suitable for investment purposes.

NZ resident settlor or beneficiary subject to NZ tax on net income but not subject to NZ tax on capital gains.

12. Portfolio Investments

NZ will trusts may name the company as trustee with instructions to invest in capital growth assets in various jurisdictions.

13. UK Domicilaries

UK resident and domiciled individuals not to use without trust an opinion of specialist counsel regarding FA 1998 rules concerning attribution of gains to settlor section 86; section 5A reporting conditions on settlor and settlor’s UK advisors, section 45 and 46 of Finance Act 81; UK domiciled and resident individuals; beneficiaries taxed to extent received benefit wherever even if not UK (income tax). Section 739 ICTA also attributes income if income payable to person resident or domiciled outside the UK.

14. What Does the Settlor want from a Trust company?

1. Concerning tax, a double tax agreement and zero tax in the state of residence of the trustee.

2. State of residence of the trustee should be developed with good judicial system and infrastructure. The absence of offshore "all crimes" legislation is considered by some to be an advantage.

3. The solvency and security of the trustee company is considered to be important.

4. Price of services of trustee can be a consideration but is not of prime concern to the good quality high net worth client.

15. NZ Tax Treaty Network

The trust company would be a company incorporated in New Zealand and so unless deemed resident in a second jurisdiction by double tax treaty would be NZ resident.

NZ has double tax agreements with the following countries:-

Australia, Belgium, Canada, China, Denmark, Fiji, Finland, France, Germany, India, Indonesia, Ireland, Italy, Japan, Malaysia, Netherlands, Norway, Philippines, Republic of Korea, Taiwan, Singapore, Sweden, Switzerland, UK and the USA.

NZ trusts i.e. resident in NZ do not suffer tax themselves but, as a jurisdiction, NZ charges tax to NZ resident settlors and beneficiaries. If a settlor and beneficiary of a trust were non NZ resident therefore income arising to the NZ resident trust would not suffer NZ income tax.

If a settlor and beneficiary were on the other hand NZ resident and the trust received capital gains, again NZ would not tax these because New Zealand does not have capital gains tax.

If the investments were in the UK, the trust dual resident in NZ and in the Isle of Man where corporate directors were resident, there being no treaty between NZ and the Isle of Man, the UK would be bound by the treaties with the Isle of Man and the treaty with NZ. If most of the directors were resident in NZ and practical management services were provided there then it would be likely the management would be treated as resident in NZ. If they were treated as dual resident, given that there are treaties with both the Isle of Man and NZ, there would be no disadvantage to such treatment by the UK.

References

1 New Zealand Trusts and International Tax Planning, Professor John Prebble, [2000] B.T.R.: 5 pp 554.

2 Income Tax Act 1994, s.BD1 and s.HH4 (1) and s.HH4 (3) (a).

3 Income Tax Act 1994, s.BD1 (2)

4 Income Tax Act 1994, s.HH4 (3B)

5 Income Tax Act 1994, s. OE 2(1)(a)

6 New Zealand Master Tax Guide 2001 cch paragraph 1-500

7 Magna Carta G.R.C. Davis, the British Library

8 Tax Planning for the Foreign Domiciliary, Third Edition, James Kesler and Peter Vains, Key Haven Publications plc 1999

9 Tax Planning for the Foreign Domiciliary, Third Edition, James Kesler and Peter Vains, Key Haven Publications plc 1999 at Introduction p 1.

10 ICTA 1998 s.740(5)

11 IHTA 1984, s 65(7)

12 s 145 and 145 ICTA 1988

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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