UK: Briefing Note: Offshore Trusts And UK Resident Foreign Domiciliaries

Last Updated: 7 August 2013
Article by Smith & Williamson

Background

Offshore trusts can be highly tax efficient for UK resident foreign domiciliaries. There are, however, pitfalls as the legislation is complex.

Over the long-term trusts can shelter from UK inheritance tax (IHT) the foreign situs assets of a foreign domiciled settlor provided:

  • the settlor was not 'deemed' domiciled at the time that the property was settled; and
  • at the time an IHT charging event occurs the property on which the charge arises is foreign situs.

This will be the case regardless of whether any changes occur with respect to the domicile of the settlor (that is, regardless of whether an actual or deemed UK domicile is acquired).

Where a foreign domiciliary (who is not deemed domiciled) settles foreign situs assets into trust there is no IHT charge on this event. This is not generally the case with UK situs assets (there are special rules for certain investments) and accordingly:

  • UK situs chattels should be exported prior to the settlement (thereby turning them into foreign situs assets); and
  • cash transfers into trust should not be made from a UK account.

UK situs assets within trust structures settled by foreign domiciliaries are generally subject to IHT (with normal reliefs and exemptions being due). Where the trust is to hold UK land or other UK situs property interposing a foreign company between the trustees and the property will mean that the trustees have foreign situs shares rather than UK situs property for IHT purposes. There may, however, be other tax reasons why this is not always desirable, including the Annual Tax on Enveloped Dwellings (ATED). This is explained below.

Whilst it may be possible to achieve the same IHT advantages with a UK trust settled by a foreign domiciliary, a UK trust would not give the same income tax and capital gains tax benefits as an offshore trust which are outlined below.

Remittance basis issues

It is important that any strategy that the trustees pursue is compatible with the individual strategies of the settlor and beneficiaries. Specialist advice and good communication is essential.

Actions by the trustees could result in an inadvertent taxable remittance by the settlor where:

  • the settlor is alive and UK resident;
  • the trustees are 'relevant persons' in connection with the settlor (as will often be the case as most trusts are established to benefit the settlor and/or immediate family members such as spouse/civil partner, minor children and minor grandchildren); and
  • the trustees remit tainted property to the UK and no exemption or transitional provision switches off the remittance charging provision.

There can be an issue where the trustees have control over remittance basis foreign income or gains/deemed gains of the settlor. This will be the case in each of the following

situations:

  1. property representing or derived from remittance basis foreign income or gains is settled;
  2. a foreign situs chargeable asset pregnant with gain is settled into the trust; or
  3. income arises within the trust and the trust is settlor-interested for income tax purposes.

Where such tainted property is within the trust structure there is a need for controls to be put in place to ring-fence it so that an inadvertent remittance cannot occur, which could be taxable on the settlor.

Anti-avoidance provisions

A non-resident trust is only subject to income tax with respect to UK source income and is also outside the scope of capital gains tax (CGT). Extensive income tax and capital gains tax anti-avoidance legislation has been enacted to prevent UK resident individuals making use of offshore structures to avoid UK tax.

The various provisions, when triggered, result in income or gains (as relevant) being attributed to UK resident settlors/beneficiaries. The extent of the attribution and the mechanisms used differ. Some charging provisions attribute on the arising basis. Others employ a matching process such that there is only attribution if a benefit is received. To allow for potential tax efficient extraction, income and capital within the trust should be segregated at all times.

There are special rules for UK resident foreign domiciliaries. Whilst they are subject to the

full range of income tax anti-avoidance provisions, foreign domiciliaries are not subject to

the settlor charge CGT anti-avoidance provisions and can benefit from favourable

transitional provisions where the beneficiary charge CGT provisions are in point. In

addition, if the UK resident foreign domiciliary is a remittance basis user he/she will:

  • be taxed on UK income attributed on the arising basis but only taxed on foreign income if it is remitted;
  • only be taxed on matched capital gains if they remit the relevant capital payment or receive a benefit in the UK.

Income tax

There are two anti-avoidance codes:

  1. the settlements code; and
  2. the transfer of assets abroad regime.

Generally, where the trust is settlor interested and the settlor is alive, the anti-avoidance provisions with respect to income tax mean that the trust structure is no more efficient than holding the property personally. Where the trust is not settlor interested (or the settlor is dead) the trust structure may enable funds to roll up free from income tax. By structuring trust distributions the remittance basis charge may not have to be paid every

year and this could be more advantageous than UK resident foreign domiciled beneficiaries holding the property personally, keeping the income offshore and accessing the remittance basis, possibly on an annual basis.

When dealing with trust/company structures one has to consider all the income within the structure. Where the settlements' code applies to the trust income both sets of legislation may be in point as there may be undistributed income at company level which can be taxed under the transfer of assets abroad regime.

The rules are complex and appropriate advice should be taken.

Capital gains tax (CGT)

The CGT anti-avoidance provisions did not apply to UK resident foreign domiciliaries prior to 6 April 2008. Prior to that date capital distributions could be made offshore and remitted to the UK without a UK tax charge provided (i) actual income was not remitted; and (ii) there was no relevant income within the structure to attach to the capital distribution.

The beneficiary charge provision can apply where after 5 April 2008 the matching rules allocate a capital gain to a capital payment made to a UK resident foreign domiciliary. (A capital payment for these purposes can also include a low interest loan or use of assets such as property or chattels for less than market rent.) However, automatic transitional provisions mean that a foreign domiciliary is not subject to CGT with respect to chargeable gains treated as accruing as the result of:

  1. a capital payment received (or treated as received) before 6 April 2008; or
  2. the matching of any capital payment with capital gains for the tax year 2007/08 or earlier tax years.

It is however essential that the beneficiary is foreign domiciled at the time of matching of the gain which may be some time after the payment is received or the gain is realised within the structure.

For these transitional provisions to be of maximum benefit it will be necessary to have an accurate picture of the capital payments and capital gains position as at 6 April 2008.

Where there is a capital payment after 5 April 2008 which is matched to gains realised in the trust structure after 5 April 2008 there will be a potential tax charge where a UK resident foreign domiciliary is:

  • taxed on the arising basis in the year that the matching event occurs; or
  • a remittance basis user when the matching event occurs and the capital payment is then remitted to the UK.

Further transitional provisions apply if a valid one off irrevocable election (commonly referred to as the rebasing election though it is strictly no such thing) has been made. A valid election must be made by 31 January following the first tax year (after 2007/08) in which a specified event takes place. Making the election switches on provisions which proportionally reduce the gain on which the foreign domiciliary is subject to CGT to provide relief for unrealised gains as at 6 April 2008. Trustees need to ensure that such an election is made on a timely basis so that the deadline is not missed.

Where there is delay in the matching of capital gains to capital payments a supplementary charge can apply to increase the rate of CGT payable by the beneficiary. However by ensuring maximum advantage is taken of the transitional and rebasing provisions this may not prove to be a significant problem for many non UK domiciled beneficiaries.

Similar matching rules also apply to Offshore Income Gains (OIGs) realised on the sale or transfer of units in non-reporting (previously termed non-distributing) offshore funds. These gains are taxed as income and they are matched in priority to any capital gains within the trust structure. However no supplementary charges apply.

The timing of distributions and disposals is crucial given:

  • the need to ensure the capital distribution does not represent or derive from remittance basis foreign income or gains settled into trust;
  • the need to extract relevant income within the structure tax efficiently;
  • the arbitrary nature of the matching rules and how they interact with the transitional provisions.

Annual Tax on Enveloped Dwellings (ATED) from 1 April 2013

Where UK residential property is acquired and the consideration for a single dwelling exceeds £2 million then, where the acquisition is by certain 'non-natural persons' which includes all companies, the Stamp Duty Land Tax (SDLT) is now at a penal rate of 15%. This higher rate does not apply to purchases by trusts but it would apply to a purchase by an offshore company owned by an offshore trust.

In addition there is an annual charge of between £15,000 to £140,000 on high value UK residential properties held in corporate structures with effect from 1 April 2013, unless a specific exemption applies. Where properties are used by trust beneficiaries ATED will apply to both existing and new high value properties owned by companies held by offshore trusts. Such structures have typically been used to ensure that no UK IHT liabilities arise in relation to the UK property.

UK CGT at 28% will also be payable on the sales of any properties which were liable to ATED and such gains will not then be matched to payments and benefits to beneficiaries of the structure. However pre 6 April 2013 gains will continue to be matched. The ATED related CGT will be calculated by reference to the 6 April 2013 value of the property unless an election is made to use the original cost.

Without specialist advice the potential to reduce/eliminate ATED liabilities can be lost. Smith & Williamson would be pleased to advise trustees to ensure optimal use is made of the reliefs and to consider whether restructuring is appropriate.

Recent Inheritance tax changes

HMRC stated in January 2013 that it had changed its view as regards the situs of 'specialty debts', especially where the debt is secured on UK property. It no longer accept that the situs of the debt is where the deed is kept but believe that it is the residence of the debtor that is important.

As many offshore trusts have lent funds directly to UK resident beneficiaries as specialty debts these should be reviewed. Particular care is needed where there is a settlor interested trust or a pre March 2006 interest in possession trust whereby any UK situs assets would be included in the estate of the settlor/beneficiary on death. Trusts where a 10 year anniversary charge is rapidly approaching should also be reviewed as, even if the loan is less than the current IHT nil rate band, an IHT charge can still apply.

Legislation was introduced as part of the 2013 Finance Act to restrict the deductibility of debts taken out to acquire excluded property. This may affect the settlor of the trust where the loan was used to obtain the foreign assets to settle the trust. Again an urgent review is suggested.

Further complications

Specialist advice should be taken

  • to deal tax efficiently with the extraction of offshore income gains; and
  • prior to trustees' borrowing funds (as borrowing for an unallowable purpose when linked with a transfer of value will trigger penal provisions).

Summary

Offshore trusts can be extremely effective tax planning vehicles for non UK domiciled individuals who wish to ensure that their offshore assets remain free of UK IHT and also allow for the significant deferral of both income tax and capital gains tax as opposed to direct ownership or holding via a UK trust. However there are administrative costs associated with such structures as well as many areas of tax legislation that can act as trap for the unwary. Seeking early advice is therefore essential.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.