UK: Offshore Trusts And UK Resident Foreign Domiciliaries - August 2014

Last Updated: 28 August 2014
Article by Smith & Williamson


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.

Non-UK residents disposing of UK residential property

The Government is consulting on implementing, from April 2015, a capital gains tax charge on 'future' capital gains of non-UK residents making a disposal of UK residential property. The proposed definition of residential property for this purpose would include commercially let residences, with some exceptions, held by offshore trusts and by non- resident companies unless 'widely owned'..

If this proposal becomes legislation it will require careful integration with existing anti- avoidance such as the charge on settlors and trust beneficiaries. Whether there will be a base cost uplift to exclude the gain prior to introduction of the legislation has yet to be resolved, as has the scope for principal residence relief.

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.

In the Chancellor's 2014 Budget it was announced that the scope of ATED charges and the ATED related CGT would be extended. From 1 April 2015 properties valued between £1 million and £2 million will be subject to an annual charge of £7,000. From 1 April 2016 a further lower band is added for properties valued between £500,000 and £1 million for which the annual charge will be £3,500.

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).


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.

We have taken care to ensure the accuracy of this publication, which is based on material in the public domain at the time of issue. However, the publication is written in general terms for information purposes only and in no way constitutes specific advice. You are strongly recommended to seek specific advice before taking any action in relation to the matters referred to in this publication. No responsibility can be taken for any errors contained in the publication or for any loss arising from action taken or refrained from on the basis of this publication or its contents.

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