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Offshore trusts: the changing tax regime

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Many individuals who are affected by the new deemed domicile rules will have created offshore trusts to keep non UK property out of the scope of UK Inheritance Tax (IHT). Often the settlors of these trusts will have retained an interest in the assets however up until now the remittance basis has offered protection from UK tax on any income or gains arising within the trust structure.

The new deemed domicile rule is being introduced to ensure long term UK resident foreign domiciliaries are taxed in the same way as UK domiciliaries. However without further legislative changes this would be very disadvantageous to those who have already created offshore trusts.

The Government has been consulting for over a year as to whether to offer any protections to UK deemed domiciled individuals. We now have draft legislation which sets out a modified version of the original proposal. Further consultation will continue until the end of January 2017 and the final law will be in the Finance Act 2017. However we have a good indication of the way forward.

For individuals with offshore trusts there are three taxes which could affect them from 6 April 2017:

1. Inheritance tax

The biggest advantage is trusts set up by non UK domiciled individuals (which are often non UK resident but not always) are the IHT protection they offer to non UK situs assets. The good news is that the Government has confirmed that this protection will remain in place for all non UK assets. The only exception to this is where UK residential property is held by a non UK company and the Government has confirmed the value attributable to such a dwelling will no longer be excluded property from 6 April 2017. (See Liz Cuthbertson’s article for further details).

2. Income tax

The income tax position will depend upon the status of the settlor and the new rules offer some protection for trusts where the settlor is deemed domiciled under the 15 out of 20 test or non UK domiciled. In both cases, the foreign income will be taxed on the settlor by reference to the benefits received by the settlor or their close family members unless it is taxable in some other way e.g. because a beneficiary is entitled to income as of right. However, if there is an addition to the trust after 6 April 2017 then the settlor is likely to become taxable on all the income of the trust as it arises so it essential that the position is kept under close review to ensure tax returns are correct.

Where the settlor is UK domiciled under general law, or is someone who was born in the UK with a UK domicile of origin then they are fully taxable on the income of the trust as if it was their own.

3. Capital gains tax

This area has changed the most since the August 2016 consultation and we are relieved that HMRC have considered an alternative approach.

Settlors of trusts, in which they or certain family members have an interest, who become deemed domicile in the UK can continue to enjoy the deferral they have at present and will not be subject to Capital Gains Tax (CGT) on the trust gains as they arise from 6 April 2017 as long as:

  • They were neither UK domiciled nor deemed domiciled when the trust was created
  • They were not born in the UK with a UK domicile of origin
  • They have not added to the trust after 5 April 2017

Where these conditions apply the gain will stockpiled until it is matched with a capital distribution which is made to a beneficiary. As with the current rules this could be a capital payment or a deemed benefit – e.g. a loan benefit relating to interest free borrowings. The taxation of the gain will depend upon the status of the beneficiary and each case will require specific review and monitoring.

The biggest change is that payments made to non UK residents will no longer reduce or ‘wash out’ gains in the stockpiled gains pool and there are various anti avoidance measures to prevent anyone from stepping around this rule.

As with income tax, it is increasingly important to ensure that tax returns are correctly completed as HMRC will be unsympathetic to ‘mistakes’. As such we strongly encourage anyone who is a beneficiary or settlor of a trust to ensure their specific circumstance is checked. To discuss this further please contact Lynsey Lord or another member of the Mercer & Hole team.

Capital gains tax

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