The taxation of offshore trusts and pitfalls to beware of!
Under UK tax law, a trust will be ‘settlor interested’ if the settlor and spouse are not specifically excluded from benefiting. The consequences of this are that income and gains of the trust are taxed in the hands of the settlor as they arise, subject to the domicile status of the settlor.
For UK resident and domiciled individuals, self-settled offshore trusts are often of little benefit since assets settled upon trust are (subject to a few exceptions) subject to an immediate inheritance tax (IHT) charge of 20% and income and gains of the trust are taxed to the settlor on an arising basis. The situation, though, is quite different for UK resident non-domiciled (RND) individuals for whom offshore trusts remain very advantageous despite changes to the taxation of RNDs introduced by the March 2017 Finance Bill (which were withdrawn due to the snap election and subsequently enacted with retrospective effect from 6 April 2017 as originally planned).
Trusts, however, should be approached with caution. The circumstances in which they can be used are relatively limited and for many individuals the thought of losing control of their wealth isn’t particularly appealing despite the potential tax benefits. Whilst steps can be taken to provide the settlor with a degree of control (ranging from the appointment of a Protector, to reserving specific powers all the way to creating a Private Trust Company structure), these will potentially taint the tax status of the trust.
Notwithstanding these words of warning, trusts are beneficial to RNDs provided careful planning steps are taken. This is because RNDs can benefit from the remittance basis of taxation (i.e. foreign source income/gains are liable to UK tax only to the extent they are remitted to the UK). In the context of a settlor interested offshore discretionary trust, income and gains arising to the trust will not be liable to UK taxation provided they are kept offshore and not remitted to the UK. Furthermore, RNDs contributing assets to the trust will not be liable to the 20% entry charge referred to above since they are outside the scope of IHT. However, the benefits of the remittance basis don’t last forever, and there are certain pitfalls RNDs need to avoid to ensure their offshore trust remains protected.
The remittance basis – make sure you claim it!
It is vital that RNDs file a UK tax return and elect the remittance basis to ensure they are not taxed on their worldwide income. The remittance basis is a yearly election, and failure to claim for a particular tax year will result in worldwide taxation. However, this rule does not extend to the non-UK income and most gains of a protected offshore trust (see below).
The Remittance Basis Charge
HMRC wouldn’t allow individuals to file on this basis without getting something in return eventually. After much political debate about the fairness of the remittance basis, and taxation of RNDs generally, the Remittance Basis Charge (RBC) was introduced on 6 April 2008. RNDs that have been resident in the UK for seven of the past nine tax years, are required to pay the RBC of £30,000 in order to claim the remittance basis for that year. For RNDs that have been resident for 12 of the past 14 tax years, the RBC increases to £60,000.
Of course, at this point it is necessary to consider whether paying the RBC is more beneficial than being subject to worldwide taxation. This is essentially a cost/benefit exercise and will depend on the level of the RNDs offshore income and gains. If the RBC exceeds the RNDs potential UK tax liability, or the benefits are marginal, then filing on the arising basis may be the best option.
Becoming ‘deemed domiciled’ and keeping your trust protected
RNDs that have been resident in the UK for 15 of the last 20 tax years are now considered ‘deemed domiciled’ for UK tax purposes, which means they are taxed in the UK on their worldwide income and gains. That is, the remittance basis of taxation is no longer available to them.
HMRC have, however, provided relief for those RNDs with offshore settlor interested trusts who become deemed domiciled. RNDs who were resident in the UK on or after 6 April 2017 and settled a trust before they became UK deemed domiciled, would otherwise be taxed on an arising basis in respect of trust income and gains. However, those trusts are given ‘protected’ status, meaning the settlor is not taxed on the non-UK income and most gains as they arise (UK residential property, UK business property, carried interest and offshore income gains are still subject to UK tax). The trust and its assets are therefore protected from UK taxation.
It is possible for a trust to lose its protected status. If an addition has been made to the trust after 6 April 2017 and the individual is deemed domiciled in the UK at the time, then the trust no longer has this protected status. This would bring the trust within the scope of UK tax and the RND would be taxed on the income and gains on an arising basis. It is therefore vital not to make any contributions to offshore trusts once an individual has become deemed domiciled.
Certain additions into the trust can be disregarded, allowing the trust to maintain its protected status; however, the rules around this are complex and require advanced planning.
Do I need to disclose this to HMRC?
If you are a UK resident, non-domiciled settlor of an offshore settlor interested trust and you have not reported the income and gains on your tax return when you should have, then a disclosure will need to be made to HMRC using their Worldwide Disclosure Facility in order to settle any outstanding tax liability.
When making a disclosure like this, HMRC have the power to request the accounts of the trust and various other pieces of information, to ensure the disclosure is correct and there are no more compliance errors. If HMRC discover you have been non-compliant, severe penalties can apply.
What should I do?
If you are the settlor of an offshore trust and are concerned about any of the issues raised above, we can help. We have a great deal of experience with regards to the planning of offshore trusts, as well as dealing with HMRC disclosures and investigations. More information on disclosures to HMRC and the information they are able to obtain, can be found in our next article below.
If you have any questions or would like to know more,
please contact Miles Dean on +44 7785 770 431 or miles.dean@AndersenTax.co.uk
or Luke Jenkinson on +44 7494 157 948