Offshore trusts – traps for the unwary
9 December 2018
Much has been written about the new UK regime for offshore trusts, introduced on 6 April 2017. The regime broadly “protects” longer term resident non-doms (those who have been resident for more than 15/20 years) from having to pay tax on most types of income and gains of trusts established and funded before becoming deemed domiciled.
In addition to “protecting” longer term residents from UK tax, the regime also introduces various anti-avoidance rules designed to prevent individuals from extracting trust funds for use in the UK. The policy behind this is that the tax exemption should only apply to funds remaining in the trust, and individuals wishing to extract funds from the trust should be subject to UK tax. This is a fair enough objective, however the government wanted to prevent any type of planning to get around these rules (i.e. to extract trust funds tax efficiently) and therefore enacted a series of anti-avoidance rules, of nightmarish complexity – even for a seasoned tax advisor!
There is general misconception that the new anti-avoidance rules only apply to individuals who have become deemed domiciled in the UK. However, that is an incorrect assumption since many of the new rules apply to all offshore trusts settled by a UK resident non-dom, irrespective of how long they have been living in the UK.
The following new anti-avoidance rules apply to all trusts established by non-doms:-
- It used to be possible for trusts to make distributions to non-UK resident beneficiaries in order to “wash out” accumulated income and gains, before subsequently making tax-free payments to UK beneficiaries. Under the new regime, washing out no longer works. Any such payments are ignored.
- Distributions of cash or provision of benefits to “close family members” of the settlor of the trust may now treated as a direct distribution to the settlor, and taxable on him or her (instead of the family member). This will result in the settlor having to pay the tax, irrespective of the fact that he or she has not received anything from the trust.
- An anti conduit rule is introduced whereby a trust payment to a non-taxable individual (e.g. non-resident) will become taxable if there is a plan or arrangement for the funds to end up in the hands of a UK resident, and this does actually happen within three years.
- Specific rules are introduced governing the valuation of benefits provided by trusts to UK resident beneficiaries. These rules can result in increased tax liabilities.
Whilst the new trust regime maintains the opportunity for tax efficiencies, the rules are riddled with complexity and it is important to plan appropriately; failure to do so can now result in unexpected future tax liabilities. The problems are particularly acute for American taxpayers who may already be incurring US tax on trust income and/or distributions. These individuals will therefore wish to avoid double taxation, and this is normally possible with appropriate forward planning.