Avoid jeopardising tax treatment of protected foreign trusts
15 October 2018
The 2017 non-dom reforms introduced the concept of a “protected” foreign trust. In the absence of these special rules, a non-dom who has been resident for more than 15/20 years would ordinarily become subject to UK tax on all of the income and gains of any trusts they have set up. The “protected trust” rules were introduced to enable such individuals to escape UK tax on most trust income and gains, the main exception being any UK source income in the trust.
The rules are however riddled with complexity. One particular trap is that the trust will lose its protected status in the event that it is “tainted”, broadly meaning that any money or value is added to the trust by the settlor or by any other trusts of which they are a settlor or beneficiary. It is important to realise that there is no minimum threshold for tainting to occur – any amount added to the trust will result in “tainting”. Tainting will have the devastating result of making the trust fully transparent for UK income and capital gains tax purposes, and is therefore best avoided unless there is a specific reason for wanting the trust to be tax-transparent (e.g. this may be appropriate for Americans in certain situations where the income is already subject to US tax).
- Tainting will occur if property or income is provided to the trust by either the deemed domicile settlor or by any other trust of which he is a settlor or beneficiary;
- There is an exception for property or income provided under an arms length transaction;
- Increasing the value of an asset owned by a trust is treated in the same way as an addition of property to the trust;
- The settlor giving a guarantee of trust obligations may taint the trust;
- The settlor providing services to the trust without charge may result in tainting;
- Loans can cause particular problems. A loan made to a trust should be carefully structured and the trustees must be required to pay interest at a rate which is not less than the HMRC official rate (currently 2.5%) at least annually.
There are still areas of uncertainty despite the rules having been in place for 18 months, and it is essential that deemed domiciled settlors seek advice before undertaking transactions with trusts they have established.