Anti Avoidance, UK Beneficiaries, Non Residents, 10 year IHT Charges & Bringing Onshore
The tax benefits of using trusts have been eroded over the last two decades – however, they are useful vehicles for the management, control and protection of assets.
As with any trust, the settlor will transfer assets on to the trustees who will manage and apply those assets for the benefit of the beneficiaries (which might include the settlor).
Offshore trusts, meaning those resident overseas, were popular for many years but alongside general changes to the taxation of trusts, and specific changes to the taxation of offshore trusts, in particular, wide-ranging anti-avoidance measures, mean that such offshore structures are far from the panacea that some people might imagine especially for UK resident and domiciled individuals.
Offshore trusts remain a popular vehicle for non-UK domiciled taxpayers, albeit their attractions have been limited for those too. This article focuses however on the position of UK resident and domiciled taxpayers.
Offshore Trusts – general tax position
Generally speaking, in absence of any anti-avoidance provisions, non-UK trustees will have the following exposure to UK taxes:
- Income tax: in respect of UK source income only; and
- Capital gains tax in respect of UK-based residential and commercial property.
The non-UK trustees will not be subject to capital gains tax in respect of disposals of other UK assets such as shares.
Offshore Trusts – Anti-Avoidance Rules
If it were not for anti-avoidance rules, the general position would appear to afford a UK resident individual a convenient means of generating income and gains within the trust without any UK tax liabilities.
There are two main sets of anti-avoidance rules that are relevant and would need to be considered by any UK resident contemplating the settlement of an offshore trust:
- Income tax – Transfer of Assets Abroad (TAA) rules; and
- Capital gains tax – the attribution of gains to beneficiaries rules.
The TAA rules are likely to apply where an interest is retained, and the settlor remains UK resident. Where they apply, the foreign income of the trust would be attributed to the settlor. There are two main defences to these rules:
- Where there is a commercial reason for establishing the trust; or
- The trust is resident in an EU member state
The rules may also result in the attribution of trust income to beneficiaries of the trust rather than the settlor when benefits are received from the trust.
The capital gains tax anti-avoidance rules apply to gains realised over a number of years that are not chargeable until distributed by trustees to a UK resident beneficiary. The computation of ‘stockpiled gains’ is quite complex. However, broadly, the rules provide for a penalty to be applied where the capital is held within the trust in order to seek a deferral of tax.
Again, these rules are only likely to be problematic if UK tax resident.
From a UK perspective, generally the rules are concerned with whether you are resident in the UK. If you are, HMRC is not really interested in where the trust or other entity resides (as long as any taxes are being paid).
Inheritance Tax (IHT) & Offshore Trusts
The transfer of assets into a non-UK trust, as for a UK trust, will be an immediately chargeable lifetime transfer for inheritance tax to the extent that the value transferred exceeds the settlor’s available nil rate band (currently £325,000 on the basis that the settlor has made no other chargeable transfers in the previous seven years). Unless reliefs such as business property relief are available to mitigate the tax, inheritance tax will be liable at the lifetime rate of 20% to the extent that the value transferred exceeds the nil rate band.
Further tax may arise if the settlor dies within seven years of the date of transfer.
Non-UK resident trusts remain potentially subject to inheritance tax in respect of UK situated assets meaning that charges to inheritance tax of up to 6% of the trust fund arise every ten years. Such charges may also arise when capital is distributed from the trust.
Trust Registration – Onshore or Offshore?
Although non-UK resident, the trust may still need to be registered with HMRC, particularly if there is UK source income or gains to report or an inheritance tax liability.
New Rules – Is it worth the bother?
Changes to the taxation of offshore trusts over the last few decades mean that they offer no or limited advantages to UK resident and domiciled taxpayers over UK trusts and may introduce unnecessary complications and expenses.
Those who are considering the establishment of such a structure should consider whether a UK trust or family investment company might better suit their objectives while those who have established historic structures may wish to consider what steps might be taken to unwind the structure.
You can also read more about Trusts below…