The UK taxation implications of non-resident Trusts will become even more complicated following further announcements made by the government in September 2017.
These changes are wide ranging. Trustees, beneficiaries and in some circumstances settlors, of non-UK resident Trusts should seek advice as to whether and to what extent they will be affected.
The changes are set to come into effect from two different dates. Those expected to come into effect from 6 April 2017 have now been confirmed by the publication of the draft Finance (No 2) Bill 2017. The government has also published draft legislation containing anti-avoidance provisions which will be incorporated into the Finance Bill 2018 and those changes are expected to take effect from 6 April 2018.
The delay in the proposed implementation of the anti-avoidance provisions is very welcome and provides a limited window of opportunity to mitigate UK tax exposure before 6 April 2018.
The changes effective from 6 April 2017
- Trusts created by non-domiciled settlors will have ‘protected status’, even after the settlor has become deemed domiciled. This enables the non-UK income and gains of the Trust to remain in the Trust tax free without the settlor needing to claim the remittance basis of taxation. Where the Trust had excluded property status for Inheritance Tax (IHT) purposes, this will be preserved (subject to the changes to the IHT treatment of UK residential property held indirectly — covered in our separate note on this subject).
- Protected status will not apply if the settlor was a ‘formerly domiciled resident’ when the Trust was created and subsequently becomes UK resident. For these individuals the Trust gains and income will be taxed on the settlor on the arising basis. For IHT purposes, the Trust assets will lose their excluded property status.
- Protected status will be lost if a Trust is ‘tainted’. Tainting occurs if the settlor or a connected Trust adds property after the settlor has become deemed domiciled in the UK. This includes the settlor loaning funds to the Trust, unless a commercial rate of interest is paid on that loan by the Trustees. Trustees should now consider whether Trusts have been tainted to understand if protected status will be affected. Trusts that have received loans from settlors who became deemed domiciled on 6 April 2017 are advised to review the status of those loans and check that they are not deemed to taint the Trust. The legislation contains provisions for corrective action for such loans to be taken before 6 April 2018.
- The method of valuing capital benefits received from Trusts has been clarified, meaning that where assets are provided to beneficiaries, they will need to be valued and the current official rate of interest applied to that valuation to ascertain the taxable benefit. Amongst those beneficiaries affected will be those who have been provided with the use of chattels where the taxable benefit was previously a low percentage of their value, which was deemed to be the ‘market rent’ for their use.
The proposed changes effective from 6 April 2018
- Washing out of gains: Capital payments made to non-UK resident beneficiaries will not ‘wash out’ gains in the Trust pool. This change removes an existing opportunity for Trustees to mitigate the UK tax liabilities of UK resident beneficiaries by choosing to make distributions to non-UK resident beneficiaries in advance of those made to UK residents, although there appears to be no similar rule for relevant income in the Trust. Therefore, Trustees may wish to consider the advancement of distributions to non-UK residents prior to 6 April 2018, while bearing in mind that any unmatched distributions at that date will be caught by the new rules. It appears that gains will however be apportioned between resident and non-UK resident beneficiaries on distributions made when a Trust comes to an end after 5 April 2018.
- Recycling of payments: Payments made to beneficiaries who are not subject to UK tax (because the beneficiary is non-UK resident or claiming the remittance basis) which are then gifted to another recipient will become taxable. This will happen if the direct receipt by that recipient from the Trustees would have given rise to a UK tax liability (for example if they are UK resident). The original proposed three year window between distribution and gift has now been removed but the anti-avoidance legislation has been restricted. The legislation will only take effect if there is an intention to make a gift when the Trust distribution is made or if arrangements are already in place to do so. This legislation also applies when more than one individual has been used, in a chain, to pass on the gift successively. There are also tracing provisions that must be satisfied to ensure that unrelated gifts are not caught.
- Close Family Member (CFM): This is the introduction of a new definition which applies to the settlor’s spouse or civil partner, and the minor children of the settlor, their spouse or civil partner. Broadly speaking these provisions will charge tax on the UK resident settlor when a benefit is provided from the Trust to a non-UK resident CFM. The settlor will have a right to recover their tax liability from the recipient of the payment and there will be a requirement for HMRC to confirm the amount of tax paid.
- Motive defence: The draft legislation contains provisions that seek to disapply the motive defence for the transfer of assets abroad rules in certain circumstances.