On 5 December 2016, HMRC published its responses to the August 2016 consultation regarding the proposed changes to the taxation of non-UK domiciled individuals (“non-doms”) along with the draft clauses of Finance Bill 2017. The draft legislation has provided much needed clarification on the new regime. However, the Finance Bill does not include the draft income tax legislation applicable to trusts (although HMRC did publish a further consultation document which provided details of HMRC’s intention in this regard).
Based on the draft legislation and the further consultation document, the tax treatment of trusts settled by a non-dom prior to becoming deemed UK domiciled is set out below.
Note, this article does not apply to returning former UK domiciliaries.
The new regime for “protected” trusts
Offshore trusts settled by individuals before becoming deemed UK domiciled will be granted “protected” status. The proposed tax treatment of “protected trusts” has changed during the consultation process; however, the key points to note are as follows:
Settlors and beneficiaries will generally be taxed on trust gains when benefits are received, rather than the settlor being taxable on all trust gains as they arise. This effectively means that an offshore trust with “protected” status, potentially offers an effective shelter for UK capital gains tax.
The “protected” status of the trust is lost, however, if the settlor “taints” the trust by adding property to the trust after they have become deemed UK domiciled. There are exceptions to this rule for example, if additional property is added by the settlor to fund trustee expenses.
Changes will be introduced to prevent trusts with geographically diverse beneficiaries from using distributions to non-UK resident beneficiaries to “washout” or reduce the pool of trust gains. This new rule will bring to an end the long-standing strategy of making carefully timed distributions to non-UK resident beneficiaries to reduce the level of trust gains available to be taxed on UK resident beneficiaries.
If capital payments, for example distributions, are made to a close family member and the recipient is not taxable in the UK (either by virtue of being non-UK resident or due to the availability of the remittance basis), there are provisions which result in the settlor being taxed.
A new anti-avoidance rule will also be introduced which targets indirect capital payments to UK resident beneficiaries (unless the capital payment is caught already by the close family member rule discussed above which applies in priority). In short, the new rule applies where a capital payment is made to a non-UK resident beneficiary, and the recipient subsequently makes an onward gift to a UK resident beneficiary within a three year period. The three year period is extended where there are “arrangements” in place for someone else to receive the capital payment.
There are other anti-avoidance or “anti-washing out” provisions within the draft legislation; however, the provisions discussed above are the more common scenarios.
Whilst there is no draft legislation for income tax, HMRC do state in the further consultation document that the settlement legislation and transfer of assets abroad provisions will effectively be dis-applied for trusts with “protected” status in relation to foreign income arising within the trust. Instead, settlors of a protected trust will be taxable on foreign income only if they (or a close family member) receive a benefit. Assuming the legislation, when finally published, is consistent with the comments in the consultation document, this mean offshore trusts provide an effective tax deferral in relation to non-UK source income.
It is assumed that similar “tainting” rules will apply to income as those set out above for capital gains.
Assuming the legislation, when finally enacted, is consistent with the above summary, it will mean that offshore trusts will continue to be a very attractive vehicle for non-doms as foreign income and capital gains can be sheltered from UK tax. The UK tax issues related to such “protected trusts” will undoubtedly be complex and specialist tax advice will be required; however, the increased complexity should, in the right circumstances, be worthwhile if it allows family wealth to accumulate free from UK tax.
Individuals, who will become deemed UK domiciled on 6 April 2017 should be taking action now to establish a protected trust as for them, time is fast running out. Non-doms who will not become deemed UK domiciled until future tax years should also consider the timing of establishing a protected trust in order to avoid their window of opportunity being missed.
Written by Kevin Loundes, Associate Director