HM Revenue and Customs has released a further consultation on the reforms intended to affect offshore trusts set up by non-UK domiciled individuals. The new consultation addresses concerns raised on some of the original proposals and seeks to justify some of the other more contentious changes.
Of most concern was the proposed “benefits” charge. This charge, if implemented would mean that a beneficiary of an offshore trust would be taxed on any benefit received from an offshore trust at a flat rate without reference to the income or gains in the trust. Although this move was an aim to simplify the taxation of offshore trusts this was widely perceived to be unfair for the many dry trusts that hold assets that produce little or no income or gains. In response to these criticisms HMRC have decided not to pursue a benefits charge but to amend the existing legislation to cater for the taxation of individuals who will become deemed domiciled for income and capital gains tax purposes under the new rules to come into effect from 6 April 2017.
HMRC have confirmed their commitment that where a non-domiciled individual has set up an offshore trust before becoming deemed domiciled, the trust will retain its excluded property status for IHT purposes. In addition, non-domiciled individuals will, in some circumstances, be protected from taxation of the trust income or gains retained in the trust or underlying entities. This protection will however be lost where additions are made to the trust on the later of 5 April 2017 or the date the settlor becomes deemed domiciled.
Capital gains tax
Non-domiciled settlors are currently outside the scope of the capital gains tax anti-avoidance rules which tax a UK resident and domiciled settlor on all capital gains realised by a non-UK resident trust on an arising basis. The consultation outlines plans to extend the scope of these rules to those who become deemed domiciled in the UK. However, they have confirmed that these rules will not apply unless (or until) additions are made to the trust, or the settlor, their spouse, minor children or stepchildren receive actual benefits from the trust. Once funds are added or a benefit is paid from the trust the settlor will lose their protection and will be subject to tax on all future capital gains arising.
The current anti-avoidance rules also seek to tax a non-domiciled beneficiary who is not the settlor and who claims the remittance basis on capital gains to the extent that they are matched to distributions remitted to or benefits received in the UK. The proposals seek to also tax deemed domiciled beneficiaries on all distributions regardless of where they are received.
Income tax
The current Settlements Legislation applies to assets held at trust level in settlor interested trusts. Under current rules, a non-domiciled individual can shield foreign income from UK tax by claiming the remittance basis. Once a claim for the remittance basis is no longer possible for long-term residents, without changes to the legislation, all foreign source income will be taxable on the settlor as it arises.
HMRC are therefore proposing to amend the legislation so that foreign source income arising to a non-resident excluded property trust will not be taxable on a deemed domiciled individual if the income is retained in the trust. UK source income will continue to be taxable as it arises. Amendments will also be made to align the transfer of assets abroad legislation, which also seeks to tax the settlor on income arising in a non-UK resident trust or its underlying entities.
Where a distribution or benefit is paid to a beneficiary this will be taxable on the settlor to the extent it can be matched with relevant foreign income – further guidance on the mechanics will be issued later in the year.
Impact for trustees of excluded property trusts
Further proposals will affect trustees of excluded property trusts and increase their reporting and tax obligations.
The most wide reaching of these changes is the intention to subject UK residential property held in overseas structures to UK Inheritance Tax (IHT). This will result in trustees who own UK residential property via an offshore company being subject to IHT 10 year charges and possible exit charges on the distribution of property.