Tax for UK domiciliaries with Offshore Trusts
We're often asked about when an offshore trust can be used tax efficiently. It can be very attractive for non domiciliaries, but what about UK domiciliaries? In this article we look at when offshore trusts can be used by UK domiciliaries.
Using an offshore trust involves a number of UK anti avoidance rules.
Firstly to establish the trust as non resident you would need to ensure that all of the trustees were non resident.
If you establish a trust as non resident there are a variety of potential UK tax advantages, just as for offshore companies. As always though, there are some particularly nasty anti avoidance rules that you’d need to consider.
The transfer to a UK discretionary trust would usually be a chargeable lifetime transfer and the trust itself would be subject to the inheritance tax regime for discretionary trusts. As such there would be a 10 year anniversary charge and an exit charge on the distribution of assets from the trust.
However providing the settlor survives for 7 years from the date of the transfer the assets transferred would usually be excluded from their estate for inheritance tax purposes.
If you used an offshore trust, the inheritance tax implications would be similar. The transfer to the trust would be a chargeable lifetime transfer ('CLT') for inheritance tax purposes, and therefore a transfer of value above your remaining nil rate band would be subject to a lifetime inheritance tax charge at 25%. If the trust was a non resident trust you would not be able to defer any capital gains on the transfer to the trust.
If the trust was an excluded property trust it would be outside the scope of the UK inheritance tax discretionary trust regime. However in order for it to be an excluded property trust it would need to hold non UK assets and be established by a non UK domiciliary. If you are a UK domiciliary the trust would therefore be subject to the usual regime of 10 yearly anniversary charges and exit charges.
Capital Gains Tax
There are some very far reaching anti avoidance rules that apply to UK domiciliaries establishing offshore, non resident trusts, especially in terms of capital gains.
The non resident trust would be outside the scope of UK capital gains tax, unless it held assets used in a UK trade. In addition it would be likely there would be no capital gains tax levied in the overseas jurisdiction where the trust is resident. This gives the offshore trust a clear advantage over a UK trust.
However there are two key anti avoidance rules that can apply.
Firstly S86 TCGA 1992 which attributes gains of an offshore trust to UK resident settlors if defined people are actual or potential beneficiaries or receive a benefit.
The term "defined person" included the settlor/their spouse, their children and their children’s spouses and their grandchildren and their grandchildren’s spouses.
This is a very wide anti avoidance rule and means that an offshore trust could only be used to shelter gains if your the spouse, children and grandchildren (and their respective spouses) were all totally excluded from benefiting from the trust.
If they weren't then the settlor would be taxed on the gains of the trust during their lifetime.
In the future after they were deceased the gains would effectively be taxed on distributions to the the beneficiaries (see below).
Using an offshore trust for Capital Gains Tax avoidance
The key occasions when you could still use an offshore trust for capital gains tax avoidance are:
Settlements where the settlor is dead
The anti avoidance rules that attribute capital gains to the settlor won't apply if the settlor is dead. If the transfer to the trust is made on death an ancillary benefit to this is that any capital gain to the date of death is eliminated.
Any gains that arise in future to the trust would not then be attributed to the settlor. It would just be any beneficiaries that could be taxed (see below).
The main problem with leaving assets to an offshore trust in a will is that it will form part of the settlor estate for inheritance tax purposes. You may therefore be looking for transfer of assets that qualify for business property relief to eliminate inheritance tax (eg shares in unquoted trading companies).
Trusts with no family beneficiaries
As we’ve seen above the anti avoidance rules attribute capital gains to the settlor where beneficiaries include:
- the settlor
- his spouse
- their children and their spouses
- their grandchildren and their spouses
Therefore if an offshore trust was made by remote relations or friends of the beneficiaries they could be effective in avoiding capital gains tax being attributed to the settlor.
A good option for this is to hold shares in newly formed trading companies.
The initial set up cost would be low and you could always ask a remote relation to set up the trust. You could also take advantage of the current low property prices and purchase bargain basement property via an offshore trust. Provided the set up was by remote relations any subsequent increase in value could be free of capital gains tax if retained overseas.
You'd need to be careful to ensure that you weren't classed as the settlor if you were actually contributing to the trust in some way. If you could therefore get the friend/relation to settle funds on the trust out of their own funds this would avoid the problem. If there is some kind of reciprocal arrangement with you routing cash back to the friend to compensate them for the cost they incurred this could well be treated as you being the settlor. To get a 'double whammy' in terms of tax benefits if you can also ensure that the settlor is a non UK domiciliary you could ensure that the trust is an excluded property trust (eg by using intermediate offshore holding companies) and therefore outside the scope of UK inheritance tax.
Setting up the trust
The best way of setting up the trust would be for the friend/relation to transfer cash to the trust. This is then free of capital gains tax and allows the trustees to purchase shares/investments etc
As a non resident trust it would be exempt from UK income tax on foreign income. Therefore by retaining trust income producing investments overseas the trust could avoid a UK income tax liability.
There are provisions to attribute income to UK individuals if they transfer assets to an offshore trust and have the power to enjoy or benefit from the trust. Therefore in order for the settlor to avoid being taxed directly on the income of the trust they would need to ensure that they and their spouse was totally excluded from benefiting from the trust.
If they weren’t, anyone who established an offshore trust and transferred assets to it could easily find themselves taxed on any income arising if they can derive a benefit from the trust.
There is though a key exception to this if the trust was established without a tax avoidance motive.