On 6 April 2018 the second round of the UK government’s most recent legislation impacting non-UK resident trusts (also known as offshore trusts) will come into effect. The new legislation has introduced the concept of a “protected” offshore trust; a trust settled by a non-UK domiciled individual before they are deemed UK domiciled (now triggered by 15 years of residence within a 20 year period) and who does not have a UK domicile of origin.
After 6 April such protected trusts will continue to enjoy favourable taxation provided they comply with the requirements of the new regime. However protected status will be lost if, amongst other things, a settlor is deemed to have added further property or income to the trust after they have become UK deemed domiciled. The UK government has made clear that additions to a trust in this context can be made in a number of ways; many of which could be inadvertently triggered by an unsuspecting settlor or trustee with potentially dramatic UK tax implications. Whilst the deadline is fast approaching, it is still possible for settlors and trustees to take pre-emptive action to protect such trusts before 6 April.
Loans from settlors to trusts
If a non-domiciled settlor, or indeed any other person, has loaned funds to an offshore trust and is approaching being, or has become, UK deemed domiciled, then they should urgently review the terms of any such loans to ensure they are compliant with the new regime.
At its most basic, the UK tax authorities, HMRC, are seeking evidence that any such loans have been made on commercial terms. Showing the commerciality of such a loan will be key to preserving the protected status of a trust. Standard guidance is that the HMRC rate of interest should simply be applied to the borrowed amount throughout the term of the loan. However assessing the commerciality of a loan is more complex and should not be (nor will it be by HMRC) merely limited to the application of a specific interest rate. HMRC will review such matters in the round when deliberating on such a question and a number of safeguards should be put in place prior to 6 April.
Changes to the gains matching legislation
Another change being introduced from 6 April relates to the “matching” legislation applicable to capital gains realised by an offshore trust. This legislation acts to match any capital gains realised by an offshore trust against physical benefits enjoyed by a trust beneficiary whether UK resident or not. Prior to 6 April 2018, any capital gains realised by an offshore trust will be pro-rated amongst the benefits enjoyed by both UK resident and non-UK resident beneficiaries in a year, in proportion with the size of the benefit each has enjoyed.
The current legislation made it possible to “drain” a trust of its gains by making a substantial payment/benefit to a non-UK resident beneficiary (likely resident in a low tax jurisdiction) in one tax year followed by a further distribution in the following tax year to a UK resident thus seeking to mitigate a UK tax charge. However, the new rules applying from 6 April 2018 will mean that such “draining” will no longer be effective from that date. Therefore, trustees should urgently consider whether it is worthwhile making a distribution to a non-UK resident beneficiary in order to drain down any gains in this way and potentially mitigate a future UK tax liability.