Taxing trust benefits - some simplicity or more complexity?

25 January 2016

Excluded property trusts – all change?

The government’s proposal to tax worldwide income and gains generated in offshore trusts on the basis of ‘benefits’ paid to UK resident deemed UK domiciled (UK-dom) settlors is going to have a major impact on the future of offshore trusts. Some detail on the change was provided by the government in a consultation document released in September 2015 and more details are expected early in 2016.

This may be welcomed by most offshore trustees as it should simplify income and gains record keeping where the settlor/beneficiary is deemed UK-dom from April 2017, or becomes deemed UK dom thereafter.

As the proposals stand, the existing treatment of the trust’s income and gains will apply until the non-dom settlor/beneficiary becomes deemed UK-dom so trustees will still need to keep detailed records in these circumstances. However, the government is considering whether the new regime should be applied to all UK resident non-doms.

What are the proposed changes?

From April 2017 non-doms who have been UK resident in at least 15 out of the last 20 tax years will be treated as deemed UK-dom for income tax, capital gains tax (CGT) and inheritance tax (IHT) purposes from their 16th year of residence.

Any individual who becomes deemed UK-dom will pay tax on the value of benefits they receive from offshore trust structures without reference to underlying income and gains, and whether those benefits are received in the UK or overseas. There is no indication yet of the tax rate which will be applied to benefits, but a rate between the current income tax and CGT rates may be considered.

The proposed rules will be based on the ‘taxable value of benefits’ received, so the key question is what the taxable value will be. If it is the value of funds received from the trust then there is the prospect of what would have previously been ‘clean capital’ being taxed. The tax profession is lobbying on this point as taxing capital is surely not what is intended?

Trustees will need to consider future requirements of beneficiaries and if action should be taken ahead of April 2017. One possibility is to make a distribution prior to April 2017 to clear out funds which may not be taxed as efficiently if distributed under the new rules.

Whilst there may be complexities for trustees in the short term, the major positive aspect for many trustees will be the potential reduction in the burden of maintaining records of income and gains.

It is also encouraging for the future of offshore trusts that they will still have the advantage of deferral of tax on income and gains until a benefit is taken, and potential protection from IHT (via excluded property trusts - other than for UK residential property). If adopted, proposals in the Draft Finance Bill 2016, however, will amend the deemed domicile rules for those otherwise regarded as non-doms, from 6 April 2017, so that excluded property trusts will, in certain circumstances, fall within their estate for IHT purposes. This will depend upon whether they were born in the UK, have previously been domiciled in the UK and whether they have been resident in the UK in at least one out of the previous two tax years.

Creation of new trusts

Another positive for overseas trustees is that there will still be advantages (tax and non-tax) for non-doms in transferring assets, other than UK residential property, into a trust before the 15 year deemed UK-dom rule starts in April 2017, particularly for UK IHT protection. Non-doms who are not yet deemed UK-dom should be considering these advantages as part of reviewing their overall UK tax positions.

What’s next?

Further details on the proposed changes are expected from the government in early 2016, with clarification on the many complex tax areas required including:

  • whether the rules will apply to all non doms;
  • how the value of benefits will be measured; and,
  • how potential double tax issues and historic income and gains will be dealt with.

With final legislation likely to be provided late in the day, and with much to be considered in relation to trustee and individual actions, early review of trust structures is well advised.