02 December 2022
As a general rule, UK resident beneficiaries can expect to pay UK tax when they receive a benefit from an offshore trust. The rules are complicated, but generally capital payments or benefits (trust distributions) received from an offshore trust will be subject to either income tax or capital gains tax (CGT), and income distributions will be subject to income tax. However, non-UK residents are not subject to UK tax on distributions received from offshore trusts.
The different treatment of non-UK and UK resident beneficiaries previously created a potential tax loophole which allowed trustees to make payments to non-UK residents who could then pass the funds on to beneficiaries in the UK tax-free.
The ‘onward gifting’ rules were introduced, with effect from 6 April 2018, to address this issue. These rules apply where a non-UK resident beneficiary receives a distribution from an offshore trust, which would not otherwise be taxed, and makes an onward gift to a UK resident, who is now taxed as if they had received the distribution directly.
The rules apply where the following conditions are met.
- The individual receiving the trust distribution is non-UK resident or a remittance basis user.
- He/she makes a gift to another person.
- The onward gift is either:
- made within the three years after the distribution date, or
- at any time beforehand, in anticipation of a trust distribution.
- The gift is traceable to the original trust distribution.
- At the distribution date, there are arrangements or an intention to make an onward gift to a UK resident.
- For the purpose of the transfer of assets abroad rules (TOAA) only, the original distribution is matched to available relevant income under the trust (s732 income).
It is automatically presumed that onward gifts are intended if they are made within three years of the trust distribution, it is very difficult to fall outside the rules if the various other criteria are met.
When the onward gifting rules apply, the UK resident recipient is treated as if the gift was a distribution paid directly to them from the trust. The gift is therefore subject to income tax or CGT to the extent that it can be matched to the trust’s untaxed income or gains, regardless of whether the recipient is a beneficiary of the trust.
Limitations to the TOAA onward gifting rules
However, income can only be attributed to an onward gift if it is matched to ‘protected income’. Protected income is non-UK income of a trust created by a non-UK domiciled individual that arises after 5 April 2017 and in a tax year when:
- the settlor was alive and resident in the UK;
- the settlor was not UK domiciled under general law and was not a returning UK domiciled individual (ie a person who had a UK domicile of origin at birth); and
- the trust was not tainted (for example, by the settling of additional funds after the settlor becomes UK domiciled).
Income is matched to onward gifts on a first in first out basis. Non-protected income that arose before April 2017 is matched in priority to protected income from later years. This means that not all onward gifts matched to income give rise to income tax charge.
If a gift is not matched to protected income and subject to income tax, it can instead be matched to the trust’s capital gains pool. CGT will be due at the usual rate plus the supplemental rate if applicable. There are different limitations to the CGT rules which are outside the scope of this article.
In summary, onward gifts to UK residents can only be matched to protected income and stockpiled gains. Where there is no protected income and no stockpiled gains, the onward gift will not be taxed.
A word of warning – the rules get even more complex if protected income is received after an unmatched onward gift or if the beneficiary receiving the distribution is taxed on the remittance basis – so beware.
For more information, please get in touch with Emma Herrity or your usual RSM contact.