The new anti-avoidance rules relating to offshore trusts are due to take effect from 6 April 2018. The rules will affect you if you are:
- a trustee of a non-UK resident trust with both UK and non-UK resident beneficiaries
- resident in the UK, receiving gifts from someone who is not resident – for example your parents
- a non-UK resident beneficiary of a trust thinking of making gifts to a UK resident - perhaps your children or a relative.
Trustees, settlors and beneficiaries of offshore trusts, together with non-UK domiciled individuals, are still grappling with new rules which took effect on 6 April 2017. However, as highlighted in our August 2017 briefing, more is yet to come as the Finance Bill 2018 includes a number of anti-avoidance provisions relating to offshore trusts.
The current position
Typically, offshore trusts settled by individuals who are not resident, domiciled or “deemed domiciled” in the UK are limited in their exposure to UK taxes, save to the extent that they have UK source income and gains. From 6 April 2017, trusts with settlors who are deemed-domiciled in the UK may also be able to benefit from the tax-free roll-up of income and gains, provided they qualify as “protected” settlements.
Where income and gains are not taxed on the settlor as they arise, UK resident beneficiaries can be taxed if they receive distributions or other benefits from the trust, to the extent that there are income or gains in the trust. Income and gains accumulate in the trust and are “matched” with amounts distributed to the beneficiaries in question - the income first, then gains – giving rise to Income Tax and Capital Gains Tax accordingly.
Distributions to beneficiaries who are not resident in the UK, or distributions offshore to UK residents who claim the remittance basis (“RBUs”), generally do not give rise to Income Tax and Capital Gains Tax charges. Where such distributions match with rolled-up gains in the trust, they can – under current rules - have the effect of “washing out” such gains, with the result that the gains may no longer be available to be matched - and therefore taxed on - a UK resident beneficiary who subsequently receives a distribution. Similarly, if income is distributed to a non-UK resident it may be unavailable to be matched with a distribution to a resident, although this generally needs to take place in the tax year in which the income arises.
The effect of the above is that it is frequently more tax efficient for trustees to distribute to non-UK resident or RBU beneficiaries. If timed correctly, this can mitigate or even completely eliminate tax for UK resident beneficiaries. The rules are complex so impeccable accounting and detailed legal advice is of paramount importance.
Occasionally it transpires that the funds which are distributed to a non-UK resident beneficiary subsequently find their way to a UK resident individual. Alternatively, the funds may be settled in a new trust for the benefit of UK residents, purportedly representing "clean" capital, free from the rolled-up income and gains which plagued the original trust.
This "recycling" of trust assets is by no means a clear run and in certain circumstances can be caught by existing anti-avoidance legislation. For example, income distributed from a trust can be traced though a series of associated operations to a UK resident recipient, or to any other trust to which it is added. However, to the extent that there is currently any scope for navigating the existing anti-avoidance provisions, from 6 April 2018 such planning may be largely defunct.
The position from 6 April 2018
No more washing out
Under the heading "disregard capital payments to non-residents”, the Finance Bill 2018 expressly prevents any kind of matching of gains with distributions to non-UK residents or to RBUs. This means that, from 6 April 2018, it may no longer be possible to “wash out” gains by making distributions to such individuals.
Therefore if there are rolled-up gains in a trust which have not been taxed on the settlor, then a UK resident beneficiary in receipt of a distribution (or other benefit) is likely to be taxed on them, regardless of any preceding distributions to non-residents or RBUs.
This seems to apply whether or not another beneficiary may have had tax in a different country by reference to the same gains. Double-tax relief is not always available.
No more recycling
Furthermore, draft Income Tax and Capital Gains Tax legislation in the Finance Bill 2018 seeks to attribute income and gains to UK residents who receive "onwards gifts" of distributions from trusts. These new anti-avoidance provisions have been dubbed the "anti-recycling rules".
In simple terms, the anti-recycling rules apply (broadly) where:
- an offshore trustee makes a distribution to a non-UK resident beneficiary or an RBU (the “original payment”)
- that non-UK resident beneficiary makes a gift to a UK resident, or there are a series of gifts which end with a gift to a UK resident.
In these cases, the UK resident may be taxed as if he or she has received a direct distribution from the trust. This could mean an Income Tax or Capital Gains Tax charge where there are rolled-up income and gains in the trust available to be matched with the distribution.
It is important to note that the UK resident need not actually be a beneficiary of the trust, or indeed have any knowledge of the existence of the trust. There are also no time limits beyond which the gift to the UK resident will fall outside of the scope of the anti-recycling rules, and a payment post-April 2018 may be caught despite the fact that the original payment took place long before that date.
However, for a UK resident to be taxed it must be the case that:
- at the time of the original payment there were “arrangements”, or there was an “intention”, of the passing-on of the whole or part of the original payment to a UK resident
- the gift includes the original payment, anything that derives from or represents the whole or part of the original payment, or any other property if the original payment is made with a view to enabling or facilitating the making of the gift.
These conditions set some limits to what would otherwise be an impossibly onerous piece of legislation. Nevertheless, the anti-recycling rules are drafted extremely widely and may apply in unforeseen circumstances.
To do now
The Finance Bill 2018 is still in draft form and may change prior to coming into force on 6 April 2018. However, assuming the legislation will be passed in something resembling its current form – which seems likely - we would recommend the following:
- Trustees, settlors or beneficiaries with trusts intended to benefit UK resident beneficiaries should take advice, if they have not done so already. The positon should be reviewed as soon as possible, as there may be mitigating actions which can be taken before 6 April 2018. For example, it may still be possible to make distributions to non-UK resident or RBU beneficiaries in such a way as to improve the position of UK resident beneficiaries.
- Trustees and beneficiaries should be wary of implementing tax planning which was proposed before the draft legislation was published. If such planning anticipated any kind of washing out or recycling income and gains, then it will certainly need to be looked at again.
- UK residents who receive gifts from non-UK residents should ascertain whether their benefactor received (or is expecting to receive) any distributions from trusts. Such beneficiaries will need to ensure that they do not find themselves charged to tax with reference to the distribution.