Finance Act 2018 received Royal Assent on Thursday 15 March. The Act, known until now as the Winter Finance Bill or Finance (No.2) Bill 2017-19, brings into force a further, albeit anticipated, set of changes to offshore trust taxation and in doing so completes the series of amendments to the taxation of resident non-domiciliaries (RNDs) and offshore trusts that was first put forward in 2015.
Why is the treatment of offshore trusts changing again?
The latest changes, which focus predominantly on anti-avoidance, are not a surprise. However, while announced some time ago, they did not form part of Finance Act 2017. Instead, they were postponed for implementation on 6 April 2018. Rather than reforming the existing regime, the new rules build on the changes brought about last year.
What is happening?
Following Finance Act 2017, protected trusts (those with non-resident trustees and which were settled while the settlor was neither domiciled nor deemed domiciled) prevent foreign income, and gains from being taxed in the hands of the settlor as long as the latter remains non-domiciled and was not UK domiciled at birth. If the trust makes a capital payment or provides a benefit then gains and income are taxed at that point.
Notably, protected status is lost if the trust is tainted by an addition after the settlor becomes domiciled or deemed domiciled.
Close Family Members
At the same time, new rules were implemented to ensure that, for income tax purposes, where a benefit is provided to a close family member of the settlor and that person is non-resident or a remittance basis user (and they make no remittance), the income tax charge is shifted to the settlor as though he had received the benefit directly.
Finance Act 2018 expands the close family member rule so that it also applies for capital gains tax purposes (and it will not matter whether or not the close family member is a non-resident or remittance basis user). It also enhances the existing close family member rule for income tax purposes so that it bites in a broader set of circumstances.
Currently, where an offshore trust makes capital payments to a beneficiary, such payments reduce the pool of trust gains available for matching to gains that arise to the trustees. One method for reducing the tax pool in an efficient manner is to make capital payments to non-resident beneficiaries so that not only is the trust pool reduced but also the payment is not subject to UK tax. This is known as “washing out”.
However, from 6 April this year, the washing out of trust gains in this way will, subject to limited exceptions, no longer be effective with the result that gains will continue to accumulate in the trust.
A further perceived trust loophole that is closed from 6 April is the ability for capital payments or benefits to be made to non-residents or remittance basis users with the intention that those payments or benefits later be transferred to a person who would have been taxed had they been the direct recipient. The latest Finance Act ensures that even if there are multiple onward gifts from the trust, if the onward gift is made within 3 years following the original payment from the trust, the final recipient in the chain will be taxed. If the final recipient is also within the scope of the close family member rule then the tax charge shifts to the settlor.
What can be done?
The latest changes represent yet another complex addition to an already complex tax regime. In its 8 January comments on the draft legislation, the Society of Trust and Estate Practitioners was of the view that “the whole anti-avoidance regime relating to offshore trusts has become too complicated. We [understand] there are relatively few individuals within HMRC who are specialists in this area. Equally, there are many advisers who will find it difficult to keep on top of all of the anti-avoidance provisions and so ensure that their clients are fully compliant.”
Clients and advisers are likely to fall into two camps: those who are already working hard to review and revise existing offshore trust structures, including by making payments abroad and to close family members before the end of the tax year; and those who are considering combining trusts with other planning or replacing them altogether.
Foreign-issued UK compliant life policies continue to be a viable addition or alternative in this context. In particular, such policies:
- will continue to deliver tax deferral after a RND becomes deemed domiciled;
- can be an alternative to the remittance basis and the payment of the remittance basis charge for shorter term RNDs;
- are not affected by the rules on tainting, which affect offshore trusts;
- remain unaffected, for income and gains purposes, by the acquisition of general law domicile;
- offer access to invested capital by way of the annual 5% allowance;
- in combination with a trust, will prevent matchable income or gains arising to the trustees while the policy is in force and untouched;
- can provide access to a broad range of investments within and outside the UK while not requiring the segregation of offshore accounts and without risk of accidental remittances from invested funds;
- retain their efficiency in other countries, should the holder decide to move in future.
By Simon Gorbutt
Associate Director - Wealth Planning Solutions
Lombard International Assurance