The Chancellor’s Budget confirmed a shift to a residence-based tax regime, impacting how offshore trusts are taxed in the UK. If you're a trustee, settlor, or beneficiary of an offshore trust, this could affect you. What challenges might arise, and how can you prepare?

In Labour’s Budget on 30 October 2024, Rachel Reeves announced the anticipated proposals for the abolition of the non-domicile regime from 6 April 2025 with a move to a residence-based system. The proposals are a fundamental re-write of the current rules regarding trust structures, especially in relation to offshore and excluded property trusts.

Income Tax

A key benefit under the current regime is that non-UK domiciled settlors, or settlors deemed domiciled under the current long-term residency test (details of which can be found here), can retain an interest in an offshore trust whilst being UK resident, but not be subject to UK tax on the foreign income realised within the trust as it arises. This means if you are the settlor of an offshore trust but have retained an interest, any foreign income realised by the trustees will only become taxable when distributions or benefits are provided to you or other UK-resident beneficiaries. Additionally, if you are still non-UK domiciled at the time the distribution/benefit is received and it is retained offshore, you can claim the remittance basis to prevent a charge to UK income tax until such a time it is remitted. Under the proposals announced in the Autumn Budget, these protections will no longer be available on income realised after 5 April 2025. Instead, if you are a UK-resident settlor of a settlor-interested trust you will become chargeable to UK income tax on all income as it arises. Depending on your previous UK residence history, the Foreign Income & Gains (FIG) regime may apply, exempting such income within your first four years of UK tax residence.

Capital Gains Tax

Furthermore, if you are a settlor with an interest in an offshore trust you are currently only subject to gains realised by the trustees as they arise if you are both UK-resident and UK-domiciled, or deemed domiciled under the formerly domiciled resident test. If you are non-UK resident and/or non-UK domiciled, gains realised by the trustees (except on UK land and property) ‘roll-up’ within the trust and are taxable on you (as the settlor) or beneficiaries when matched to a capital distribution or benefit received. These protections will also be removed from 6 April 2025, and gains realised by offshore trustees will be taxable directly on you if you have retained an interest in the trust and are UK resident. Again, the FIG regime may apply, exempting such gains within your first four years of UK tax residence. The effect of this combined with the income tax changes, means if you are a UK resident settlor who has retained an interest in an offshore Trust you could become chargeable on all income and gains as they arise – a stark contrast to the current rules.

Inheritance Tax (IHT)

Previously, and until 5 April 2025, the trust’s IHT status was determined by the domicile of the settlor when assets were settled. Therefore, if you settled a trust whilst neither UK-domiciled, nor UK deemed domiciled, the assets are currently ‘excluded property’, provided they are not UK assets or assets deriving value from UK land and property. The effect being that any such assets are outside the scope of UK inheritance tax indefinitely.

With the abolition of the non-domicile regime and the introduction of a residence-based system, the IHT status of the trust will depend on your historic residence status. Once you have been UK resident for at least 10 of the previous 20 tax years, you will be a ‘long-term resident’. When you are considered a long-term resident, the trust will enter the relevant property regime and all assets will be within the scope of UK IHT, with a charge of up to 6% on distributions of capital and each 10-year anniversary of the settlement. It is therefore now crucial to review your residence history and understand how this may affect the trust.

Additionally, if you cease to be a long-term resident, by being non-UK resident for a certain number of years, the trust will be removed from the relevant property regime, triggering a 6% IHT exit charge. It will therefore be possible for a trust’s assets to switch in and out of the scope of IHT in accordance with your long-term residence status. In addition to the IHT charges on capital distributions or 10-year anniversaries, the Gift with Reservation of Benefit (GWROB) rules will apply if you retain an interest in the trust. This means the trust will face inheritance tax charges of up to 6% if you are a long-term resident settlor, and the trust’s value will also be within your estate on death and subject to IHT of 40%. However, as a concession, GWROB rules will not apply to trusts created prior to 30 October 2024, so an IHT charge should not arise on non-UK assets held within such trusts on death. As this concession does not apply for new trusts, if you are considering settling a trust, excluding yourself from benefit may be crucial to avoid double IHT charges.

Planning Points

Gains and income realised within offshore trusts prior to 6 April 2025, that have not previously been subject to UK tax, will remain within ‘protected pools’. As such, there will only be UK tax consequences on you, as the settlor, or beneficiaries when distributions and benefits are matched to these amounts.

The draft legislation also extends the availability of the Temporary Repatriation Facility (details of which can be found here) to these distributions, provided the UK resident recipient has claimed the remittance basis previously, potentially allowing income and gains to be taxed at 12%, rather than up to 45% and 38.4%, respectively.

Additionally, the proposals allow a four-year window whereby foreign income and gains arising in the first four years of UK tax residence will not be subject to UK tax, even if remitted. This would mean if you are a UK resident settlor with offshore trust interests, you won’t be subject to UK tax on the foreign income and gains arising to the trustees in the first four years of your UK residence. It will be critical to establish the IHT position of assets held in offshore trusts. Under the new rules, a taxable event could occur on or shortly after 6 April 2025, and trustees must ensure they are aware of their UK tax obligations, as HMRC tends to penalise offshore omissions more harshly.

What to expect next

Following the Budget, draft legislation was released and debated in Parliament. The final legislation is expected to be enacted in early 2025 with no major changes expected. This provides a relatively short window for trustees to organise trust affairs before the 6 April 2025 implementation date.

How we can help

It is vital to review your trust’s circumstances and understand exposure under the new rules and opportunities available. Part of this review process will be to reflect on your existing circumstances and intentions in the short and longer term. We are currently working with our clients to consider their UK funding requirements (including extraction from existing trusts/companies), succession planning, and their timescale for living in the UK. Please note that our advisory services are charged at our hourly rates and a formal engagement will need to be in place before any advice is provided.