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Offshore trusts – they are still worth it

Many of the tax advantages often associated with offshore trusts are a thing of the past, but they can still offer tax benefits to international families alongside the other non-tax reasons for choosing to hold assets in a non-UK resident trust.

Last updated: 29 July 2020

Trusts have always been used by the well advised for three purposes:

  • wealth protection
  • succession planning and
  • tax mitigation.

 

The separation of the legal and beneficial ownership of assets through the use of a trust provides the opportunity to give away assets to trustees without relinquishing control to vulnerable or naive family members or giving up the ability to receive income or a return of the capital if needed. Use of an offshore jurisdiction can also provide an additional layer of privacy or protect assets from creditors or former spouses, in some circumstances. Most offshore centres are well regulated and an offshore trust company can provide highly experienced and knowledgeable individuals to manage the trust and its assets. Although this will come at a cost, it can also bring peace of mind that the trust is in the hands of individuals with the necessary time, skills, independence and understanding of the responsibilities of a trustee, to protect the trust assets in the long-term.  

The UK’s highly complex anti-avoidance legislation has developed over the last 20 years to eliminate many of the tax advantages still available in the last century to UK resident settlors and beneficiaries. Nevertheless, for individuals domiciled outside the UK, there remain a number of offshore trust strategies which can defer or reduce UK taxation.

About the author

Maggie Gonzalez

+44 (0)20 7556 1370
gonzalezm@buzzacott.co.uk

Last updated: 29 July 2020

Trusts have always been used by the well advised for three purposes:

  • wealth protection
  • succession planning and
  • tax mitigation.

 

The separation of the legal and beneficial ownership of assets through the use of a trust provides the opportunity to give away assets to trustees without relinquishing control to vulnerable or naive family members or giving up the ability to receive income or a return of the capital if needed. Use of an offshore jurisdiction can also provide an additional layer of privacy or protect assets from creditors or former spouses, in some circumstances. Most offshore centres are well regulated and an offshore trust company can provide highly experienced and knowledgeable individuals to manage the trust and its assets. Although this will come at a cost, it can also bring peace of mind that the trust is in the hands of individuals with the necessary time, skills, independence and understanding of the responsibilities of a trustee, to protect the trust assets in the long-term.  

The UK’s highly complex anti-avoidance legislation has developed over the last 20 years to eliminate many of the tax advantages still available in the last century to UK resident settlors and beneficiaries. Nevertheless, for individuals domiciled outside the UK, there remain a number of offshore trust strategies which can defer or reduce UK taxation.

What are the advantages from an inheritance tax perspective?

For the non-UK domiciled settlor, placing foreign assets into a trust in advance of becoming deemed UK domiciled continues to provide protection from inheritance tax, without the need to give up any interest in the trust assets. While the classic offshore trust structure holding UK residential property through a non-UK resident company has ceased to provide inheritance tax protection for the property, other foreign assets unconnected to UK residential property remain protected.

What is an offshore trust?

What is an offshore trust?

An offshore trust is one resident for tax purposes outside the UK. A trust will be non-UK resident if:

  • All of the trustees are non-UK resident, or
  • Where there are both UK resident and non-UK resident trustees, the settlor was not resident or domiciled in the UK when the trust was settled.

Offshore trusts are not subject to UK tax on their income and gains, except for on income from UK sources and capital gains on interests in UK real estate, companies deriving their value from UK land and UK businesses. As a result, the UK has a host of anti-avoidance legislation that seeks to tax UK resident settlors as if the trust did not exist and, failing that, to tax UK residents receiving benefits from those structures. These provisions apply not only to offshore trusts set up in low tax jurisdictions, with UK tax avoidance in mind, but also those established in the settlor’s home country, when there was no connection to the UK, including situations where tax is paid locally on the income and gains.

Tax on settlors

Tax on settlors

A UK resident settlor will continue to be taxed on all the trust income and gains, if the settlor or their spouse (or for capital gains tax their immediate family) can benefit from the trust, unless the trust qualifies as a “protected trust”. Where a trust has protected status, the settlor will continue to be taxed on the UK source income but the foreign income and all capital gains (if not taxed on the trustee) can be rolled up within the trust tax free. A trust settled by a non-UK domiciled settlor will be a protected trust, provided the settlor was not deemed UK-domiciled when settling the trust and does not make any additions to the trust after becoming deemed UK domiciled.

Tax on beneficiaries

Tax on beneficiaries

Distributions of income to UK resident beneficiaries (including the settlor) are subject to income tax. Capital distributions may also be subject to income tax if tax avoidance motives are associated with the trust and the distributions are deemed to be made out of accumulated trust income.  

A capital distribution not subject to income tax is treated as if it were a distribution of the accumulated trust capital gains. Gains are matched to capital distributions in the order last in, first out, taking each year of assessment as a whole. Where capital distributions exceed the total accumulated capital gains, the charge is limited to the total gains. However the excess is not truly free of tax unless the trust is fully distributed because it is carried forward and matched to future capital gains or income. Because the tax charge can be deferred for many years if there are no capital distributions, a “supplementary charge” is also applied to gains not matched to capital distributions in the year they arise or the following year. This acts as a crude interest charge and can increase the tax rate to a maximum of 32% after six years. 

Where a UK resident beneficiary is domiciled outside the UK and claiming to be taxed on the remittance basis, provided distributions are paid offshore, the distribution is received tax free, as long as it is not remitted to the UK.

Planning opportunities

Planning opportunities

In the right circumstances an offshore trust can provide protection from UK taxation.  

A non-UK domiciled settlor is able to hold foreign assets in an offshore trust so that those assets are not subject to inheritance tax as part of their taxable estate, once they become deemed UK domiciled. In addition, income and capital gains can be accumulated tax free in an offshore trust, where the settlor is non-UK domiciled or non-UK resident, with income tax and capital gains tax only payable on amounts distributed to UK resident beneficiaries.

While the tax legislation applying to offshore trusts is highly complex, with the right advice, such a trust can still deliver tax savings, particularly for the non-UK domiciled settlor or beneficiary.

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