There have been a number of recent developments in respect of the changes to the taxation of non-doms and offshore trusts.
The Finance Bill, which will take effect from 6 April 2018, provides revised legislation regarding the recycling of benefits from offshore trusts via non-resident beneficiaries and the tax treatment of distributions to close family members of the settlor.
In addition, in late January and early February HMRC published its long-awaited guidance in respect of the changes taking effect from 6 April 2017, in particular the operation of the mixed fund segregation.
This briefing summarises our understanding of the changes affecting UK resident non-domiciled individuals and offshore trusts.
Provisions taking effect from 6 April 2017
Individuals who were born in the UK with a UK domicile of origin but who later acquire a domicile of choice (returning non-doms) will be treated as domiciled in the UK as soon as they become resident in the UK. Trusts created whilst a returning non-dom was non-domiciled will be treated as if created by a UK domiciled individual.
Those who may be affected by these rules should take advice immediately as their tax position may have changed significantly and they will not benefit from some of the reliefs available for those who are deemed domiciled under the long-term non-dom rules.
From 6 April 2017, individuals who have been resident in the UK in 15 out of the previous 20 years will be deemed to be UK domiciled (deemed-dom) for income tax, capital gains tax and inheritance tax purposes.
Non-dom individuals with less than £2,000 of unremitted income and gains will continue to be automatically entitled to the remittance basis of taxation even once they are deemed-dom.
Capital gains tax rebasing
The rebasing will only be available to individuals who became deemed-dom from 6 April 2017 and who have paid the remittance basis charge at least once (a qualifying individual). Returning non-doms cannot be qualifying individuals.
The asset being rebased must have been owned by the individual on 5 April 2017 and must not have been situated in the UK during the period from 16 March 2016 to 5 April 2017. There appears to be no requirement that the individual owned the asset (a qualifying asset) throughout this period.
The rebasing will apply automatically to qualifying assets sold by a qualifying individual on or after 6 April 2017, although an election may be made to disapply the rebasing.
Segregating mixed funds
There will be a two-year window from 6 April 2017 for non-doms to segregate their mixed funds.
Only funds held in bank accounts by individuals can be segregated; other assets will need to be realised into cash before segregation. The opportunity will be available to all non-doms who have used the remittance basis before 6 April 2017 (other than returning non-doms).
There are additional provisions regarding the position for individuals who have unremitted foreign income and gains from before 6 April 2008. It will be possible to segregate pre-2008 income and capital gains and there are specific rules about how pre-2008 transfers should be dealt with.
HMRC has now published guidance on mixed fund segregation. Individuals looking to take advantage of these rules may therefore progress with this.
Foreign capital losses
Foreign capital losses realised after an individual becomes deemed-dom will be allowable against all capital gains, even if an election under s16ZA TCGA 1992 has not been made.
Foreign chargeable gains arising to an individual who became non-UK resident prior to 8 July 2015 (ie when the non-dom changes were announced) and then returned to the UK within five years, will not be subject to the temporary non-residence rules if the individual is deemed-dom in the year of return.
Protections for foreign settlor-interested trusts
The protections will apply to all foreign settlor-interested trusts set up by non-dom individuals (whether deemed-dom under the new rules or not), except returning non-doms. These protections will make non-resident trusts very attractive for many non-doms, including those who are currently paying the remittance basis charge, as income and gains may be rolled up in such trusts without the need to claim the remittance basis and pay the remittance basis charge.
Capital gains tax protection for foreign settlor-interested trusts
There will be a capital gains tax protection for foreign trusts established before the settlor became deemed-dom. Without this protection, deemed-dom settlors would be subject to capital gains tax on trust capital gains as they arise. Instead, capital gains will only be taxable to the extent that they can be matched to benefits received from the trust.
Income tax protection for foreign settlor-interested trusts
There will be similar income tax protections for foreign trusts established before the settlor became deemed-dom. Existing provisions, which deem trust income to belong to the settlor, will no longer apply in respect of foreign income at both the trust level and in any underlying corporate entities. Therefore, the settlor will only be subject to income tax by reference to benefits received by him/her which are matched to income. In addition, a settlor may be taxed in respect of income matched to benefits received by close family members.
The settlements legislation and transfer of assets abroad provisions will still apply to UK source income arising to settlor-interested trusts and their underlying companies. UK resident settlors will therefore be taxed on such income as it arises and there will be no protection.
The transfer of assets abroad provisions will still apply to all income arising to non-UK companies which are not held by a protected trust. This will also be the case where a company is held partly by a trust but there is an individual shareholder or loan participator. UK resident shareholders/loan participators will therefore be taxed on such income as it arises (for deemed-dom individuals) or when remitted (for remittance basis users).
Undistributed foreign income and unmatched foreign gains arising before 6 April 2017 will be available to match to benefits received after 5 April 2017 by all beneficiaries, including settlors.
Unmatched capital benefits received by the settlor before 6 April 2017 will be carried forward to match to capital gains arising after 5 April 2017. Such unmatched capital benefits will not be matched to income.
Unmatched capital benefits received by beneficiaries other than the settlor before 6 April 2017 will be matched to income or capital gains arising after 5 April 2017. Income retained by a trust or underlying company which has been taxed on the settlor (eg because it was remitted to the UK by the trust or company) will not be matched to future benefits and therefore not taxed again.
Tainting protected settlements
The capital gains tax and income tax protections for trusts will not be available if the trust is tainted.
Where property is added (directly or indirectly) to a trust by the settlor after he becomes deemed-dom, it will become tainted and the capital gains tax and income tax protections will no longer be available. In addition, this protection will be lost if property is added to a trust by the trustees of a second trust and the settlor of the first trust is the settlor or a beneficiary of the second trust.
Property transferred to a trust as a result of an arm’s length transaction will be ignored. However, loans made to a trust which are not on arm’s length terms (eg which are interest free) may lead to the protections being lost.
Where the settlor of a trust became deemed-dom from 6 April 2017, the trustees will have until 5 April 2018 to ensure any loans are on arm’s length terms and any interest is paid. Similarly, where the settlor of a trust will become deemed-dom from 6 April 2018, the loan will need to be on arm’s length terms from 6 April 2018 (although any interest payable need only be paid by 5 April 2019). All loans to and from trusts and/or underlying companies should therefore be reviewed as a matter of urgency.
Valuing trust benefits
The government has confirmed that new rules on valuing certain benefits from trusts will apply from 6 April 2017. Statutory methods of valuation will cover loans made to beneficiaries, the use of movable property including artwork, and the use of land including residential properties.
Excluded property for inheritance tax
Non-UK situs assets held by trusts set up before an individual is deemed-dom for inheritance tax will remain outside the scope of inheritance tax, subject to the new rules regarding UK residential property held through overseas companies.
Where gains are taxed on an individual under the carried interest rules, they will not also be matched to benefits received from a trust. However, when the proceeds of such a gain are distributed by the trust, they may still be matched to other capital gains realised in the trust.
Provisions taking effect from 6 April 2018
The changes which will take effect from 6 April 2018 relate to how income and gains in offshore trusts are taxed when beneficiaries receive capital payments. These rules had previously been announced in December 2016 as part of the consultation into the changes to the taxation of non-doms. However, they were not included in the first Finance Bill, published in March 2017.
Capital payments received by non-resident beneficiaries
Capital gains will no longer be matched to capital payments received by non-resident beneficiaries. This means that it will not be possible to ‘wash out’ capital gains from a trust by making distributions to non-resident beneficiaries. This is already the case for trust income. In addition, capital payments will be disregarded if they are made to a beneficiary who is UK resident when they receive the payment but become non-resident before the payment is matched to a capital gain.
An exception to these provisions is where a capital payment is made to a beneficiary who is temporarily non-resident (ie non-resident for a period of less than five tax years). Such individuals will be deemed to have received the capital payment in the year they return to the UK.
Another exception is in the year a settlement ends when distributions to non-residents will be matched to capital gains.
Capital payments received by close family members of the settlor
Where the settlor of a trust is resident in the UK during a tax year and a capital payment is made in that tax year to a beneficiary who is a close family member of the settlor, the capital payment is treated as being made to the settlor. These provisions apply to both income tax and capital gains and will have the effect that the settlor is taxed on any income or capital gains matched to the capital payment. These rules apply to income from 6 April 2017 but will be extended to capital gains from 6 April 2018.
For income tax purposes, the settlor will only be treated as the recipient of the capital payments if the actual recipient is either not resident in the UK or is a remittance basis user. For capital gains tax purposes, the settlor will be treated as having received the capital payment regardless of whether, in the absence of this provision, the actual recipient would have been subject to tax in respect of the capital payment.
For these purposes, a close family member includes the settlor’s spouse, civil partner, cohabitee or minor child (of the settlor or their spouse/civil partner/cohabitee). Minor grandchildren are not close family members for these purposes.
If a beneficiary receives a capital payment from a trust which is not taxable and they make an onward gift, the subsequent recipient will be treated as having received the capital payment. These provisions apply to both income and capital gains and may have the effect that the subsequent recipient is taxed on any income or capital gains matched to the capital payment.
In order for these provisions to apply, the following criteria must be met:
- The original beneficiary is either not resident in the UK or is taxed on the remittance basis and does not remit all of the capital payment.
- The above provisions in respect of capital payments to close family members of the settlor do not apply.
- The subsequent recipient is resident in the UK when they receive the onward gift.
The rules will only apply where the onward gift is made in the three years after the original payment was made, or before if it is made in anticipation of the original beneficiary receiving the payment. This represents a return to the rule first announced in December 2016, after the three year timeframe was removed from the September 2017 version of the legislation.
The onward gift must be of or include one of the following:
- The whole or part of the original payment.
- Anything that derives from or represents the whole or part of the original payment.
- Any other property, if and only if, the original payment is made with a view that a gift will be made to the subsequent recipient.
This means that gifts made which are not at all connected to the receipt of the original payment should not be caught by these rules. However, the rules are broadly drafted and therefore care must be taken.
Where a series of gifts are made, the recipient of the last gift in the series will be treated as having received the original payment from the trust.
If the subsequent recipient of the gift is a close family member of the settlor of the trust, then this provision will apply in connection with the above provision to tax the settlor as though they received the capital payment.
Non-doms who are not already deemed-dom under the new rules should consider the creation or further use of foreign trusts to hold investments.
- Non-doms who are not already deemed-dom may wish to consider receiving trust distributions whilst they are still able to use the remittance basis.
- Non-doms who became deemed-dom from 6 April 2017 should consider whether they can take advantage of the automatic rebasing of non-UK assets for capital gains tax purposes. In particular, individuals who have not previously paid the remittance basis charge may wish to consider if it is worth doing so for 2016-17, or for another year for which they are still in time to make the election.
- Non-doms with mixed funds should analyse these funds to determine if there is clean capital available that may be remitted to the UK without a tax charge.
- Trustees of offshore trusts should review any loan relationship as a matter of urgency to ensure that steps are taken before 5 April 2018 to avoid the tainting of trusts.
- Trustees of offshore trusts with both UK resident and non-resident beneficiaries may wish to consider making distributions to non-residents prior to 5 April 2018 in order to ‘wash out’ stockpiled capital gains.
- Trustees of offshore trusts where the settlor is UK resident may wish to consider making distributions to close family members of the settlor prior to 5 April 2018.
For more information regarding any of the issues raised here, please speak to your usual Saffery Champness partner. Alternatively, contact Clare Cromwell.