Tax Talk: Excluded property trusts: how to use them for tax advantage
Excluded property trusts have long been a route to inheritance tax (IHT) protection for those who are not UK-domiciled or deemed domiciled. Since 6 April 2017, you may also benefit from new protections against income tax and capital gains tax (CGT).
What is an excluded property trust? Foreign assets (those situated outside the UK) are excluded from UK IHT if they are held in a settlement made by someone who was not domiciled or deemed domiciled in the UK when the assets were settled. If you are neither UK-domiciled nor deemed domiciled, you may be able to create such a trust. But it will not help those who were born in the UK with a UK domicile of origin.
If set up properly, excluded property status can be achieved even if the settlor is a potential beneficiary of the trust. And the status is retained even if the settlor later becomes domiciled or deemed domiciled in the UK.
Although it’s possible to qualify for IHT benefits if the trust is UK resident, it works better for income tax and CGT if it is non-UK resident. Our guidance below is based on that assumption.
What about UK situs assets?Most UK assets do not qualify for excluded property status, but it’s sometimes possible to overcome this by enveloping them in an underlying foreign company. UK residential property is an important exception, and value attributable to this will remain liable to IHT even if enveloped.
Income tax protectionThe UK has anti-avoidance rules that tax the settlor on income arising in trusts they have created but retained a benefit from. Rules effective from April 2017 now give the majority of settlors protection from income tax in relation to income retained in the trust unless the trust is ‘tainted’ (for example, by adding to it after the settlor is deemed domiciled in the UK).
Protection does not extend to all types of income and will be lost if the settlor becomes domiciled in the UK under general law (as opposed to merely deemed domiciled).
While the trust income remains protected, a settlor will generally be taxed only on UK income they receive from the trust and on the trust’s foreign income they receive and remit to the UK. The trustees may be liable for tax on UK income but not on foreign income.
CGT protectionOffshore trusts are not subject to UK CGT other than on direct or indirect interests in UK residential property. But anti-avoidance provisions do seek to tax UK resident settlors or beneficiaries on the gains of the trust.
Provided the settlor was not domiciled or deemed domiciled in the UK when the settlement was created, they will not be taxed on gains arising in the trust. But they will, instead, be taxed in the same way as other beneficiaries.
Capital gains of the trust are attributed to beneficiaries to the extent that they receive capital payments or benefits from the trust. Remittance basis users will only pay tax on the attributed gains if and when they are remitted to the UK.
Benefits in a nutshellIHT protection can be obtained in relation to foreign assets even if the settlor later becomes UK-domiciled or deemed domiciled. By enveloping within a foreign company, the protection can extend to most UK assets, but not UK residential property.
Income tax protection is available for foreign income that is retained in the trust so long as the settlor either remains non-UK-domiciled or becomes deemed UK-domiciled. CGT protection is available on the same basis.
Using a foreign trust to shelter income will make a difference to decisions about claiming remittance basis particularly where the ‘remittance basis charge’ may apply, since this income will no longer feature.
Don’t miss the small printIncome tax and CGT protections will not apply to a settlor who acquires a UK domicile of choice under general law.
Complex anti-avoidance provisions apply to the remittance basis, to prevent remittance by circular means. For example, benefits passed to close family or to others that are then passed back to the settlor or his close family.
The protections only apply from 6 April 2017, so income received earlier is taxed on a different basis. Segregation of pre- and post-2017 income will help to identify the income pools to which the different rules apply.
If you’d like us to review your current offshore trust structures or are considering setting up a new structure, please speak to your usual PKF contact.
Written by Barry Luscombe and Shaharan Deen in our London office.