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Advanced Domicile Planning – use of Overseas Trusts

Special rules for capital gains tax apply in relation to settlements whose trustees are, or become, not resident and not ordinarily resident in the United Kingdom.

Such trustees are not, in general, chargeable to capital gains tax [TCGA 1992, s 2(1)] but over the years specific anti avoidance legislation has been introduced to close perceived ‘loopholes’ whereby UK resident beneficiaries obtain a benefit from such trusts.

Therefore a UK capital gains tax liability may arise in the following circumstances:

  • Trustees becoming non-resident are subject to an ‘exit charge’,
  • Settlors retaining an interest in the trust.
  • Beneficiaries of such offshore settlements receiving ‘capital payments’.

Non-UK Domiciled Settlor

In general, any gains realised by the trustees are attributed to the settlor under s86 TCGA 1992, where the settler retains an interest in the settlement. Additionally, gains realised by non-UK companies owned by the trustees are attributed to the trustees (and thus to the settlor) under s13 TCGA 1992.

The settlor retains an interest in the settlement if he or a defined person enjoys a benefit from the trust.

The defined person includes:

  • The settlor’s spouse;
  • Any child of the settlor or his spouse;
  • The spouse of any child;
  • Any grandchild of the settlor or of his spouse; and
  • Any spouse of such grandchild.

However, these rules only apply to charge trust gains on the settlor if he is both resident and domiciled in the UK in the year in which the gains arise [s86(1)(c) TCGA 1992].

Where the settlor is either not UK resident or not domiciled in the UK these rules do not apply and the Non-UK Domiciled Beneficiaries trust gains are not taxed on the settlor on an arising basis.

Where trust gains are not taxed on the settlor as described above, HM Revenue & Customs requires the trustees to calculate the gains realised by the trust and these are pooled (‘the section 87 pool’). These gains are not charged to tax on the trustees but are allocated to beneficiaries who receive capital payments.

UK resident and domiciled beneficiaries receive capital payments, such gains are treated as the beneficiary’s personal gains [s87(4) TCGA 1992] and taxed at their marginal rate of tax. In certain circumstances the tax charge is increased by a supplemental tax representing notional interest and is set at a rate of 10% per annum. However, if the beneficiary is not resident in the UK at a time when he receives a capital payment then there will be no capital gains tax payable [s2(5) TCGA 1992].

Alternatively, if the beneficiary is not domiciled in the UK, it is expressly provided that he shall not be chargeable to UK capital gains tax on the receipt of a capital payment [s87(7) TCGA 1992].

Practical Example and Pitfalls

For Inheritance Tax purposes it is usually recommended that the following structure is adopted by Non UK Domiciled individuals.

In such a structure, the UK assets will be protected from UK Inheritance Tax as the assets owned by the trust comprise shares in a non UK company and are thus regarded as “Excluded Property” [s48 (3) IHTA 1984].

Now consider the following;
• The Offshore Company disposes of the UK property for £2m realising a gain of £1m.

• The entire gain of £1m is to be paid to a UK Resident but Non-UK Domiciled Beneficiary.

For Capital Gains Tax purposes, the gain realised by the Offshore Company will be apportioned to the trustees under s13 and a s87 pool created.

However, in order for the trustees to make a payment of £1m from the trust, the cash must be extracted from the company. It has two options:

  1. Liquidate the company realising a gain of say £1m.
  2. Withdraw £1m as a dividend.

Under option 1, the gain on liquidation will be added to the s87 pool; thereby increasing the pool to £2m (effectively doubling up the gain). This route may cause an increase in the overall tax charge if capital payments are made to UK resident and domiciled beneficiaries. Although there is some measure of relief against double taxation, these can be problematical in practice.

Under option 2, the dividend will be taxable as income on UK resident beneficiaries and the benefits of the offshore structure could be lost.

The above is only a summary of some of the tax consequences arising from the use of overseas settlements. This is an extremely complex area of UK tax law and accordingly no action should be taken with obtaining further specialist advice.