Given the numerous changes to UK tax law affecting trusts one might be forgiven for wondering if they still have a place in succession planning outside wills. There are, however, many circumstances in which trusts can still be used in a relatively tax neutral way, and others in which the tax benefits they offer have been deliberately preserved.
Although used far less than they were prior to the major reforms in 2006, for UK individuals, trusts do still have a part to play in lifetime inheritance tax and succession planning. This is particularly so for those with business assets which qualify for business or agricultural property reliefs where the traditional drivers for keeping the family business, estate or farm intact for future generations remain.
One case is in planning for non-UK domiciliaries (non-doms). The erosion of tax benefits enjoyed by non-doms has been balanced with a recognition that the UK needs to remain an attractive place for foreign talent and investment, in the face of steep competition from other countries such as Italy and Portugal. One aspect of this is that trusts created for certain non-doms can still provide tax-efficient succession planning if certain restrictions are followed. A look at the structuring done under the pre-6 April 2017 rules, and a comparison with today, will help to illustrate this.
Planning under the old rules
Take the example of a typical non-dom we will refer to as Max. Back in 1999, Max was considering spending more time in the UK and wanted to buy a home for his family to use. He was aware he may become UK tax resident long term, and that ultimately he might become deemed UK domiciled.
At that time – being prior to 6 April 2017 – all non-UK assets owned by a non-dom (who was not deemed domiciled) were ‘excluded property’ for IHT purposes. This meant such property, which included residential real estate in the UK, held via a company outside the UK, was disregarded for inheritance tax (IHT) purposes. Max could therefore transfer a UK home, which was owned by a Jersey company, into a Jersey discretionary trust established for his family including himself. No IHT arose on the transfer, and he would not have expected any IHT to arise while the property was held in trust either, because of the excluded property status.
Max also did not need to worry about the ‘gift with reservation rules’. He was a beneficiary of the trust, so in fact had reserved a benefit in it, but the trust fund was excluded property so its value was disregarded for IHT purposes. Importantly, the excluded property status was retained when Max became deemed UK domiciled for IHT purposes in 2016 under the deemed domicile rules of the time. The planning therefore enabled him to have a family home in the UK which could continue to be used by the family during and after his lifetime, but which would also remain outside the IHT net.
For this reason, this type of planning was often used to preserve the excluded property status of a non-dom’s property outside the UK. Had it remained in Max’s name, it would have fallen into the IHT net, but being in trust the protection from IHT was retained.
When the annual tax on enveloped dwellings (ATED) was introduced in 2013, imposing an annual tax on residential property held within a company, this gave rise to an annual tax charge on retaining the property in the structure. However, given the very substantial IHT benefits, together with the succession planning offered by the structure, the trustees and Max decided to keep the property in the structure.
With effect from 6 April 2017, the rules changed. From this date the Jersey company, which held the UK home, was in the UK IHT net. Its shares would be valued by reference to the value of the UK home. At the next ten year anniversary, in 2019, an IHT charge would therefore arise. An exit charge would also arise if the property was distributed to Max or another beneficiary.
More significant was the application of the reservation of benefit rules. Max had reserved a benefit in the UK home – and this was now treated as a UK asset for IHT purposes. As well as the trust charges, the value of the UK home would be in Max’s estate.
Maintaining the status quo was evidently not an option, as it gave rise to two sets of IHT and ATED. So Max took advice on what his options were. Taking a mortgage out on the property would not work – unless a mortgage is taken out in order to purchase or improve a property it is deducted from a non-dom’s excluded property, if such is available.
One option that might have worked was to take the property out of the company, and exclude Max from the trust. This way the trust IHT charges would apply, but ATED would cease and the property would not be in Max’s estate. Max wanted to use the property, though, so would have had to pay the trustees rent to live there. He was not comfortable with this idea, and the trustees were not keen to have to deal with the income tax, administration and compliance that would have arisen as a consequence.
Another option was for the company to sell the property and invest in other assets, which would be outside the IHT net. But the family were attached to the property, so this would not have been an appropriate choice.
So instead, the trustees decided to take the property out of the structure, and have it transferred into Max’s own name, and the names of his wife and adult children who all used the property regularly. There were some tax consequences to doing this, but they were quite moderate. From the time the distribution was made, the UK home was divided between the estates of Max, his wife and his adult children. They could all use the property by virtue of their part ownership. If Max or any of the others died a portion only of the value of the property would be in their estates, and all individuals’ nil rate bands could be used to reduce the total IHT. The structure also had some of the succession planning benefits of the trust – probate would not be necessary, and the property would effectively still be maintained for the family.
What if the trust had contained other sorts of assets?
Let’s say Max had settled another trust which contained assets outside the UK, but no shares in a company holding UK residential property. In this case the story would be very different.
It would be important first to consider another important change introduced with effect from April 2017, which was a change in the deemed domicile rules. There is now a new long-stayer rule, which is that an individual is deemed domiciled for all UK tax purposes if, like Max, they were UK resident for at least 15 of the past 20 years.
Importantly for Max, non-UK assets – other than UK real estate held by a foreign company – settled by such an individual prior to becoming deemed domiciled as a long-stayer (or actually UK domiciled) remain outside the IHT net even when the individual becomes actually UK domiciled or deemed domiciled under the long-stayer rule. The trust would therefore offer the same advantage it did prior to April 2017 – it provides succession planning, while keeping the individual’s foreign assets outside the IHT net. Had this been the case, there would be good reason to keep the trust in place.
Had Max been born in the UK with a UK domicile of origin, the situation would have been very different again. On returning to the UK he would have become deemed domiciled as a formerly domiciled returner. Foreign assets settled by such an individual lose their excluded property status for IHT in the tax year following the individual’s return. So the assets held in trust would be subject to the trust IHT charges, and would be in Max’s estate. The trustees would need to consider options such as excluding Max, or winding up the trust altogether.
What if someone like Max was relocating to the UK in 2019, rather than 1999? A trust would still enable them to establish good succession planning while keeping their foreign assets (other than UK residential real estate held via a company) outside the scope of UK IHT in the event of their acquiring a UK domicile or deemed domicile under the long-stayer rule.
The non-dom would not even have to rule out putting a UK property into the trust. If the trustee purchased the property using a mortgage, the capital outstanding on the mortgage would be deductible from the value of the property for IHT purposes. This could significantly reduce the IHT burden.
Does a trust need to be outside the UK?
An often overlooked point is that for this planning to work the trustee does not need to be outside the UK. It is the location of the assets and the domicile of the settlor at the time of the transfer which determines the excluded property status of the assets. If the trust includes beneficiaries who are UK resident, or who may become so, having a UK resident trust might help simplify the income and capital gains tax position of the trust, as the complex anti-avoidance provisions which can affect non-UK trusts do not apply. Compliance under new rules such as the Common Reporting Standard might also be simplified.
Settlors may find the idea of a trust under an offshore law such as Jersey or Guernsey to be more appealing than a trust under the more traditional UK law, as these jurisdictions offer more progressive types of trust. For example a Jersey or Guernsey trust might continue indefinitely, allow the settlor to keep certain powers, or may be established for purposes which do not qualify as charitable. However, in many cases, the laws of those jurisdictions do not require the trustee to be resident in the jurisdiction, and such trusts can often be created with a UK resident trustee.
In summary then, trusts, either onshore or offshore, can still offer non-UK domiciliaries most of the benefits they ever did, both in terms of succession planning and tax. They provide a means for assets to be held for the benefit of the family, without the family ever having to deal with the complications of international probate. They allow economic benefit to be separated from control, enabling assets to remain intact even after the individual’s death. At the same time, the assets can remain outside the IHT net for many years.