Trusts are a popular and effective vehicle for owning and directing the destination of assets as well as for maintaining independent control, for instance by protecting younger members of the family from themselves or fortune hunters, and affording a level of confidentiality. Offshore trusts can also be a useful method of mitigating tax liabilities for UK resident individuals in the right circumstances. We discuss below some of the key points to consider when setting up an offshore trust.
Are Offshore Trusts tax efficient vehicles for non-UK domiciled individuals?
Yes, despite numerous pieces of anti-tax avoidance legislation, holding assets in an offshore trust can have tax advantages for a UK resident but non-UK domiciled ("RND") individual, even if they can benefit from the trust fund, although the precise tax implications will depend on a number of factors including who established the trust and when, what assets were settled and who is included in the beneficial class.
A discussion of the concepts of 'residence' and 'domicile' is outside the scope of this note, but broadly from 6 April 2013 onwards, residence is determined in accordance with a set of statutory tests which takes into account factors such as the country in which you work and/or have homes and the number of days you spend in the UK in any tax year. In contrast, a UK domicile is either acquired at birth or by coming to the UK with the intention to remain here permanently. It is quite common for someone from overseas to come to live in the UK for a significant period, becoming resident here but remaining domiciled abroad for UK tax purposes.
If the settlor (broadly the person creating the trust) is a RND, gains can be rolled up in an offshore trust tax free. The settlor will not be taxed on trust gains as they arise, even if he or his family can benefit. A UK CGT charge may instead arise when the trust gains are "matched" to payments made or benefits received by a UK resident beneficiary. Further if the recipient UK resident beneficiary is also a RND and claiming the remittance basis, a CGT charge will only arise if the benefit is received in, or the payment is brought into or used in, the UK. Offshore trusts are therefore particularly useful where the main beneficiary or beneficiaries are non-UK resident or likely to have left the UK before receiving a payment from the trust.
Similarly, foreign sourced income of a discretionary trust can also be rolled up tax free, if the settlor and his spouse cannot benefit and any minor children do not receive trust income above a certain limit. Further even if the RND settlor or their spouse can benefit, the income can still be rolled up offshore tax free in certain circumstances provided that they claim the remittance basis and the income is kept segregated and is not brought to or used in the UK.
Finally, offshore trusts can also help mitigate Inheritance Tax ("IHT"). Non- UK domiciled individuals are not liable to IHT on non-UK assets, but if they become UK domiciled or they have been resident in the UK for 17 tax years and become "deemed" domiciled as a result, they will be liable to IHT on their worldwide assets. However, foreign assets settled into trust whilst the settlor is still non-UK domiciled, will remain outside the UK IHT net even if the settlor becomes domiciled in the UK. Offshore trusts can therefore be very useful for long term UK residents, who nonetheless retain significant amounts of foreign property.
Are Offshore Trusts tax efficient vehicles for UK domiciled individuals?
They can be, but only in much more limited circumstances.
Where a UK resident and domiciled settlor, his/her spouse, children, grandchildren and their spouses can benefit from the trust, the settlor will be taxed on any gains as they arise.
However if the settlor is dead or no close family members can benefit then gains can be rolled up CGT free in much the same way as described above. The position is slightly better in relation to the foreign income of a discretionary trust as this can be rolled up and sheltered from UK income tax if the settlor and his spouse are excluded, for instance in a trust for the benefit of his children/grandchildren.
If a UK domiciled settlor is excluded from all benefit from any trust (offshore or otherwise) the assets will usually be outside his estate for IHT purposes, although the trust will be subject to 10 year charges and exit charges and there may be a charge on the initial gift into trust.
Who should be the trustees?
Offshore trusts are often administered by professional trustees situated in the chosen jurisdiction. When appointing professional trustees, the settlor will need to consider the reliability and competency of the trustees, how they are regulated, ease of communicating with them and their likely costs. The settlor will also need to be confident that the trustees are familiar with and understand his aims and objectives and for this reason may also consider appointing family members or a trusted advisor from outside the jurisdiction.
It might be assumed that an offshore trust is any trust administered outside the UK. However, for both income tax and CGT purposes a trust will only be taxed as non-UK resident if either all the trustees are non-UK resident or if at least one of the trustees is non-UK resident and the settlor is not resident, ordinarily resident or domiciled in the UK at the time the trust was created or when funds are added. In certain circumstances an offshore trustee can also be deemed resident in the UK if they act as a trustee in the course of business through a branch, agency or permanent establishment in the UK. Therefore great care needs to be taken if a UK resident trustee is to be appointed alongside offshore trustees or if there is an offshore professional trustee with many UK connections, to ensure the appointment cannot inadvertently make the trust UK resident either immediately or at some point in the future.
Where should the trust be located?
Choosing where an offshore trust will be established and administered and which legal system will govern it may be obvious. For instance, an individual may have connections with a certain country or own property or other assets there. Otherwise, the most fundamental consideration is to ensure that the trust and taxation laws of the chosen jurisdiction allow the settlor to achieve his goals. For instance, if protection against creditors is a settlor's fundamental aim, the specific asset protection legislation of the relevant jurisdiction will need to be analysed and assessed. Practically, if settling assets in an offshore trust is going to be tax efficient it is also helpful if it is situated in a low tax jurisdiction, otherwise foreign taxes may outweigh any UK tax savings.
Do you need a protector?
Many foreign law trusts require the exercise of certain trustees' powers (for instance to distribute assets) to be subject to the consent of a "protector" and/or allow the protector to exercise some powers himself, such as the power to appoint and remove trustees. Whilst being a protector may appeal to a settlor (as it allows him to retain some element of control without actually being a trustee) depending on the settlor's tax status and the extent of his powers, his appointment as a protector could jeopardise the offshore residence status of the trust so care does need to be taken in this respect.
In the right circumstances an offshore trust can be an effective and tax efficient asset protection and succession planning vehicle. However, the law concerning trusts and their taxation is complex and planning should not be undertaken without obtaining thorough advice beforehand and throughout the trust's administration.