On 27 January 2009 HM Revenue & Customs (HMRC) published draft guidance on the application of the residence tests to overseas trust companies.
The residence of a trust determines how the trustees, the settlor and the beneficiaries (including investors) of the trust are subject to UK tax on income and gains.
With effect from 6 April 2007, a uniform test was introduced for determining whether a trust is UK resident for both income tax and capital gains tax purposes. Prior to this date, different tests existed for income tax and capital gains tax purposes. This meant that a trust could be resident for income tax purposes and non-resident for capital gains tax purposes, and vice versa.
Except for a trust created through a will or intestacy (where the residence of the deceased individual determines the residence status of the trust), under this uniform test a trust is UK resident if:
- all the trustees are UK resident; or
- at least one of the trustees is UK resident and any settlor was resident, ordinarily resident or domiciled in the United Kingdom (at any time when such settlor transferred property to the trust or, if the settlor is deceased, immediately before any such transfer).
In all other circumstances a trust is not UK resident.
A trustee is UK resident when the trustee acts as a trustee in the course of a business carried on by the trustee through a "branch, agency or permanent establishment" in the United Kingdom. The "permanent establishment" test is relevant to corporate trustees. HMRC accepts that the "branch or agency" test only applies to non-corporate trustees.
An overseas trust company would be UK resident for these purposes if it carries on a business through a permanent establishment in the United Kingdom. HMRC has provided draft guidance, as summarised below.
Overseas trust companies and a permanent establishment in the UK
HMRC considers that an overseas corporate trustee would have a permanent establishment in the United Kingdom (and hence be UK resident) in respect of a particular trust, if the corporate trustee generally provides professional trustee services for a fee through a permanent establishment in the United Kingdom and it is carrying on the business of that particular trust through that place. A corporate trustee generally provides trustee services for a fee if it is those activities from which it substantially derives its profits.
HMRC has summarised this test with the following three questions:
- Is the corporate trustee carrying on a business in the United Kingdom?
- If the corporate trustee is carrying on a business in the United Kingdom is it carrying on that business through a permanent establishment in the United Kingdom?
- If so, is the corporate trustee carrying on the business of that particular trust in the course of its business through the permanent establishment?
The test is on a "trust by trust" basis. An overseas corporate trustee may be trustee to several trusts and it is possible that it could be UK resident in respect of one or some, but not all, of those trusts.
A corporate trustee could have a UK permanent establishment but it is only when it is acting through that place that the deemed residence rules apply in relation to the particular trust for which the company acts as trustee.
In line with the commentary to the Organisation for Economic Co-operation and Development Model Tax Convention, "carrying on business" means, in this context, activities which are the core activities of a trustee (and not merely auxiliary or preparatory), such as:
- the general administration of the trust;
- investment strategy;
- monitoring investment performance;
- decisions on distributions of, and dealing with, trust income; and
- dealing with accounts, tax returns and record keeping.
In deciding whether a corporate trustee is UK resident for the purposes of a particular trust, HMRC will look at where the core activities are physically being carried out. However, as well as the nature or significance of the individual activities, HMRC would also consider the frequency of such activities.
HMRC's draft guidance provides a number of examples and scenarios illustrating what activities, when performed in the United Kingdom, would result in a corporate trustee being UK resident in respect of a particular trust.
An overseas professional corporate trustee (and, if it is the sole trustee, the trust) would not be UK resident by virtue of (in summary):
- UK meetings being held to either gather purely factual information about potential assets to inform future investment strategy or, prior to establishment of the trust, to discuss with a potential settlor possible terms of the trust and investment strategy;
- a one-off UK meeting with a beneficiary to discuss the potential release of capital and associated imposition of certain conditions on the beneficiary where all other core activity meetings have been held outside the United Kingdom;
- it contracting, on an arm's length basis, with a UK group company for the provision of investment advice including where the UK group company has authority (hence acting as agent) to buy and sell commodities with a view to realising profits for the trust subject to trading limits (but contrast below); or
- an employee or director of the trustee corporation attending meetings in the United Kingdom at the offices of a group company with prospective settlors.
An overseas professional corporate trustee (and, if it is the sole trustee, the trust) would be UK resident by virtue of:
- UK meetings being held for the general administration of the trust and with investment managers, accountants and beneficiaries etc and where the investment and distribution policies are prepared in the United Kingdom, albeit with formal agreement of those strategies made at one or two very brief meetings held outside the United Kingdom - HMRC refer to this process as "rubber stamping";
- it contracting, on an otherwise than arm's length basis (in particular, at less than the customary rate), with a UK group company for the provision of investment advice including where the UK group company has authority (hence acting as a dependent agent) to buy and sell assets with a view to realising profits for the trust; or
- an employee or director of the corporate trustee attending meetings in the United Kingdom at the offices of a group company with beneficiaries of existing trusts where the subject matter and frequency of those meetings is sufficiently significant to constitute core activities or where the employee or director has sufficient delegated authority to do business on behalf of the trust.
In principle, the application of a single uniform test for the purposes of determining whether or not a trust is UK resident for income tax and capital gains tax purposes is welcome. However, the detail of the guidance is, to an extent, cause for concern.
HMRC's draft guidance is a timely reminder that care is required to ensure that an intended "offshore" trust is, and remains, properly regarded as non-resident for UK tax purposes. Moreover the draft guidance is indicative of the increased desire of HMRC to look more closely at, and challenge the validity of, offshore trust arrangements.
Where a trust is intended to be non-resident for UK tax purposes, it is prudent to ensure, when using professional corporate trustees, that those entities are registered outside the United Kingdom and that they do not, in relation to that particular trust, hold any meetings in the United Kingdom. Any dealings with connected UK persons (group companies or individuals), in respect of the trust, should be on an arm's length basis and kept to a minimum (in terms of significance of subject matter and frequency) with regards to core activities and care must be taken to ensure that the extent of any delegated authority is not sufficient to enable that person to be a deemed dependent agent of the trust or trustee.
Finally, it is important to ensure that decision making outside the United Kingdom by professional corporate trustees is not merely a "rubber stamping" affair. All core activity proposals put before the trustees should be properly considered with all trustee board meetings being properly conducted and properly documented and, to this extent, when choosing overseas professional corporate trustees, it is worth setting out the rules in the trust's constitutional documents and enquiring and researching (if at all possible) the way in which they deal with this process.