Complications that can arise in UK/US trusts

A family trust remains a popular vehicle to allow for the passing of wealth to the next generation. This is because it can provide flexibility, discretion and an element of control which is attractive to many.

For US citizens, US trusts are often discussed in estate planning. They are an efficient vehicle to deal with often time consuming and costly probate processes in various states.

For transatlantic mobile families, the creator of a trust might be in one country and the beneficiaries in another. It is therefore very important to understand the rules applying to such arrangements.

Residence Position of Trusts – UK vs US

In many cases, the UK and the US both consider trusts as separate taxable entities from those who create them and from those who can benefit from them. Both therefore have rules which establish the tax residence position of the trust.

In the UK, the residence of the trust is determined by the residence of the Trustees. A situation can arise where some of the Trustees are resident in the UK and some outside the UK. Where this happens, the domicile and residence of the settlor at the time when the trust was funded also has a bearing on its residence status.

From a US tax perspective, the residence of a trust is established by the Court and Control Tests. In order for a trust to be considered ‘US resident’, a US court must be able to exercise primary jurisdiction over the trust, and a US person or persons must have the authority to control all of the substantial decisions of the trust.

Tax Position of US Trusts

For US tax purposes, the income and gains of a US trust are tentatively taxable at the trust level.  However, where distributions have been made to the beneficiaries, the trust is entitled to a deduction against its income (but generally not against its capital gains) for the amount distributed.  That income is then passed on to the beneficiaries and subject to tax in their hands.  Trust capital gains are generally taxed at the trust level regardless of distribution.

It is worth noting that, in general, US tax rates for trusts are less beneficial than those for individuals.

There is an exception to this in the case of trusts which are classified as “grantor trusts”.  Trusts generally fall within this classification if the grantor is also a beneficiary of the trust or retains certain powers over the assets held in the trust.  In these circumstances, the assets of the trust are considered to be owned by the grantor (or grantors) for US income tax purposes, and any income or gains would typically be taxed in their hands rather than at the trust level.

From a UK tax point of view, there would typically be no tax on a US trust at the trust level except to the extent that the trust held UK assets that generated UK taxable income (e.g. UK real estate or UK business interests).

Tax Position of UK Trusts

The US tax treatment of a UK trust will depend very much on the nature of the trust. 

If the trust is considered a “Foreign Grantor Trust” (broadly, any trust resident outside the US which was settled by a US person and could benefit a US person), the assets and any income or gains arising would be subject to tax in the hands of the grantor.

If the trust is not a “Foreign Grantor Trust”, the trust itself will not be subject to US tax except to the extent that the trust held US assets that generated US taxable income (e.g. US dividends, US real estate or US business interests).  Distributions to US beneficiaries will however result in potential tax charges to those beneficiaries, as discussed below.

For UK tax purposes, a UK trust will be liable for tax on its income and gains.  Generally, this tax will be applied at the highest rates (currently 45% for income, 39.35% for dividends, and 20% or 28% for capital gains).

There are special rules for “settlor interested trusts”.  These are typically trusts where the settlor is also among the class of beneficiaries.  In these circumstances, the settlor will typically be liable to UK tax on the income and gains of the trust with credit available for the tax paid by the trust.

Beneficiaries of UK vs US Trusts

Both countries also have their own rules as to how they regard distributions to tax resident beneficiaries.

In the UK, income distributions from a UK trust to a UK resident beneficiary result in that income being subject to tax in the hands of the beneficiary, but with a tax credit for the tax paid by the trust.

Where a UK resident receives an income distribution from a US trust, they will be subject to tax on that income.  If the beneficiary is also a US taxpayer, the availability credits for foreign taxes will depend on the nature of the income and how it is dealt with under the terms of the UK/US tax treaty.

Capital distributions from foreign trusts to UK resident beneficiaries are often more problematic, as they can be matched to trust capital gains of the current year, prior years, and even future years.  The resulting matched gains are then taxed in the hands of the beneficiary with penalty taxes applying in the case of distributions matched to historic capital gains. A key problem that can arise in these circumstances is that a UK beneficiary could be personally liable for UK tax on a capital gain realised by a US trust in an earlier year on which that US trust has already paid US taxes.

From a US perspective, beneficiaries receiving distributions of income from a US trust will be subject to US income tax on their share of the trusts income.  The types of income generated at the trust level will retain their character in the hands of the beneficiary (e.g. distributions representing interest will be taxable as interest, distributions representing dividends will be taxable as dividends, etc.).

Beneficiaries receiving distributions from a foreign nongrantor trust are similarly subject to US income and capital gains tax, where the distribution represents current year income and gains.

However, if the income and gains of a foreign nongrantor trust (known as distributable net income or DNI) are not distributed within the calendar year or within 65 days of beginning of the new calendar year if an appropriate election is made, they become undistributed net income (UNI).  If a distribution during the year exceeds the DNI of the trust, it is next considered to represent UNI.

The tax computations and reporting for distributions of UNI are extremely complex.  When UNI is distributed to a beneficiary, it is taxed as ordinary income regardless of its original nature.  The tax rate applied to this income is based on an average rate of three of the preceding five tax years (disregarding the highest and the lowest). Additionally, interest is chargeable on the tax due based on the number of years that the trust has been in existence.

Without careful planning, it’s very easy for inefficient tax situations to arise. For example, where the income and gains are taxed on the trust in one country. But the beneficiary is potentially being taxed on the income and gains of the trust in the other county. This can cause double taxation issues as it is a situation not well provided for in the double taxation agreement. 

In Summary

Are you a family considering setting up a family trust where there are people involved both in the UK and US? If so, it is important to carefully consider where the trust should be tax resident. You need to ensure it is set up appropriately. There are a number of factors to consider in this decision including the expected level of income and gains and expected distribution policy of the trust. It’s really important to take advice in order to be as tax efficient as possible.

Inheritance tax for settlor interested offshore trusts

In the previous part of our series on offshore trusts we considered the UK capital gains tax treatment of beneficiary-taxed offshore trusts.  In this sixth part of our series we consider the inheritance tax (IHT) treatment of settlor interested offshore trusts

This is part 6 of our Offshore Trusts blog series, written by our Associate Director Lawrence Adair. Read part one here: ‘All you need to know about Offshore Trusts’. Part two here: ‘Residence Positions and Offshore Trusts’. Read part three here: ‘Settlor-Interested Offshore Trusts’ . Read part four here: ‘Beneficary-Taxed Offshore Trusts’ Read part five here: ‘Capital Gains Tax on Beneficiary-Taxed Offshore Trusts’

General exposure to IHT

There are no specific IHT provisions for offshore trusts – provisions apply equally to UK and offshore trusts.

The scope of IHT is primarily based on domicile and situs of assets as follows:

UK domiciles:                 Worldwide assets

Non-UK domiciles:       UK assets only (non-UK assets are regarded as ‘Excluded Property’)

Importance of settlor’s domicile

For trusts, it is the domicile of the settlor when assets first became comprised in the trust that is relevant.  The residence of the trustees is not important for IHT. 

So if the settlor was non-UK domiciled when the assets first became comprised in the settlement, the scope of IHT for the trust is limited to its UK assets.  This is so even if the settlor’s domicile subsequently changes, subject to one exception.  Trusts whose settlor is a ‘formerly domiciled resident’ are subject to IHT on their worldwide assets regardless of the settlor’s previous domicile.  A ‘formerly domiciled resident’ is someone who is UK born, has a UK domicile of origin and is UK resident for the tax year and at least one of the two preceding tax years.

Assets subsequently added to the settlor’s trust and transfers between trusts

If funds are subsequently added to a trust, the settlor’s domicile position is revisited.  It is, though, possible to keep the original and added funds separated for excluded property purposes.

The settlor’s domicile position is also revisited where there is a transfer between settlements.  If they are UK domiciled at the time, the transferee settlement cannot qualify.

Situs of assets for IHT purposes

The situs of assets for IHT purposes is based on common law principles.  The situs of some of the more common types of assets are given below:

Registered shares and securities:       where the register is held

Land and property:                                  where the land is located

Bank accounts:                                          where the branch is located

Simple debts:                                             where the borrower resides

Specialty debts:                                         where the deed is held (unless the debt is secured solely on UK property)

Partnership interest:                               where the business is carried on

LLP interest:                                                as for registered shares and securities

‘Excluded property trusts’ and use of non-UK underlying companies

Trusts set up by non-UK domiciliaries are often referred to as ‘Excluded Property Trusts’.  This is because they typically only hold non-UK situs assets (i.e. excluded property) to keep the trust outside the scope of IHT.

If there is a desire to hold UK assets these will typically be held via a non-UK underlying company.  This adds a corporate veil over the assets meaning the trust still only holds non-UK assets.  This solution does not apply for UK residential property interests which since 2017 have been subject to special provisions.

UK residential property interests from 2017

From 6 April 2017, certain UK residential property interests are not excluded property despite them being non-UK situs assets under the situs rules.  The interests concerned include:

• interests in non-UK partnerships and closely held non-UK companies, to the extent their value is attributable to UK residential property;

• loans financing the acquisition or enhancement of UK residential property and residential property interests; and

• collateral put up for such financing.

Furthermore, proceeds realised from the disposal of residential property interests (partnerships and companies) and the repayment of loans remain exposed to IHT for two years afterwards.

Gift with reservation of benefit

Where the settlor of a trust is also a beneficiary, gift with reservation of benefit provisions apply which effectively mean trust assets remain within the settlor’s estate for IHT purposes.  However, excluded property rules take priority over gift with reservation rules.  Therefore, property which qualifies as excluded property is not subject to the gift with reservation provisions.

Relevant property regime

Except for certain beneficiary taxed interest in possession trusts, trusts are subject to an IHT relevant property regime to the extent of non-excluded property.  This broadly subjects trusts to IHT each 10 year anniversary with proportionate charges where capital leaves the trust between 10 year anniversaries.  With the exception of the two-year overhang for UK residential property interests, it is the situs at the point of the relevant charge that is important for whether assets are excluded property or not.

3 most important points to take away

Inheritance tax for trusts is based in the settlor’s domicile and situs of assets rather than the residence of the trustees

Trusts created by non-domiciled settlors can be kept outside the scope of inheritance tax by holding only non-UK assets (UK assets can be held via non-UK companies for this purpose though this is not effective for certain UK residential property interests)

Even if the settlor is a trust beneficiary, gift with reservation anti-avoidance rules do not apply to excluded property held in trusts

Written by Lawrence Adair

Offshore Trusts Series

In the previous part in our series on offshore trusts we considered the UK income tax treatment of beneficiary-taxed offshore trusts.  In this fifth part of our series we consider the capital gains tax treatment of beneficiary-taxed offshore trusts.

This is part 5 of our Offshore Trusts blog series, written by our Associate Director Lawrence Adair. Read part one here: ‘All you need to know about Offshore Trusts’ . Read part two here: ‘Residence Positions and Offshore Trusts’ Read part three here: ‘Settlor-Interested Offshore Trusts’ . Read part four here: ‘Beneficiary Taxed Offshore Trusts’

Capital gains tax on beneficiary-taxed offshore trusts – assessment of trustees

As for a settlor-interested offshore trust, one that is beneficiary-taxed is not liable to capital gains tax except that the trustees are assessable on gains from UK property interests.  These are taxed as follows:

Residential property interests:

28% capital gains tax with capital gains rebasing for interests held at April 2015

Commercial / certain indirect property interests: 

20% capital gains tax with capital gains rebasing for interests held at April 2019

Capital gains tax on beneficiary-taxed offshore trusts – assessment of beneficiaries

Gains not assessed as UK property gains, including pre-April 2015 / 2019 gains due to rebasing, are generally assessable on UK resident beneficiaries.  How they are assessed is that they are stockpiled for matching to capital payments received by the beneficiaries. This includes notional capital payments (see the fourth part of the series for more details of these). Unless the payment is matched to foreign source income under income tax anti-avoidance provisions.

Gains are not matched to capital payments made to non-UK resident beneficiaries except in the tax year a trust ceases.

The rate of tax on matched gains is up to 20% depending on the beneficiary’s level of income.   In addition, a surcharge of up to 60% applies if a gain is not matched to a capital payment made in the same or following tax year.  This can increase the effective rate to 32%.

Where capital payments are made to more than one beneficiary in a tax year, gains are matched to beneficiaries in proportion to payments received.

Capital payments not matched to gains in a particular tax year are carried forward for matching in future tax years.  Similarly, unmatched gains are carried forward.

Trust capital losses, however, can only be set against beneficiary-taxed trust gains of the same or future tax year.  They cannot be set against the beneficiary’s personal gains or any settlor-interested gains.  In addition, a beneficiary’s personal capital losses cannot be set against matched trust gains.

Capital gains tax on beneficiary-taxed offshore trusts – gains assessed on others

While gains of beneficiary-taxed offshore trusts are principally taxed on the beneficiaries, there are some instances where they can be taxed on someone else.

A UK resident settlor is treated as receiving capital payments, with gains matched accordingly, where the payment is to a spouse / civil partner (including those living together as such) or their minor children.  The residence of the recipient spouse etc. is irrelevant while tax legislation gives the settlor entitlement to recover any tax they pay from their spouse etc.

Where certain conditions are met for capital payments made to a non-UK resident beneficiary, someone other than the recipient beneficiary can be treated as receiving a capital payment if an onward gift of it is ultimately made to a UK resident person.  This will be the settlor if the onward recipient is a spouse etc. though tax legislation again gives them entitlement to recover any tax they pay from their spouse etc.

Capital gains tax on beneficiary-taxed offshore trusts – remittance basis for UK resident but non-domiciled individuals

The remittance basis can be claimed by UK resident but non-UK domiciled individuals for non-UK gains matched to capital payments. (Except where a UK resident settlor is treated as receiving direct capital payments made to their spouse etc.).

Capital gains tax on beneficiary-taxed offshore trusts – other matters for UK resident but non-domiciled beneficiaries

One final point relates to two reliefs for UK resident but non-domiciled beneficiaries.  Prior to 2008/09, such beneficiaries were not assessed at all to offshore trust gains attributed to capital payments received by them.  When this was changed from 2008/09 two transitional reliefs were introduced:

1. An exemption for pre-6 April 2008 gains and capital payments; and

• Rebasing of assets held on 6 April 2008 and standing at a gain.  This is to restrict the tax payable to the post-April 2008 growth.  An irrevocable election covering all relevant assets is required to be made by the trustees. This must be made by 31 January after the first tax year in which a capital payment is received by a UK resident beneficiary.

3 most important points to take away

Other than certain trustee-assessed UK property gains, gains of a beneficiary-taxed offshore trust are stockpiled for matching to capital payments made to UK resident beneficiaries. (And non-UK resident beneficiaries in the tax year the trust ceases). Though there is surcharge of up to 60% on the tax liability for gains matched at least two tax years later

Capital payments made to a beneficiary of a beneficiary-taxed offshore trust can be treated as received by the settlor or another individual in certain circumstances including where the payment is to the settlor’s spouse or minor children

UK resident but non-domiciled beneficiaries can benefit from the remittance basis for non-UK gains of a beneficiary-taxed offshore trust matched to them and from transitional reliefs for pre-2008/09 gains and capital payments

Written by Lawrence Adair

Income Tax

In the previous part in our Offshore Trusts series we considered the UK income tax and capital gains tax treatment of settlor-interested offshore trusts.  In this fourth part of our series we consider the income tax treatment of non-settlor interested, or beneficiary-taxed, offshore trusts.

This is part 4 of our Offshore Trusts blog series, written by our Senior Tax Manager Lawrence Adair. Read part one here: ‘All you need to know about Offshore Trusts’ . Read part two here: ‘Residence Positions and Offshore Trusts’ Read part three here: ‘Settlor-Interested Offshore Trusts’

Income tax on beneficiary-taxed offshore trusts – trustee position on UK income

UK income received by a beneficiary-taxed offshore trust is initially taxable on the trustees at a rate depending on the type of trust and income source.  As noted in the first of our series, trusts can either be on a discretionary or life interest basis.  The initial rate of income tax for each type is:

Discretionary:       up to 45% depending on the income source

Life interest:         up to 20% depending on the income source

Income tax on beneficiary-taxed offshore trusts – trustee position on non-UK income

Unlike UK income, non-UK income received by a beneficiary-taxed offshore trust is not taxable on the trustees.

Income tax on beneficiary-taxed offshore trusts – beneficiary position generally

How a beneficiary of a beneficiary-taxed offshore trust is taxed depends on the type of trust and their residence.

Income tax on beneficiary-taxed offshore trusts – beneficiary position for discretionary trusts

A beneficiary of a discretionary offshore trust is taxed in the UK according to income distributions received; with the situs of the income being non-UK.

If the beneficiary is non-UK resident they are not taxable in the UK on income distributions received. But may be able to claim repayment of any UK income tax paid by the trustees.

A UK resident beneficiary, on the other hand, is taxed at up to 45% depending on their income levels. With credit given for the UK tax paid by the trustees (provided the trustees are fully UK tax compliant).  As well as income distributions; it is possible for payments which are capital in nature to be matched to foreign source income where broadly there was a UK tax avoidance motive in setting up the trust.  Capital payments for this purpose include notional payments. Such as low or interest-free loans or low or rent-free use of assets.

As noted in the last part of series, there can be occasions where a settlor is assessable on discretionary distributions of trust income received by their minor children including on all distributions relating to UK source income.

Income tax on beneficiary-taxed offshore trusts – beneficiary position for life interest trusts

A beneficiary of a life interest trust is taxed in the UK according to their share of trust income for each tax year – with the situs of the income being based on the underlying sources.  The income assessed on them can include income from underlying offshore companies. Where broadly there was a UK tax avoidance motive in setting up the trust structure.

If the beneficiary is non-UK resident they are only taxable in the UK at up to 45% on UK income sources.

A UK resident beneficiary is taxed on all sources at up to 45% depending on the underlying sources and income levels.

For both non-UK and UK resident beneficiaries a credit is given for the UK tax paid by trustees.

As with discretionary trusts, a settlor will be assessable on UK trust income attributed to their minor children and possibly non-UK income.

UK resident but non-domiciled beneficiaries – remittance basis

A beneficiary tax charge for a UK resident but non-UK domiciled beneficiary is subject to a remittance basis claim for where the distribution is not remitted to the UK.  This could be for the entire distribution in the case of a discretionary trust. Or the underlying non-UK sources in the case of a life interest trust.

3 most important points to take away

• One factor affecting UK Income tax for beneficiaries of beneficiary-taxed offshore trusts is the type of trust. For discretionary trusts they are assessed based on distributions received. Whilst, for life interest trusts assessment is based on income as it arises

• Residence status of beneficiaries of beneficiary-taxed offshore trusts impacts the extent to which they are assessable to UK income tax on trust income. A non-UK resident beneficiary is not assessable to the extent of non-UK income. (Which for a discretionary trust is the whole distribution received)

• The settlor of a beneficiary-taxed offshore trust remains assessable to UK income tax for most trust income received by their minor children, particularly UK source income

Written by Lawrence Adair

Settlor-taxed non-UK resident trusts – income tax and capital gains tax

In the last part in our series on offshore trusts we considered rules for establishing trust residence.  Once it is established that a trust is non-UK resident, our thought turns to how it will be taxed in the UK.  A key consideration is whether the settlor retains an interest in the trust, i.e. whether it is settlor-interested.   In this article we consider when a trust is settlor-interested for UK income tax and capital gains tax purposes and the tax implications of this.

This is part 3 of our Offshore Trusts blog series, written by our Senior Tax Manager Lawrence Adair. Read part one here: ‘All you need to know about Offshore Trusts’ . Read part two here: ‘Residence Positions and Offshore Trusts’

The definition of settlor-interested for capital gains tax is wider than that for income tax.  Each tax is considered separately below, starting with income tax.

Income tax – definition of settlor-interested

For income tax, a settlor is broadly treated as having an interest in a trust if trust assets are or may become payable to, or applicable for the benefit of, the settlor or his spouse / civil partner.  For clarity on the position, trust deeds often explicitly include or exclude the settlor and their spouse / civil partner. 

Income tax on settlor-interested trusts – UK income

UK income received by a settlor-interested offshore trust is initially taxable on the trust at up to 45%. This is depending on the type of trust and income source.  However, the income is also taxable on the settlor at up to 45% including income from underlying offshore companies, where broadly there was a UK tax avoidance motive in setting up the trust structure.

To avoid double taxation the settlor gets credit for the income tax paid by the trust.  In addition, if the settlor is required to pay additional tax on trust income then the additional liability can be recovered from trust.  Conversely, if the settlor receives a tax refund this must be paid over to the trust.

A settlor can also be assessable on trust income where their minor child can benefit.  This is not a general assessment on them but only where their child receives a distribution from the trust.

Income tax on settlor-interested trusts – non-UK income

Unlike UK income, non-UK income received by a settlor-interested offshore trust is not taxable on the trust. But the default position is that it is still taxable on the settlor at up to 45%.  Again, this includes income from underlying offshore companies. Where, broadly there was a UK tax avoidance motive in setting up the trust.

However, settlor-interested rules are ‘switched off’ for certain trusts created by non-UK domicilairies. If the non-UK income is ‘protected foreign source income’. In which case, the income is only assessable when it is distributed.  Furthermore, the settlor will only be assessable to the extent that they receive a distribution. (Except for exceptions for distributions to a spouse or minor child who are not immediately assessable to UK tax on the distribution.)

Conditions

Several conditions apply for income to be protected foreign source income, mainly focused on the settlor’s domicile.  They must have been non-UK domiciled and not deemed domiciled when the trust was created. And not have become UK domiciled or a ‘formerly domiciled resident’. (Broadly born in the UK with a UK domicile at birth and has returned to the UK.)

Tainting

Also crucial is that the trust must not become ‘tainted’ so care is needed to avoid this.  Tainting occurs when the settlor provides property or income, for the purposes of the trust, at a time when they are UK domiciled or deemed domiciled.  This includes property provided directly or indirectly.  Tainting occurs from the first tax year in which property is provided.  An obvious example of tainting is where further assets are added by the settlor.  Less obvious examples of tainting include settlor loans where the interest charged is less than HMRC’s official interest rate. 

A settlor tax charge is subject to a remittance basis claim where the distribution is not remitted to the UK.

Protected Trust

A protected trust will be particularly useful where a settlor can no longer claim the remittance basis. And trust distributions can be restricted to being made only when required.  They can also allow avoiding the need to pay the remittance basis charge where the settlor’s only non-UK income is protected trust distributions brought to the UK.

As well as income distributions, it is possible for distributions which are capital in nature, to be matched to protected foreign source income. Where, broadly there was a UK tax avoidance motive in setting up the trust.

Capital gains tax – definition of settlor-interested

There is a wider, more complex, definition of settlor-interested for capital gains tax purposes.  As for income tax it includes where the settlor or spouse /civil partner can benefit. It also includes potential or separated spouses, children, grandchildren and companies controlled by any of these individuals.  However, for a trust to be settlor-interested for a particular tax year, a defined person must be able to benefit, and the settlor must be both UK resident and UK domiciled.

For the domicile requirement, there are protections to ignore deemed domiciles. These mirror the income tax protections outlined above for foreign income, including tainting of the trust.  If the protections are met, the trust is not settlor-interested for capital gains tax.

Capital gains tax – assessment of gains on settlor

An offshore trust is not liable to capital gains tax except for gains on UK property interests.  Instead non-UK property gains are either assessable on the settlor or beneficiaries with those realised by a non-protected settlor-interested trust assessable on the settlor at up to 28% depending on the type of gain.  This includes gains from underlying offshore companies, where broadly there was a UK capital gains tax or corporation tax avoidance motive in setting up the trust.

To avoid double taxation the settlor can recover any capital gains tax paid from the trust.

Trust capital losses, however, can only be set against settlor-interested trust gains of the same or future tax year.  They cannot be set against the settlor’s personal gains.

3 most important points to take away

The settlor or his family benefitting from a trust can make it settlor-interested so that the settlor is assessed on trust income and gains as they arise.

Non-UK domiciled settlors can be protected from settlor-interested rules so that foreign income or gains assessed on them are limited to distributions.

For non-UK domiciled settlors to benefit from settlor-interested trust protections it is important that the trust does not become tainted.

Written by Lawrence Adair

Feature Article by Alex Picot Trust

Establishing trusts has long been a popular wealth structuring tool for high-net-worth families. It involves giving away legal title, ownership and an element of control of family assets to a business based in an overseas jurisdiction. 

A fundamental question for new clients is ‘Can I really trust a Trustee?’

Professional trust companies, operating in reputable and highly regulated jurisdictions have been providing fiduciary services to clients since the middle of the last century.  While the reasons for the use of trusts may have evolved over time the role that professional trustees fulfil remains as current as ever.

This article explores why clients continue to be comfortable creating offshore family trusts.

Why do people use offshore trustees?

UK resident foreign domiciled individuals who have assets held overseas or people locating to the UK who have not yet arrived are able to have their surplus overseas wealth managed and controlled in specialist offshore finance centres.

Trusts can offer benefits in ensuring assets are held in a tax compliant manner for succession purposes, family governance reasons, to avoid future dilution or break up of family businesses or other cherished family assets.

Trustees can hold a wide range of assets from banking and traditional investment portfolios with quoted and unquoted holdings; real estate; family business assets; works of art; and moveables such as yachts and planes.

There continue to be tax advantages for the settlors and the beneficiaries of the trusts if the vehicles are structured correctly at the outset with professional legal and tax advice taken to ensure the arrangements are tailored for the needs of each individual family.

Oversight of the Trustee

Consider the offshore trust as a virtual overseas ‘warehouse’. 

The ‘warehouse’ can hold a wide range of family assets and investments. 

The settlor and beneficiaries of the trust have the rights to inspect the assets at any time and obtain full information on how they are being managed and looked after.

The Trustee has a written document (Trust Deed) which sets out the rules and regulations as to what powers sit with the Trustee and which regulate the actions the trustees are empowered to undertake.  The trustees can only take assets out of the ‘warehouse’ if they are for the benefit of the persons listed in the Trust Deed as beneficiaries. 

The trustees are also accountable to the beneficiaries to demonstrate that the investments have been professionally managed.  These obligations, enshrined in Trust Law, ensure that professional trustees are required to adhere to the highest standards at all times.

Settlors provide further guidance to their trustees through Letters of Wishes (LoW). 

While not legally binding (as if they were there would be a danger that the wide powers issued to the trustees under the terms of the Trust deed could be constrained) a LoW is a useful guiding document that settlors give to their trustees.  It sets out their views on how the trust assets should be managed and their wishes on future distribution policies.

A LoW is particularly important once the settlor is no longer alive or able to communicate with the trustees.  The LoW can be updated at any time and trustees regularly review the contents of these with the Settlor.

What role does a Protector play?

The Trust Deed can contain provisions for certain powers to sit with an independent third-party called a Protector. 

In most instances these powers are limited to the hiring and firing of trustees, but can also be extended wider (subject to tax considerations around the jurisdiction of the Protector) to include protector consent being required for any changes to the beneficiaries, investment strategy or to consent to distributions above a certain threshold.

Having a trusted individual (perhaps a business associate or long-standing family advisor) act as Protector ensures that there remains an independent set of eyes and ears to look out for the beneficiaries and to step in and effect a change of trustee should the need ever arise. This is a further incentive to ensure that trustees live up to the promises around their service levels made to their clients at the outset of the relationship. 

Additional Comfort – the right jurisdiction

Well-run and highly regulated International Financial Centres, such as Jersey, ensure that all businesses that provide trustee services to third parties must be properly licenced and are then routinely supervised by their regulator.  Key personnel in the business are individually assessed as being appropriate to manage the business. 

All employees are required to act with due skill, care and diligence when fulfilling their role and to act in the best interests of the client at all times.

Family Engagement

Trustees are required to keep full books and records of the structures that they administer. 

Face-to-face meetings between trustees and their clients are actively encouraged and regular review meetings with the participation of the legal / tax / investment advisors are an important way of ensuring that the structure remains up to date and continues to fulfil the purpose for which it was established. This also ensures trustees are aware of any changes in family circumstances.

Summary

Offshore trusts continue to play an important and relevant part of the overall design of an international family’s estate and wealth structuring arrangements. 

While the notion of parting with valuable family assets to an unfamiliar company in an overseas jurisdiction may seem alien at first, as can be seen, there are a number of ways of providing the assurance new clients seek when establishing a family trust. 

Each family’s circumstances are different and the solution that works for them will be determined with bespoke arrangements tailored to suit their requirements.

Written by Steve Gully and Hannah Roynon-Jones

About the authors

Steve Gully and Hannah Roynon-Jones, Directors at Alex Picot Trust

Alex Picot Trust is a management owned, private client focused independent trust company based in Jersey and has been providing fiduciary services to private families since 1932.

Alex Picot Trust is a registered business name of Alex Picot Trust Company Ltd which is regulated by the Jersey Financial Services Commission to conduct trust company business.

www.alexpicottrust.com

Additional Offshore Trust Blogs, News & Resources

Introduction and background to Offshore Trusts

Something we are frequently asked by clients is ‘what are the consequences of being a beneficiary of, and receiving, distributions from a family trust based outside the UK’.

Without review and planning, significant income and Capital Gains Tax (CGT) charges may arise, as such distributions could be allocated to accumulated income and capital gains within the Trust.

In the coming weeks, we will be posting a series of blogs about this complex, but relatively common issue.

To get things underway, we will start with a brief summary of the history of Offshore Trusts and an outline of their use for tax and succession planning.

A wide range of structures are available for families to hold their wealth, many of these being entities established outside the UK. UK tax law typically puts foreign entities into the following key categories:

• Partnerships
• Companies or,
• Trusts

Companies are opaque and partnerships transparent, however Trusts are neither.

Instead, the UK tax system has a separate regime for how Trusts are taxed, including offshore trusts with a UK nexus.

Historically, many families have used Offshore Trusts as their structure of choice since they offer flexibility for both tax and succession planning, while also offering the potential for asset protection.

The principal UK taxes to be considered for Offshore Trusts are Income Tax, CGT and Inheritance Tax (IHT). Each needs to be considered separately. For example, a particular entity may be considered a settlement for IHT purposes, but may not be a settlement for either Income Tax or CGT purposes.

The taxation of Offshore Trusts in the UK has changed significantly over the years.

Some of the key changes affecting beneficiaries are:

1981: the introduction of a beneficiary CGT charge

2008: the extension of the beneficiary CGT charge to UK resident but non-domiciled beneficiaries

2017: the extension of deemed domicile status to income tax and CGT brought with it trust protections for settlor-interested trusts meaning certain income and gains could instead be beneficiary-taxed

There have also been key changes affecting trustees:

2006: more trusts brought within the charge to IHT

2015: the introduction of non-resident CGT for UK residential property

2019: the introduction of non-resident CGT for UK commercial property and UK property rich vehicles

The taxation of Trusts is also affected by the type of Trust. The two main types of trust are:

1. Discretionary: trustees have discretion over distribution of income and capital

2. Life interest: beneficiaries have a fixed entitlement to income but trustees may have discretion over distribution of capital

The UK tax system for Offshore Trusts can, however, be complex and so our series of blogs will demystify Offshore Trusts to show the benefits of using them to hold family wealth tax efficiently without falling into any ‘bear traps’.

Here are our 3 most important points for you to take away:

Trusts offer significant flexibility

Trusts are subject to a separate UK tax regime, which can be complex

The key taxes are Income Tax, Capital Gains Tax and Inheritance Tax

Written by Lawrence Adair