What are Offshore Trusts and How Do Offshore Trusts work?

7 September 2021

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