Offshore trusts – are they still worth it?

What are the advantages from an inheritance tax perspective?

If you are a non-UK domiciled settlor, placing foreign assets into an offshore trust structure in advance of becoming deemed UK domiciled will continue to provide you with protection from inheritance tax, without the need for you to give up any interest in the trust assets. While the classic offshore trust structure holding UK residential property through a non-UK resident company has ceased to provide inheritance tax protection for the property, other foreign assets unconnected to UK residential property remain protected.

What is an offshore trust?

An offshore trust is one resident for tax purposes outside the UK. A trust will be non-UK resident if:

• All of the trustees are non-UK resident, or
• Where there are both UK resident and non-UK resident trustees, the settlor (i.e. the person providing the funds) was not resident or domiciled in the UK when the trust was settled.

Offshore trusts are not subject to UK tax on their income and gains, except for on income from UK sources and capital gains on interests in UK real estate, companies deriving their value from UK land, and UK businesses. As a result, the UK has a host of anti-avoidance legislation that attributes trust income and gains to UK resident settlors or, failing that, to tax UK residents receiving benefits from those structures. These provisions apply not only to offshore trusts set up in low tax jurisdictions, with UK tax avoidance in mind, but also those established in the settlor’s home country when there was no connection to the UK.

Tax on settlors

As a UK resident settlor, you will continue to be taxed on all the trust income and gains, if you or your spouse (or for capital gains tax purposes, your immediate family) can benefit from the trust, unless the trust qualifies as a “protected trust”. Where a trust has protected status, you will continue to be taxed on the UK source income but the foreign income and all capital gains (if not taxed on the trustee) can be rolled up within the trust free of UK tax. A trust settled by a non-UK domiciled settlor will be a protected trust, provided you were not deemed UK-domiciled when settling the trust and do not make any additions to the trust after becoming deemed UK domiciled.

Tax on beneficiaries

Distributions of income to UK resident beneficiaries (including the settlor) are subject to income tax. Distributions made under a power to advance capital may also be subject to income tax if tax avoidance motives are associated with the trust and the distributions are deemed to be made out of accumulated trust income.  

A capital distribution not subject to income tax is treated as if it were a distribution of the accumulated trust capital gains. Gains are matched to capital distributions in the order of realisation ‘last in, first out’ or LIFO, taking each year of assessment as a whole. Where capital distributions exceed the total accumulated capital gains, the charge is limited to the total gains. However the excess is not truly free of tax unless the trust is fully distributed because it is carried forward and matched to future capital gains or income. Because the tax charge on trust gains can be deferred for many years if there are no capital distributions, a “supplementary charge” is also applied to gains not matched to capital distributions in the year they arise or the following year. This acts as a crude interest charge and can increase the tax rate to a maximum of 32% after six years. 

If you are a UK resident beneficiary, domiciled outside the UK and claiming to be taxed on the remittance basis, then distributions received offshore are considered tax free, provided they are not ‘remitted’ to the UK (remittance is widely defined).

Planning opportunities

In the right circumstances, an offshore trust can still provide you with some protection from UK taxation.  

As a non-UK domiciled settlor, you are able to hold foreign assets in an offshore trust so that those assets remain outside the scope of inheritance tax even after you become deemed UK domiciled. In addition, income and capital gains can be accumulated tax free in an offshore trust, where you as the settlor are either non-UK domiciled or non-UK resident, with income tax and capital gains tax only payable on amounts distributed to UK resident beneficiaries.

While the tax legislation applying to offshore trusts is highly complex, with the right advice, such a trust can still deliver tax savings, particularly if you are a non-UK domiciled settlor or beneficiary.

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