October 2017 Tax Services The non-dom newsletter Eighteenth edition 25 October 2017 Introduction Welcome to the trust special edition of the non-dom newsletter. In this edition, we hear the views of our team in Guernsey who are at the sharp end of the trust changes We also take a deeper dive into protected settlements, and look at the risks of tainting. If you would like to discuss any of the issues raised in this newsletter, please get in touch for contacts, click here. Hello Trustees: welcome to the new world. This editorial comes to you from the slightly sunnier shores of Guernsey. The Channel Islands as a whole are home to a great number of trusts and trustees, and the effect of the UK non-dom changes has very much been felt on the islands. At first glance, a number of the changes appear negative from a trustee s point of view. One downside is the change to IHT on UK residential property, making offshore structures effectively look-through for IHT purposes. We may see the need for offshore structures holding UK residential property tail off as a result. However, we do see a number of positives for the industry as well. In particular, we see a great opportunity with respect to protected settlements. For non-doms currently tax resident in the UK, and for non-doms looking to move to the UK in future, the protected settlement regime looks a very attractive proposition, in effect allowing for the tax free roll up of non-uk sourced income and gains on an arising basis if certain conditions are met. In Guernsey and across the UK we have an expert team to help you to adjust to these changes. Please see the contacts list in this edition or speak to your usual adviser. On the ground here in Guernsey, we have seen a wide range of responses to the new rules, from large scale restructurings to a wait-and-see approach. An immediate focus on pre-existing structures will be to avoid tainting by additions, or non-commercial transactions, post April 2017. We reflect on this further below. Given the great rewards (and risks) inherent in the protected settlement regime, we address it in more detail in this edition of the newsletter. We are entering into a new world for trustees. We think it is an exciting one, full of opportunity. But equally, to succeed in it, trustees must continue to deliver first class administration and be aware of the impact of the new tax rules.
Protected Settlements: the great switch off What is a protected settlement? A protected settlement is one established offshore by an individual before they become domiciled or deemed domiciled in the UK under the 15/20 year test. In effect the protections mean that the non-dom settlor will not be taxed on non-uk source income and gains that arise and are retained in the trust or underlying entities. This is because HMRC have (in the case of a protected settlement) switched off some of the anti-avoidance provisions which would otherwise subject the settlor to tax. Who can create a protected settlement? In order for a trust to be treated as a protected settlement, it must be settled by a non-uk domiciled individual prior to him or her becoming domiciled or deemed domiciled in the UK. Those born in the UK with a UK domicile of origin cannot create a protected settlement, even if they have subsequently acquired a domicile of choice elsewhere. What are the benefits of a protected settlement? There are a number of benefits for UK resident nondoms from creating a protected settlement. Capital Gains Tax Prima facie, an individual who is deemed domiciled in the UK will be subject to UK Capital Gains Tax on their worldwide gains, on an arising basis. However, if assets are settled into an offshore trust prior to the individual becoming deemed domiciled, any gains on such assets will not be taxed on the individual in the UK on an arising basis. Instead, capital gains will only be taxable in the UK where they are matched to benefits received from the trust by persons tax resident in the UK. If the recipient is domiciled or deemed domiciled the remittance basis will not apply to any benefits received from the trust. Income Tax An individual who is resident and domiciled in the UK will be subject to UK Income Tax on their worldwide income, on an arising basis. However, non UK source income held within a protected settlement will not be taxed on the individual in the UK on an arising basis. Previous rules which treated trust income as belonging to the settlor no longer affect such income. Instead, such income will only be taxable in the UK where it is matched to benefits received from the trust by persons resident in the UK. Again, if the recipient is domiciled or deemed domiciled the remittance basis will not apply. Inheritance Tax An individual who is domiciled or deemed domiciled in the UK will be subject to UK IHT on their worldwide assets. However, non UK-situs assets that are held in offshore trusts established prior to the individual becoming UK domiciled will be treated as excluded property. Excluded property will be outside the scope of UK IHT. The only exception relates to UK residential property, which is now subject to IHT however it is held. Effectively the protections mean that non-uk source income and gains can be rolled up in the offshore structure, and foreign assets kept outside the UK IHT net. The non-dom newsletter 2
The protected settlement regime thus provides significant benefits to non-doms currently resident in the UK. It also provides an attractive proposition to HNWIs looking to relocate to the UK. However, it is critical that all parties exercise caution, as these benefits can easily be lost. Both the Capital Gains Tax and Income Tax protections will be lost if the trust becomes tainted. Even a small amount of tainting will be enough to cause the trust to lose its protections. Taint what you do Protected trust status (as described above) will be lost for both income tax and capital gains tax purposes if property or income is added to a protected trust by a settlor who has become deemed domiciled. The protections will be lost if the addition of property is by the settlor, or by the trustees of any other trust of which the settlor is a beneficiary or settlor. In such event the anti-avoidance provisions which attribute income and capital gains to the settlor are switched back on. In effect, the trust becomes transparent. Examples of tainting might include: The settlor adding further monies to the trust. This is perhaps the most obvious example of tainting and therefore the easiest to avoid The settlor working for a company owned by the trustees and not receiving a commercial salary The settlor living in a house owned by the trustees and using his own funds to pay for a new kitchen Loans There are special rules on loans. An outstanding uncommercial (e.g. at a low or nil rate of interest) repayable on demand loan entered into before an individual becomes deemed domiciled on 6 April 2017 will taint a protected trust. There is a transitional one year grace period, so that the trust will not be tainted provided that either: The principal of the loan is repaid, and all interest payable under the loan is paid, before 6 April 2018, or The loan is subject to arm s length terms (official rate of interest set by HMRC), before the year ending 5 April 2018, with the interest paid to the lender for the period 2017/18 and subsequent years. The legislation provides that a loan will be regarded as being on arm s length terms (and hence tainting will not apply) if, and only if: In the case of a loan made to trustees, interest at the official rate of interest (currently 2.5%) or more is charged and actually paid annually. In the case of a loan made by trustees, interest at no more than the official rate is charged and actually paid annually. A loan will be treated as an addition of property (of the whole loan) if interest is not paid, or is capitalised or the loan is varied such that the terms become non-arm s length. Non-arm s length loans outstanding at the time the settlor becomes deemed domiciled will be treated as additions (of the whole loan) at that date. The settlor paying insurance on a trust asset The settlor failing to reclaim tax he has paid from trustees where the legislation entitles him to do so There are some exceptions to the tainting rules: Property added under a transaction (other than a loan) entered into on arm s length terms Property provided inadvertently, without the intention to confer gratuitous benefit Loans made on arm s length terms The non-dom newsletter 3
The payment of interest to trustees under a loan made by trustees on arm s length terms Repayment of a loan made by the trustees Property or income provided in pursuance of a liability incurred before 6 April 2017 Payment of expenses where and to the extent that the trust s expenses exceed its income for a tax year Expenses In addition to loans, there are also special rules allowing settlors to contribute to trusts without tainting where this is needed to meet certain trust expenses. A contribution is only permitted in this way where the settlements expenses relating to tax and administration exceed its income for the year. It should be noted that expenses must exceed total income for the tax year, so payments to cover a short fall in cash-flow before income is received will not be permitted. In addition, it is only expenses of the trustees which are covered by this exemption contributions to meet the expenses of underlying companies will result in tainting...it s the way that you do it There is no doubt that the tainting rule will add to a trustee s burden. This is not a new pressure. Tainting existed when the rules were changed for offshore trusts settled by UK domiciled individuals in Finance Act 1991. HMRC published Statement of Practice 5/92 at that time to give taxpayers some additional guidance on what is meant by tainting. Although the statement refers to different law, there is certainly some read across and it can provide guidance on what is meant by a transaction entered into at arm s length and the kinds of expense that would qualify as administration and taxation expenses. While a helpful guide in some respect, the statement nevertheless leaves many questions unanswered. In addition, the fact that it was produced with different law in mind should not be forgotten and it should only be used with caution. With such large stakes riding on an accidental tainting of a settlement, there will be an increased premium on good trusteeship. UK Residential Property held in companies With effect from 6 April 2017, all UK residential property is subject to UK IHT even if held within a structure. In a nutshell, this is achieved by preventing interests in non-uk close companies and partnerships from benefitting from the excluded property rules to the extent that their value represents value from UK residential property. It is the value of the shares that is within the trusts estate, but only to the extent that those shares derive their value from relevant property. So if a non-uk company owns only UK residential property the full value of the shares will cease to be excluded property, but this value is likely to be less than the property value. In calculating the value, the value of any loans at company level can be taken into account. However, the loans must be deducted from all the assets of the company, pro-rate, even where they are secured against the property. The corollary to the fact that loans can reduce the value of the shares or partnership interest is that certain relevant loans can also be within the new rules and cease to be excluded property. Very broadly, a loan will be a relevant loan where the proceeds of that loan have been used by the debtor to acquire UK residential property or an interest in a company or partnership that holds or acquires UK residential property. The IHT exposure of the trustees can continue even where the interest in the close company or partnership has been sold or the loan repaid. In these circumstances, the proceeds of sale are also prevented from being excluded property for a period of two years following the disposal or repayment. A sale of the UK residential property by the company, however, can remove the IHT exposure for the trustees with immediate effect. Trustees will also need to be aware of the possibility for double taxation where the settlor retains an interest in the trust. In such circumstances the gift The non-dom newsletter 4
with reservation rules are likely to apply alongside the 10 year anniversary and exit charge rules, meaning there may also be a tax charge on the death of the settlor. Unlike the anniversary charge which can be predicted and planned for, a charge on the death of the settlor is likely to be unexpected and will also generally be much larger. Trustees may wish to consider how such a charge could be met. In some cases, life insurance may be appropriate. In some cases, trustees may want to consider the application of business property relief (BPR), where portfolios of properties are held and there is sufficient activity to constitute a property rental business. Trustees with these kinds of portfolios may wish to begin familiarising themselves with the BPR rules and where appropriate seek professional advice. Trust Register On 19 May 2017 HMRC quietly announced that form 41G (a form used to register trusts and estates for UK self-assessment tax returns) had been withdrawn and would be replaced by a new Trusts Registration Service during summer 2017. The register will apply for any and all trusts with a UK tax consequence, which could include an income tax, capital gains tax, inheritance tax or stamp duty land tax liability. Registration also applies to trusts that have already registered with HMRC. The register became available to unrepresented trustees in July this year and for agents earlier this month. Existing trusts with a selfassessment ('SA') reference have until 31 January 2018 to register. Trusts with no SA reference with income or gains for 2016/17 must register by 5 December 2017 Further changes in the pipeline Further changes to the taxation of offshore trusts are proposed from 6 April 2018. Draft clauses setting out the changes were published on 13 September and were considered in detail in our last newsletter. As a reminder, the key changes proposed are as follows: A benefits charge for settlors and close family members will largely impact settlor interested trusts where the benefits would not otherwise be taxable under the Transfer of Assets Abroad provisions Capital payments to non-residents and to migrating beneficiaries may be disregarded when attributing capital gains of offshore trusts and will not therefore reduce the pool of gains available to be matched to other beneficiaries. This change is not limited to protected settlements. There will be attribution of certain gains charges to a settlor where benefits are received by close family members There will also be attribution of capital gains and of deemed income to recipients of onward gifts (the recycling rule). The rules are complex and can result in amounts becoming taxable on the settlor in certain circumstances. The new provisions may impact on actions taken before 6 April 2018. Trustees and beneficiaries may therefore urgently wish to review their position before 6 April next year. In particular, trustees may wish to review their capital payments/gains position, particularly where there are both UK and non-uk resident beneficiaries. In addition, the onward gift rules will apply to gifts made after 6 April 2018, even where the original payment from the trustees took place before that date. The non-dom newsletter 5
Action stations: what to do if you are a trustee Trustees do not give tax advice (typically), but it is difficult to think of any offshore trusts that will not need to be reviewed following the changes to the non-dom regime. So what should trustees be doing? We make some suggestions below: 1. Understand the key technical drivers. Although trustees do not provide tax advice they will need to understand the main tax rules and the consequences that flow from them. For those administering trusts, the key points to focus on include: Offshore trusts will have a favoured status post- 6 April but only if they are not tainted. Under this favoured status, they will be known as protected settlements. The capital gains and non-uk source income can roll up free of UK tax in the trust in most cases, even if invested in the UK. If a benefit is provided to a beneficiary post-6 April 2017, that beneficiary will be subject to tax if they are dom or a deemed dom even if the benefit is provided outside the UK. Trustees will therefore, more than ever, need to take tax advice before making distributions or providing benefits. 2. Avoid tainting. This is probably the key thing for trustees to focus on. Tainting has started from 6 April 2017. Tainting is the provision of property or value to an existing trust by a settlor or a trust of which the settlor is a beneficiary. Trustees should ensure: No additional settled funds (unless covered by an exclusion) are received from settlors once they become deemed domiciled. Review the terms of all existing loans (made to and by the trustees) to check whether these might taint the trust once the settlor becomes deemed domiciled. Ensure that all interest is paid and collected when due. Any funds added to the trust to settle expenses such as tax or administration will not taint the trust, provided that the addition is limited to covering the deficit of the expense and the trust income for the year. Be careful to ensure the Settlor is not settling invoices directly whilst trust income for the year has not been exhausted or calculated. Ensure that any income that life tenants or others are entitled to is paid out in a timely fashion and not retained within the trust. So what practical steps should trustees take to avoid tainting? The short answer is to alert settlors to the problem, tell them to take advice and proceed with care. Other actions which may help include: Not accepting any additions to a trust post-6 April 2017 unless the person making the addition confirms they have taken tax advice (not only for their own position but on the wider tax consequences of the addition) Being aware of the position of interest-free loans and review the client portfolio for these Reading SP5/92. This was published by HMRC the last time that tainting haunted offshore trust jurisdictions and is well worth dusting off (see it s the Way that you do it above) Thinking about fees. Payment structures must be reviewed and no fee payment accepted post- 6 April unless it is fit for purpose in the new regime. HMRC has agreed that certain payments can be made to trustees for their services without tainting but that payments to underlying companies cannot. Agreements may thus need adjusting 3. Be aware of the new and forthcoming antiavoidance provisions and their potential impact on historic actions, present positions and future events. Trustees should consider recommending to clients that they have their structures healthchecked in light of the new rules. This may include a review of the capital payments position ahead of the proposed 2018/19 changes. The non-dom newsletter 6
4. The requirement to provide ownership information for trusts to a central authority will be a new obligation for trustees and is likely to present a number of challenges. The category of persons to be reported is very wide, going far beyond what was required on form 41G. The valuation of trust assets as part of the registration process also takes on added importance as there will now be a requirement to report asset values. The lack of clarity on these matters makes it very difficult for trustees to plan for the new Trust Register. However, in the absence of further guidance, trustees should ensure they at least have up to date documentation for settlors and active beneficiaries as a minimum. 5. Following the introduction of UK residential property held by companies falling within the scope of UK IHT, Trustees should review 10 year anniversary IHT exposures to ensure compliance and IHT is paid on time to avoid penalty. Trustees may also want to plan for any potential tax charges resulting from the death of the settlor. And finally. Who would be a trustee? All this new complexity, all this new administrative burden, the worry of tainting the list could go on. But beneath it all, our message to trustees is a simple one: there is sunshine. There remain many advantages for non- UK domiciled individuals to having a welladministered offshore trust. However, with tainting so easy to do and so significant from a tax perspective, good administration will be key. The new rules will enable offshore jurisdictions to show the quality of their administration and the commercial awareness of their people. As we say, sunshine is on its way be that in the BVI, Cayman, the Channel Islands, the Isle of Man or other offshore centres. 6. Following recent changes, many trusts restructured to exclude the settlor from the trust and a market rent was paid for the settlor s occupation of the trust property. As a result, Trustees should ensure the relevant UK tax filings are completed following the receipt of the UK source of income. 7. The final what to do point if you are a trustee? Pick up the telephone to EY if you need support. We would be pleased to help. The non-dom newsletter 7
EY Assurance Tax Transactions Advisory About EY s Private Client Services Contact details For further information, please contact one of the following or your usual EY contact: London David Kilshaw 020 7783 0763 dkilshaw@uk.ey.com John Mackay 020 7951 2779 jmackay@uk.ey.com Elaine Shiels 0121 535 2110 eshiels@uk.ey.com North Martin Portnoy 0161 333 3275 mportnoy@uk.ey.com Andrew Shepherd 0161 333 2726 ashepherd@uk.ey.com Trevor Sherlock Katherine Bullock Scotland 0191 247 2527 0113 236 4303 tsherlock@uk.ey.com kbullock@uk.ey.com Sean Cockburn 0131 777 2371 scockburn@uk.ey.com South Paul Cooper 0117 981 2076 pccoper3@uk.ey.com EY s Private Client Services offers tax-related domestic and cross-border planning and compliance assistance to business-connected individuals and their associated entities. In addition, in today s global environment, crossborder services can help meet the evergrowing needs of internationally positioned clients. Our dedicated resources in major markets around the world serve individual clients needing a wide range of tax services, including tax compliance, tax planning and tax advice relating to their business interests, investments and other financial-related assets. We have experience working with individuals and companies of all sizes across many aspects of the tax life cycle planning, provision, compliance and controversy. The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF. 2017 Ernst & Young LLP. Published in the UK. All Rights Reserved. ED None In line with EY s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content. Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com/uk Ireland Sherena Deveney 028 9044 1460 sdeveney@uk.ey.com Channel Islands Elaine Connor Daniel Collins Emma Hosking- Williams 01534 288 275 01481 717 598 econnor2@uk.ey.com DCollins@uk.ey.com 01534 288 780 EHosking- Williams@uk.ey.com BACK The non-dom newsletter 8