The UK Inland Revenue recently released its second round of consultation on the reform of the taxati...
The UK Inland Revenue recently released its second round of consultation on the reform of the taxation of trusts. There are some important issues for offshore trust companies to consider that have arisen from the paper.
Primarily, the document reaffirms the Revenue's proposals for the reform of the taxation of trusts in the UK. It is primarily aimed at UK resident trusts, and there will be no attempt to reform the largely complicated and punitive income tax and CGT anti-avoidance regime in place where UK resident and domiciled individuals set up offshore trusts.
However, one area that will impact certain trust companies will be the proposals to reform the residence tests for offshore trusts. It is probably sensible to do so, as at the moment there are two different residence tests depending on whether the tax in question is income tax or CGT.
The current income tax test is based on the residence of the trustees. If all the trustees are UK resident then the trust is treated as UK resident and its worldwide income is liable to UK tax. If all the trustees are non-resident the trust is treated as non-UK resident, so only UK source income is within the UK tax regime.
Where only some of the trustees are not resident, the tax residence of the trust is determined under s110 FA 1989, which is based on the status of the settler. If the settler was resident, ordinarily resident, or domiciled in the UK at the time they either made the settlement or later provided funds for it, then the trust will be treated as UK resident. Otherwise the trust is treated as non-resident.
The residence test for CGT is determined by 69 TCGA 1992 and is very different from the income tax test. S69 says that trustees of a settlement are treated as a single and continuing body of persons who are treated as UK resident and who are ordinarily resident, unless the general administration of the trusts is usually carried on outside the UK, and the trustees or a majority of them for the time being are not resident or not ordinarily resident in the UK.
Due to the different residence tests, a trust can be UK resident for income tax purposes, but non-UK resident for CGT purposes. For example, a UK resident settlor can arrange for their trust to be non-resident for CGT purposes by ensuring firstly that the general administration of the trust is ordinarily carried on outside the UK, and, secondly, that a majority of the trustees are not resident or not ordinarily resident in the UK. Such a trust would be UK resident for income tax purposes because of section 110 FA 1989.
In the Inland Revenue's first consultative document, it was suggested that the residence tests should be harmonised, either by using one of the two tests above, or by way of a new residence test. The first of the new tests was to treat all trusts with at least one UK resident trustee as UK resident. The second was more controversial in that it would treat all trusts as UK resident where the settlor was UK resident, regardless of the residence of the trustees.
Thankfully, due to the compliance difficulties and the threat to the UK professional trustee sector, both of the new tests have been dropped. Instead, it is pretty certain that the Inland Revenue will go with a single test based on the income tax test.
What does this mean for offshore trustees? Many such trusts may be arranged in a way that there are one or two UK resident trustees, possibly a lawyer or family member. If the settler was UK resident or domiciled when the trust was created, then these trusts will become UK resident for CGT purposes. The trust assets will then become subject to CGT at the 40% rate applicable to trusts, and any unrealised gains may also be deemed to have been realised. The Inland Revenue have proposed giving trustees in this situation a 12-month transitional period in which to rearrange their affairs if they wish to do so.
The above information is based on our interpretation of Modernising the Tax System for Trusts, a Revenue consultative document August 2004, which is not guaranteed to become law. No responsibility can be taken for any subsequent changes or interpretation to the contrary, or any action taken or refrained from being taken as a result.
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