HAVE PROTECTED TRUSTS TURNED INTO FALSE PROMISES?
Those worrying about what else has been neglected, whilst the UK government’s attention is wholly fixed on Brexit and infighting, will take no comfort from HM Revenue’s recent statement that offshore income gains are not within the new Protected Trusts regime.
The introduction of the Deemed Domicile rules for income and capital gains tax from April 2017 ended the unlimited access to the tax advantages of the ‘remittance basis’. These rules apply to long term UK resident non-doms (those who had been resident in the UK for more than 15 out of the previous 20 tax years).
However, the government put in place a series of measures, including a new tax regime for trusts, to encourage long term resident non-doms to stay in the UK. These rules give long term resident non-doms the opportunity to set up Protected Trusts prior to becoming deemed domiciled so that foreign income and gains within the trust escape tax until a trust distribution is made or a benefit received from the trust.
Sadly, whilst drafting the legislation necessary to implement this salve for those about to become deemed domiciled, a crucial omission occurred. Any Offshore Income Gains on ‘non-reporting’ offshore funds were not included in the safe list of investments which could sit within a Protected Trust.
Non reporting offshore funds include any offshore fund that does not report to HM Revenue. This may include hedge funds, private investment funds and most foreign investment funds.
Many bodies including the Chartered Institute of Taxation, the ICAEW and the Law Society have lobbied HM Revenue for a speedy correction to the legislation. However, HM Revenue has issued a statement saying that it will not amend the current legislation to extend the Protected Trust regime to include Offshore Income Gains at this time. Alarmingly, HM Revenue has stated that current demands on parliamentary resources make it hard to justify returning to this matter.
What effect does the drafting error have?
A UK resident deemed domiciled settlor of certain Protected Trusts may now incur an immediate income tax charge on any Offshore Income Gains arising from the disposal of non-reporting funds by the trustees. This includes gains made by the trust or any company owned by the trust. A Protected Trust is caught if the settlor or his wife can benefit from the trust. In some circumstances, tax arises even if the settlor and the settlor’s spouse are not beneficiaries (for example, if they have made loans to the structure or have previously received benefits from the structure).
Foreign source income within a Protected Trust can only be protected from income tax if it would be “relevant foreign income”, if it was received by the settlor personally. Offshore Income Gains can only be relevant foreign income of an individual who is non-UK domiciled and a remittance basis user. Where an individual is deemed UK domiciled, he or she cannot be a remittance basis user. Therefore, the legislation as it currently stands defines by omission that the Offshore Income Gains of a settlement with a deemed domiciled settlor are not ‘protected foreign source income’ and disposals may well give rise to an income tax charge for the settlor on the gains as they arise.
What action should offshore trustees and their advisers take?
Professional tax advice should be undertaken to determine whether the trust is caught and if it is to review the trust’s investment strategies in the light of HM Revenue’s statement. It may be prudent to invest in reporting funds, or in some cases consider whether corrective action can be taken to the trust structure.
The 31st January submission deadline is fast approaching for the first tax returns of individuals who became deemed domiciled in the year ended 5 April 2018. Offshore Income Gains arising within Protected Trusts will either need to be declared in their tax return or a white space disclosure made to claim a purposive interpretation of the law.
Only when these returns have been reviewed by HM Revenue and precedents established will we know how light a touch HM Revenue will decide to take on a purposive interpretation of the law to shelter all income and gains within the trust in the spirit of Parliament’s original intentions.
For a non-UK domiciled settlor who is not yet deemed domiciled, who has set up a Protected Trust containing non-reporting funds, he or she now needs to consider whether the remittance basis still needs to be claimed and the remittance basis charge paid to shelter any Offshore Income Gains within the trust. The claim should ensure that any Offshore Income Gains within the trust qualify as protected foreign source income and so cannot be taxed on the arising basis.
For help on any of these matters please contact us at:-
Mark Davies & Associates Ltd
0203 770 5600