The publication of the draft Finance Bill 2017 on 5 December 2016 contained a series of unexpected and far reaching changes to the taxation of offshore trusts. In some cases there is a short window of opportunity before 6 April 2017 to benefit from the existing rules, which are far more generous than what's planned. This briefing sets out the main changes and some planning ideas.
Currently, the "last in, first out"' legislation allows an effective capital gains tax planning technique for offshore trusts with geographically diverse beneficiaries. The legislation permits the "'washing out" of trust gains by making a capital payment to a non-UK resident beneficiary in one tax year and then delaying a capital payment to a UK resident beneficiary until a later tax year when there are no trust gains left to be matched.
The trust payment to a non-UK resident beneficiary reduces the trust pool of gains, but does not result in a tax charge on that beneficiary. Provided that the payment to the non-UK resident beneficiary is genuinely intended to benefit them (and the cash or other distributed asset is not simply passed back to UK residents straight after), HMRC generally accept this practice without challenge.
Changes under 2017 rules
A major change which is being introduced in the Finance Bill 2017 will affect many offshore trusts and will take effect from 6 April 2017. The new rule will prevent a payment to a non-UK resident beneficiary being matched to trust gains. Even though the non-resident recipient will still not pay tax on what they receive, the capital payment will no longer reduce the pool of trust gains available for future matching. This means a subsequent trust distribution to a UK resident beneficiary is more likely to trigger a tax charge. The inability to wash out gains will apply to all offshore trusts regardless of the residence/domicile status of the settlor.
A new anti-avoidance rule on "recycling benefits" will also apply where trust payments are made to a non-resident beneficiary (or to a remittance basis user beneficiary who does not remit the funds to the UK), who then loans or gifts the funds to a UK resident beneficiary within three years of the original distribution from the trust. In these circumstances the payment will be taxed as if made direct to the UK resident beneficiary.
In a separate change, if a capital payment is made to a close family member of the settlor (essentially a spouse or minor child), who is non-UK resident or a remittance basis user, new anti-avoidance provisions will apply so that the gain is treated as accruing to the settlor. This applies regardless of the domicile status of the settlor.
Where the settlor is UK resident, this could lead to an immediate CGT charge on the settlor.
The combined effect of these changes will be to end the flexibility trustees currently have to make tax-efficient distributions to non-UK resident beneficiaries, followed by tax-free payments to UK residents.
Trustees should act now and seek tax advice on how to maximise distributions out of offshore trusts to non-UK resident beneficiaries before April 2017 with a view to reducing the tax burden on subsequent payments to UK resident beneficiaries.
Discussions with HMRC indicate that payments to non-resident beneficiaries made before 6 April 2017 and matched before 6 April 2017 will be dealt with under the current rules and will be able to wash out pre 6 April 2017 gains. It is only unmatched payments to non-residents that are ignored post 6 April 2017, i.e. a large unmatched capital payment made now to a non-resident (unless temporarily non-resident) cannot be used to match and wash out future trust gains arising after 6 April 2017.
For further information, or if you would like us to analyse your particular circumstances and advise on a tailored mitigation strategy, please contact Andrew Goldstone at firstname.lastname@example.org or +44 20 3321 7205 or your usual Mishcon de Reya tax contact.