What is an offshore trust?
A trust is a legal relationship created by a settlor, when assets are placed under the control of trustees for the benefit of beneficiaries or for a specified purpose.
The term ‘offshore trust’ is generally taken to mean a trust which is resident outside the UK. The residence status of a trust is generally determined by that of its trustees:
| Trustees’ residence | Trust’s residence |
| Trustees all UK resident | UK resident |
| Trustees all non-UK resident | Offshore |
| Trustees a mix of UK & non-UK resident | dependent on tax status of the settlor |
What is the tax status of the settlor of an offshore trust?
Domicile is a UK legal concept, and working out where you are domiciled can be complicated with many factors that need to be considered. Generally however, it refers to the country or legal jurisdiction which someone considers to be their permanent home. Domicile is an important consideration for settlors of trusts, both in terms of any benefits which can be available for creating the trust and in terms of how the trust is actually taxed in the UK.
How are offshore trusts taxed?
The taxation of trusts depends on a variety of factors, including the tax profile of the settlor and the beneficiaries and the tax profile of the trust itself.
Inheritance Tax
In broad terms UK-resident, non-domiciled individuals are subject to inheritance tax on only their UK situs assets. When a person has been resident in the UK for 15 out of the previous 20 tax years, they become “deemed domiciled” and following this, their worldwide estate becomes subject to UK inheritance tax.
Prior to becoming deemed domiciled, an individual can set up an offshore trust to hold their non-UK assets, thereby excluding these assets from the UK inheritance tax net. An exception applies in respect of UK land and real estate (held either directly or indirectly), which cannot be sheltered from inheritance tax in this way.
If the trust is settled by a UK domiciled (or deemed domiciled) individual or if it holds UK situated assets (including indirectly held UK land/real estate) it will be subjected to UK inheritance tax charges, regardless of its residence status.
Income and Capital Gains Tax
In broad terms, non UK resident trusts are only liable to tax on their UK source income and to Capital Gains Tax on disposals (whether directly or indirectly) of UK land and property.
In order to deal with the fact that non resident trusts are not fully taxed on their income and gains, UK resident beneficiaries receiving benefits from a non resident trust will be taxed on any benefits based on the income and gains which have arisen to the trustees of the trust over time (as a result of the ‘matching’ rules).
If the recipient of the benefit is UK-resident but non-domiciled, they may be able to take advantage of the remittance basis of taxation to mitigate tax on their benefits, provided that these are received and retained outside the UK.
What are the disadvantages of an offshore trust?
Offshore trusts and structures are the subject of much anti-avoidance legislation and can often be the subject of scrutiny by the UK Revenue.
There is also the loss of control over the assets put into trust to be considered, which comes with the separation of the legal and equitable ownership following their settlement.
What are the advantages of an offshore trust?
An offshore trust can still provide shelter from some UK taxation. They can also offer the opportunity for the roll up of potentially tax free capital gains and income, for reinvestment by the trustees.
There can also be non-tax advantages, including asset protection, succession planning and more confidentiality as compared to a domestic trust.
Timing is critical and it is essential that non-domiciled individuals think ahead before becoming deemed domiciled, so as not to miss their window of opportunity to access offshore trusts as an effective and valuable tax planning tool.
Article by Melissa Solly, Legal Director in the Tax and Trust Team. For further information, please contact Melissa or your usual contact in the Private Client or, alternatively, telephone on 020 7465 4300.
