When do Offshore Trustees pay UK Income Tax?
Offshore trustees are often surprised to learn that they can be liable to UK income tax. This is the case whether the non-resident trust is a family/personal settlement or an offshore pension (only UK registered pensions are exempt from income tax). This article contains a brief summary of the income tax issues non-resident trustees should bear in mind.
The starting point is to check that the trustees really are non-resident for UK income tax purposes. Since 6 April 2007, the trustee residence tests for income tax and capital gains tax were combined. For income tax, the test is in section 475 of the Income Tax Act 2007 (‘ITA’). This explains that trustees will be UK resident if either:
- all the trustees are resident in the UK; or
- at least one trustee is UK resident (and one is not resident) and the settlor was UK resident, ordinarily resident or domiciled at the time the settlement was created.
For trusts set up on the settlor’s death (i.e. will trusts) the question is whether the settlor was UK resident, ordinarily resident or domiciled immediately before his/her death.
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If the trustees do not fall into any of the above categories, they are both non-UK resident and not ordinarily UK resident. However offshore trustees will be UK tax resident if they act as trustee in the course of business through a branch, agency or permanent establishment in the UK.
Liability to UK income tax
Unlike capital gains tax, the liability to UK income tax does not rest solely on residence. In other words, non-resident trustees are liable to pay UK income tax on UK source income. Foreign source income, which is received by a non-resident, is not within the scope of UK income tax.
Concept of disregarded income
There are limits to the liability of non-residents, even on UK source income. The rules are in s810 etc ITA 2007, which create the concept of ‘disregarded income’. The non-resident has no further liability to UK tax on the ‘disregarded income’ other than any tax that was deducted at source or tax that is treated as having been paid by way of a tax credit.
The following types of income are ‘disregarded’ when received by a non-resident:
- savings and investment income (including dividends from UK shares);
- annual payments (including bank interest);
- pension income;
- social security income;
- certain transaction income; and
- other income as designated by Treasury regulation.
It is worth noting that rental income from UK properties is not within the definition of ‘disregarded income’.
For non-resident trustees this limit of liability only applies if the beneficiaries are also non-resident. If any UK individual or UK resident company is an actual or potential beneficiary of the trust income, the offshore trustees will be liable to additional tax even on ‘disregarded income’.
The ‘special rate’ for trustees’ income
The rate of income tax payable by the trustees is in some cases the ‘special trust rate’. This is currently 40% (going up to 50% from 6 April 2010) for non-dividend income and 32.5% (going up to 42.5%) for dividend income.
Trustees are liable to the special trust rate of income tax whenever the trust deed provides for accumulation of income or it gives the trustees discretion as to who to appoint trust income to (and it is not a charitable trust). This therefore will apply to any discretionary family settlement. It will also apply to any offshore pension before the member becomes entitled to draw income (since the income is accumulated).
ITA 2007 also introduced a concept of the ‘first slice’ of trust income. Section 491 looks at how much of the trust income should be taxed at the special trust rate (called ‘trust rate income’). If the total trust rate income received by the trustees is less than £1,000, it is not taxed at the special trust rate. If the trust receives more than £1,000 of trust rate income, that first £1,000 is not taxed at the special trust rate. Effectively, this is like a basic rate tax band for trustees.
However this £1,000 threshold is lowered if the settlor has created other trusts that are ‘current’, i.e. in existence at any time in the tax year. The £1,000 basic rate tax band is reduced (to a minimum of £200) depending on the number of current trusts set up by the same settlor. For example, if the settlor had set up two trusts, they would each have a basic rate tax band of £500.
Ownership of UK land
If any UK situated land is held on trust, the non-resident trustees will have to register under the Non-Resident Landlord scheme in order to receive the rental payments gross. Otherwise, the tenant or any UK property agent has to deduct tax at source. The trustees may have expenses to set against the rental income, so it could be to their advantage to register to receive the rental gross so they pay tax only on the net rental income when their tax returns are filed. However, if the trust is discretionary or accumulates income, then the rate of tax on the net rental income would be the higher trust rate (see above).
Many offshore trustees therefore choose to hold UK property via an underlying company. Not only does this give protection from liability, it also reduces the rate of tax due on the UK rental income. Offshore companies only pay tax at the basic rate on UK rental income, rather than at the special trust rate.
Settlor interested trusts
A ‘settlor interested trust’ is one where the settlor has an interest, as defined in s625 of the Income Tax (Trading and Other Income) Act (‘ITTOIA”) 2005. A trust will be ‘settlor interested’ if the settlor or his/her spouse (or civil partner) can benefit from the trust property in any way.
Section 624 ITTOIA explains that income of a settlor interested trust is treated as being the settlor’s income during the settlor’s lifetime. The settlor is taxed on the gross trust income, ignoring any trustee expenses.
For years up to 2005/6, if it was a settlor interested trust then the trust income was charged at the settlor’s personal tax rate. From 2006/7 onwards, the rate applicable to trusts will apply (to discretionary trusts or ones that accumulate trust income) even if it is a settlor-interested trust.
For most settlors, this is unlikely to make a difference as they’re usually higher rate taxpayers. If the settlor is a lower rate taxpayer, however, this can make a difference (e.g. if they’re retired). However the settlor has the right under s646 ITTOIA to recover the tax from the trustees. The settlor may request a certificate from HMRC to confirm the amount of tax paid. The settlor will not have any further tax liability provided the amount he recovers from the trustees is no greater than the tax he paid under the settlor interested trust rules. However, it may not be possible to enforce this UK statutory right of reimbursement against the offshore trustees.
Non-resident trustees need to be aware of their potential liabilities to UK income tax. The concept of ‘disregarded income’ will be of no help to non-resident trustees if any of their beneficiaries are UK resident. Rental income is not within the scope of ‘disregarded income’ and may be taxed at the higher trust rate. Offshore trustees may need to own UK situated land via an offshore company to reduce the income tax bill on the rental income.
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