When do Offshore Trustees pay UK Capital Gains Tax? (Updated article)
Offshore trustees usually take the view that they are outside the scope of UK capital gains tax (‘CGT’). Whilst this is correct, this does not mean that non-resident trustees can ignore CGT completely. This article contains a brief summary of the CGT issues non-resident trustees should bear in mind.
The starting point is to check that the trustees really are non-resident for UK CGT purposes. Since 6 April 2007, the trustee residence tests for income tax and capital gains tax were combined. For CGT, the test is in section 69 of the Taxation of Chargeable Gains Act 1992 (‘TCGA’). This explains that trustees will be UK resident if either:
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- 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.
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. The old exemption for UK professional trustees (who were treated as non-resident) was abolished when the trust residence rules were combined.
Liability to UK capital gains tax
Unlike income tax, where the tax liability depends on the source of the income, for CGT you look solely at residence. Section 2(1) TCGA confirms that CGT is only payable by persons who are resident or ordinarily resident during any part of the tax year the gain arises.
This means non-resident trustees are not liable to pay CGT even on disposing of a UK situated asset. Care is needed that the trustees are not trading in the UK (in which case the profits of that trade are likely to be subject to UK income tax, rather than CGT).
There is also a potential CGT ‘trap’ due to the change of residence rules. It is possible that a trust was treated as UK resident under the old rules, but is now non-resident under the new tests set out above. If that is the case, the trustees are treated as having disposed of all the trust assets and reacquired them at market value on the date of ‘exportation’ of the trust. A charge to CGT then arises on this deemed disposal (presuming the assets have gone up in value) under s80 TCGA. This charge may be avoided if the trust assets are limited to cash in sterling, as this is not an asset for CGT purposes (see s21(1) TCGA). Otherwise, the trustees (and beneficiaries) could be surprised that the trust has been exported, even though none of the trustees have actually moved.
Concept of ‘trust gains’
Even if the non-resident trustees are outside the scope of CGT, sadly this does not mean they can ignore CGT completely. The trustees may need to keep sufficient records to permit the settlor and/or beneficiaries to calculate the gains made in the trust.
The TCGA contains anti-avoidance rules for non-resident trusts. Effectively these are intended to tax either the settlor or the beneficiaries on gains made by the offshore trustees. These rules therefore only apply when the trustees are non-resident for CGT purposes. The gain is however calculated in exactly the same way as if the trustees were UK resident.
CGT charges for settlors
Section 86 TCGA provides that the settlor of the trust is taxable on all gains made by the offshore trustees, even if s/he doesn’t actually receive anything from the trust. However, these rules can only apply if the settlor is UK resident and domiciled.
Many clients presume that if they move to the UK, there is an automatic uplift in the value of their assets (either held personally or in trust). Sadly this is not the case. The ‘base cost’ for CGT purposes will therefore be the initial acquisition value, even if the settlor was not UK resident at that time.
Section 86 only applies if the settlor has an ‘interest’ in the trust. Strangely, this is a different test to the income tax notion of a settlor-interested trust. For CGT purposes, the settlor now has an interest if any of the following ‘defined persons’ are beneficiaries:
- the settlor
- the settlor’s spouse*
- any child of the settlor or of the settlor’s spouse*
- the spouse* of any such child
- any grandchild of the settlor or of the settlor’s spouse*
- the spouse* of any such grandchild
- any company controlled by any of the above persons
- a company associated with such a company.
(* the term spouse now includes registered civil partners.)
This is much broader than the settlor interested trust rules for income tax, which look solely at whether the settlor and his/her spouse (or civil partner) are beneficiaries. The list of ‘defined persons’ was slightly shorter before 17 March 1998 and trusts set up prior to that date may be sheltered to a limited extent from the new rules (e.g. the settlor’s grandchildren may be ignored as ‘defined persons’).
Where s86 applies, the offshore trust is effectively transparent for CGT purposes. So although the offshore trustees are not themselves liable to CGT, they will need to keep sufficient records to allow the settlor to calculate his/her liability to CGT on the trust gains.
The settlor will pay CGT at his/her usual rate. However the recent increase in CGT to 28% (from 23 June 2010) will not affect settlors until next tax year. The settlor will pay CGT at 18% for all trust gains arising in 2010/11. The settlor can also offset personal losses against the trust gains, before calculating the tax liability. This contrasts with the position of the beneficiaries, see below.
The settlor has a right to reclaim the tax from the trustees. The settlor can request a certificate from HMRC confirming the amount of tax paid. The settlor will have no tax liability on receiving reimbursement of that tax from the trustees. However the settlor may not be able to enforce this UK statutory right of reimbursement against the offshore trustees, particularly if the settlor is not actually a beneficiary personally.
CGT charges for beneficiaries
Many offshore trusts will be outside the scope of s86, because the settlor is not UK domiciled, is not living in the UK or has died. The offshore trustees may still however need to calculate trust gains, so the beneficiaries know what their tax liabilities are.
Section 87 TCGA contains provisions to tax beneficiaries on gains made by offshore trustees. Here the charge can only arise if the beneficiary receives a capital payment or some other form of capital benefit from the trust. This would include occupying a property rent-free or receiving an interest-free loan.
The amount the beneficiary receives, by way of capital payment or benefit, will be ‘matched’ to the gains made by the offshore trust. The beneficiary is then taxed on those gains.
Prior to 6 April 2008, s87 only applied if the beneficiaries were UK domiciled. However, from 2008/2009 onwards this is no longer the case so s87 applies irrespective of the beneficiary’s domicile status. The beneficiary does still however have to be UK resident and ordinarily resident to be taxed under s87. There are also exclusions for trust gains that arose prior to 6 April 2008 or for distributions to non-domiciled beneficiaries before that date.
If the beneficiary is taxed on the remittance basis, only capital payments/benefits received in the UK will trigger a charge to CGT. However, if the beneficiary is occupying a UK property rent-free, this will be treated as a UK situated benefit and tax will be payable.
The rules in s87 are extremely complex, designed to tax beneficiaries whether or not they receive the capital payment/benefit in the same year the trust gains arise. Beneficiaries cannot, sadly, set their personal losses against s87 trust gains.
There are also provisions to increase the level of tax payable, if trust gains are ‘stockpiled’ in the offshore trust before being matched to beneficiaries. This surcharge can increase the tax bill to a maximum of 44.8% since the increase in CGT rate. Still, it could be worse. When the CGT rate was 40%, the maximum payable by a beneficiary under s87 was 64%!
The mid-year increase in tax rate will have an adverse effect on UK beneficiaries of offshore trusts. It seems that the new CGT rate will apply to all gains that are ‘matched’ after 23 June 2010, even if the trustees made the gain prior to that date. So a higher-rate beneficiary will pays tax at 28% (at least) on trust gains from now onwards.
Finance Act 2008 also introduced an election for trustees to revalue the offshore trust assets as at 6 April 2008. This is an irrevocable election and must be made by 31 January following the tax year in which s87 first becomes relevant (e.g. by a payment or benefit being paid). This rebasing will only apply to the trust beneficiaries who are UK resident but non-domiciled. Any UK resident and domiciled beneficiaries will be taxed on the full (non-rebased) trust gains.
Non-resident trustees are not themselves liable to CGT but need to be aware of the potential liabilities of their UK resident settlors or beneficiaries. For a UK resident and domiciled settlor, an offshore trust will effectively be transparent for CGT purposes under s86 TCGA.
From 2008/9 onwards, non-domiciled beneficiaries are caught by s87 TCGA, if they are UK resident and ordinarily resident. Their tax liability depends on receiving a capital payment or benefit from the trust, which is then matched to the trust gains. The rules are particularly complex and include a surcharge to increase the tax payable to 44.8% (currently). The change of CGT rate on 23 June 2010 will adversely affect beneficiaries of offshore trusts. It appears that any payments matched to gains after that date will be taxed at the new higher CGT rate.
Non-resident trustees will need to keep sufficient records to calculate their trust gains, as if they were UK tax resident, to see what charges may arise under s86 or s87 TCGA.
Originally published in July 2010; updated November 2010
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