Trustees should be well aware of the new rules, in force since 6 April 2017, concerning the tax treatment of offshore trusts. However, it is important for offshore trustees who are now trustees of a "protected settlement" to ensure any outstanding loans have been properly dealt with before the deadline of 5 April 2018, to protect the interests of their beneficiaries.
What is a protected settlement?
The "protected settlements" regime is a significant change to the way trusts are taxed. It applies to offshore trusts created before the settlor becomes UK domiciled or deemed domiciled under the new 15 out of 20 year rule.
The regime operates to protect a UK resident, deemed domiciled settlor from being taxed on the arising basis on trust income and gains within the protected settlement. Instead, the settlor will only be taxed when they receive trust distributions or benefits, or when a close family member of the settlor receives a distribution and that close family member is either non-resident or UK resident but claiming the remittance basis. A close family member includes the settlor's spouse, cohabitee and minor children.
UK resident beneficiaries will continue to be taxed on benefits they receive to the extent that the benefits can be matched against trust income or gains (with income taking priority). A non-domiciled beneficiary can still enjoy the remittance basis provided the benefits from the trust are received outside the UK and are matched with non-UK income or gains. In contrast, a UK resident domiciled or deemed domiciled beneficiary will be taxed on the arising basis on all benefits received, to the extent that the benefits can be matched with trust income or gains.
Once protected settlement status is lost, the deemed domiciled settlor (assuming they have an interest in the trust and continue to be UK resident) will always be taxable on an arising basis on all trust income and gains, whether or not they receive a benefit.
How to maintain protected settlement status?
Tainting occurs when a deemed domiciled settlor (including another trust of which that settlor is either settlor or a beneficiary) makes an addition to the trust or an underlying company not on arm's length terms. There is no de minimis and the consequences of tainting are permanent.
There are some exceptions that trustees should be aware of. Most importantly, the settlor (or another trust of which the settlor is settlor or a beneficiary) can make an addition in respect of the trust's tax liabilities or administration expenses, but only where the current year's income of the trust is insufficient to cover such costs.
One key risk area for trustees is loans made by (or to) the settlor where the terms of the loan are not on arm's length terms.
What to do about outstanding loans?
A loan from the settlor to the trust on soft terms is likely to be treated as an addition to the trust. Similarly, a loan from the trust to the settlor at a penal rate of interest could also be an addition. In both cases the trust will be tainted and its protected status will be permanently lost, at great tax cost to the settlor.
Trustees were given until 5 April 2018 to deal with any outstanding loans which fall foul of the tainting provisions. As such, trustees should urgently review any loans from the settlor to the trust or underlying company (or vice versa) as these may need to be restructured or varied by 5 April. Any such variation will need careful consideration to ensure that an inadvertent tax charge does not arise.
What should trustees do now?
Trustees should make sure that any existing loans do not fall foul of the tainting rules and make any necessary adjustments by 5 April.
Trustees should make regular diary notes to ensure that their settlors' UK residence periods are noted. They should have regular conversations with their settlors to record the settlor's deemed domicile status. They need to be particularly careful that the settlor does not make any addition to the trust after he or she has become deemed domiciled.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.