26 Mar 2018

CAPITAL letters - Issue 27

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Offshore trusts: how protected is 'protected'?

The remittance rules used to be both easy to understand and apply but, following the 2008 reforms to the taxation of non-doms, significant revisions were made and are now embodied in the alphabet soup that is section 809 of ITA 2007. To say this section is hard to follow is an understatement – even the numbering is bewildering. For instance can you tell me if s.809EZDA comes before or after s.809AAZA?

Anyway, buried amongst this alpha-numeric maze is s.809L which tells you what ‘remitted to the UK’ means and it makes clear (sort of) that money brought into the UK by a ‘relevant person’ will be taxable upon the taxpayer. Section 809M gives the meaning of a relevant person and this includes the trustees of a settlement of which that person is a settlor.

A combination of sections 809L and 809M have meant, since 2008, that trustees of offshore trusts have to be very careful about remitting any kind of income to the UK as this could be a constructive remittance by the settlor, leading to an unfortunate tax charge. Any kind of remittance of income was caught, even money remitted simply for investment purposes.

The introduction of the Business Investment Relief (BIR) rules a few years ago meant that trustees then had an opportunity to bring money into the UK for a qualifying trading purpose without risking a constructive remittance problem for the settlor. This was all well and good, but it still did not allow investments of a non-trading character.

Protected trusts

It was therefore a surprise when the full details of the Finance Bill 2017 became known as it was clear that HMRC's new concept of a protected trust would mean that (mostly) s.809L would be switched off, thereby enabling trustees to bring income into the UK for any purpose without the needing to qualify under BIR. It also meant that income arising to trust structures was not immediately taxable upon the settlor. This looks like a massively generous gesture by HMRC and therefore highly suspicious. As you will read below, the truth is rather more nuanced and you may need to curb your enthusiasm (if indeed you were showing any at this stage).

Settlor attribution

The introduction of the protected trust regime means that making constructive remittances on behalf of the settlor will become harder, but not impossible. The following paragraphs may make your head hurt a little.

There are two potential settlor charges where constructive remittances are possible. The first is under section 624 of ITTOIA (known by the kids in the street as the 'settlements code') and the second is section 720 ITA (no street name currently detected). Unfortunately, the protection from a section 624 charge is not perfect and great care needs to be taken if pre-5 April 2017 trust income has found its way down to an underlying company and income is remitted from there to the UK (this is often a result of trustees lending money to its underlying companies). Income arising after April 2017 would appear to be fully protected, regardless of where it arose.

Fortunately, the protection under section 720 is much wider and the remittance of income, even pre-5 April 2017 income, is OK from any part of the structure. However, note that if the settlor is a co-shareholder in a company underneath the trust, the income of that company is not protected and the entire income arising to the company is attributed to the settlor, regardless of the size of the shareholding. I hope you are following this.

The capital sum problem.

We have another problem to contend with when it concerns the income of underlying companies and this stems from section 727 ITA – a much overlooked provision which applies to an individual who is entitled to a capital sum from an offshore trust or company. The problem is that the protections introduced in April 2017 do not extend to fully switching off section 727 and this means that a settlor, who would otherwise be protected from trust income or underlying income of a trust structure, is caught if he/she is entitled to receive a capital sum from any of the underlying companies. When this applies the income of that company (not the rest of the structure) will be taxable upon that individual. Now, this scenario will not arise in every trust structure but it will certainly be a problem where, for instance, a settlor has made a loan to an underlying company as the right to the repayment of a loan is an entitlement to a capital sum. It is also an issue if the settlor is a co-shareholder in an underlying company as a shareholder will be entitled to a capital sum upon liquidation.

The beneficiary remittance problem

As you will see from the above, whilst settlors are mostly protected from constructive remittances or income arising to the trustee, it is not all plain sailing. The position for beneficiaries is extremely confused and worthy of closer attention. What must be remembered is that post-April 2017, because section 720 is switched off, settlors are treated as if they were ordinary beneficiaries and that means that they fall within the charging regime in section 731 ITA.

This particular configuration has led to what is possibly an unintended consequence but one which HMRC seems to be enjoying. The problem is contained in section 735 which, previously, was not much of an issue because trust income was treated as 'settlor income' (per section 720) which the trustees would keep offshore, for fear of a constructive remittance. By switching off section 720 you suddenly make section 735 much more interesting - and not in a good way.

Now, if a distribution is made offshore to a beneficiary who claims the remittance basis which is 'matched' to income which has previously been remitted to the UK by the trustees, then there is a tax charge (even if the beneficiary has not remitted anything to the UK). This sounds totally wrong but is actually right – a statement which succinctly sums up the whole world of taxation.

Business investment relief

When the protected trust rules first were announced some people speculated that we may not need the BIR rules anymore. This is clearly not the case, particularly in respect of the section 735 problem described above.

We would encourage trustees to always claim BIR if it is available, unless the settlor and/or the beneficiaries are all non-UK resident (in which case you would never have had a remittance problem in the first place).

Conclusion

In some respects the protected trust rules have made life easier for settlors in that it is now harder for their trustees to make a taxable constructive remittance on their behalf.

Where the settlor is deemed domiciled and/or the beneficiaries are either domiciled or deemed domiciled then the section 735 problem does not exist (because no one has the benefit of the remittance basis anyway). However, where the settlor and/or the beneficiaries are not deemed domiciled then there is a problem and it is strongly recommended that the trustees continue to segregate income and make sure that they do not remit it to the UK. If a remittance must be made then it is important to see if BIR will apply, in which case use that relief. If BIR does not apply then if you really must bring the money into the UK it is important that your beneficiaries (including the settlor) are aware that future distributions to them could end up being taxable even if they do not bring that distribution into the UK.

As you will appreciate, these rules are very complex and we are advising all trustees to carefully review their structures to make sure that one of the awkward problems described above doesn’t apply to you.

 

The office mug

No, I'm not referring to your least favourite person in the office, but instead that trusty drinking vessel that's always on your desk but rarely in the washing up bowl. If you drink gallons of tea, like me, then it will be hard to prevent the build-up of those rust coloured stains, no matter how much you scrub it. The answer is to invest £1 or so in a small tub of bicarbonate of soda (you will find it in the bakery products aisle at the supermarket). You simply put a few teaspoons of it into the mug, top up with water and leave it for as long as possible. Rinse out and your mug will be as clean as a new pin.

 
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KEY CONTACT

Emily Osborne

Emily Osborne
Partner

T:  +44 20 7809 2433 M:  +44 7525 896 899 Email Emily | Vcard Office:  London

James Quarmby

James Quarmby
Partner

T:  +44 20 7809 2364 M:  +44 7958 776 759 Email James | Vcard Office:  London

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