The April 2017 UK tax rule changes mean that non-domiciled individuals who have been tax resident in the UK for 15 of the preceding 20 tax years are ‘deemed domiciled’ in the UK for all tax purposes.
This makes their income tax, capital gains tax and their worldwide estate is subject to inheritance tax (IHT).
The use of offshore trusts and the benefit of the ‘protected settlement’ regime can help mitigate these tax implications.
But, in order to maximise the benefit of these protections; being income and CGT deferral advantages, which have even been slightly improved in the new rules, and IHT protection for certain assets, it is important for clients to hold the “right” assets, writes VG private client director Debbie Lumsden.
The “wrong” assets
So what happens when a client find themselves in the fortunate position of being able to settle a ‘protected settlement’, but does not hold the “right” assets?
When considering which assets are most suitable to consider settling into a ‘protected settlement’ and maximise the afforded protections, clients should ensure that assets are non-UK situs.
As a non-domiciled individual, you are only subject to IHT on UK assets.
Non-UK assets are “excluded property”, are outside the scope of UK IHT and, if settled into trust, continue to be protected from IHT even after the individual becomes ‘deemed domiciled’ in the UK.
This is an important protection as UK IHT is currently 40% on death.
Transfers of UK assets into trust during the lifetime of the settlor are subject to an initial upfront IHT charge at a rate of 20% of the value of the transfer exceeding the tax free available nil rate band of £325,000 ($424,887, €359,414) (as well as potential on-going IHT exposure for the trustees) which makes this unattractive.
Are all non-UK situs assets suitable to settle into a ‘protected settlement’?
The optimal asset classes are non-UK cash, non-UK equities and non-UK co-investment as, in addition to there being no upfront charge to IHT on settlement into trust, there are other ongoing tax benefits including the fact that the trustees are not subject to UK CGT on a future sale of these assets.
However, there are some non-UK situs assets which may not be ideal for settling into a trust.
These include carried interest, interest in partnerships which hold UK investments and non-reporting offshore funds with offshore income gains (OIGs).
While the reasons and precise tax treatment differs for each, broadly speaking these assets would continue to be taxed on the settlor (assuming UK tax residency) regardless if the assets are held in a ‘protected settlement’.
What are the options for clients holding UK assets?
Some assets are easier to “convert” to non-UK situs assets than others.
For example, UK cash held in a UK bank account can become non-UK situs simply by transferring it to a non-UK bank account.
For clients holding UK shares, it may be possible for them to sell these to a non-UK company before settling the non-UK company shares into trust.
For clients holding UK property there is not always an easy answer as the tax cost and complexity associated with buying, owning and selling property has increased significantly for non-UK trustees.
In most cases, it very much depends on each client’s unique circumstances and to some extent the value of the assets.
Case study: A client holding predominantly UK equities
A recent client’s main assets were UK equities (the “shares”).
Had the client settled the shares on trust they would have been exposed to the upfront IHT charge (outlined above).
However, the shares were expected to realise a substantial capital gain and if held in trust at the time of sale, the trustees would have no liability to UK CGT on the gain.
It was therefore a case of analysing which would have the better outcome in terms of reduced tax exposure and in this case the upfront IHT charge on settlement was worthwhile in light of the significant CGT saving that would otherwise have been taxed on the client personally.
While becoming ‘deemed domiciled’ in the UK can present clients with a conundrum, this can be overcome with seeking the advice of trusted advisers and service providers.
This article was written for International Adviser by Debbie Lumsden, private client director at independent fiduciary and administration solutions firm VG.
