NON-DOM changes: further clarification
anti-avoidance provisions deferred
Just over 18 months since the changes were first announced,
we now have a fairly final draft of the legislation giving effect
to one of the most fundamental reforms to the way nondomiciliaries are taxed in the UK. This confirms and clarifies
many of the points which have been announced by HMRC
over the last few weeks as well as containing some significant
changes which have not previously been publicised.
The big news, however, is the surprise announcement on the
day after the publication of the Finance Bill that most of the
anti-avoidance provisions which were to be included as part of
the changes to the way in which offshore trusts are taxed (and
which would in many cases apply to all offshore trusts and not
just those with non-domiciled settlors) are to be deferred until a
future Finance Bill as the legislation has proved too complicated
to finalise in the time available. HMRC has confirmed that these
anti-avoidance provisions will only become effective from the
start of the tax year to which that Finance Bill relates and will
not be backdated to 6 April 2017.
This does mean that some of the transactions planned for the
period before 6 April 2017 can now safely be deferred. However,
there is still plenty which needs to be done before that date.
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Clarification / changes in the revised legislation
1.1 Inheritance tax on UK residential property
Whilst this is welcome, it does still mean that the total exposure
to inheritance tax may not take into account the existence of the
debt (i.e. in substance there will be no deduction for the debt)
and in some circumstances may exceed the value of the UK
residential property.
For example, assume a bank makes a loan of £1m to an
individual to buy a property worth £2m. The individual is the settlor
of a trust which gives security to the bank for the loan over assets
worth £2m. The loan may not be deductible from the value of the
property if it is not secured over the property and so the full £2m
value of the property may be subject to inheritance tax. In addition,
£1m of the collateral (the value of the loan) will also be subject to
inheritance tax.
Care will therefore need to be taken in structuring loan
arrangements where the proceeds are going to be used (directly
or indirectly) to acquire UK residential property.
Additional anti-avoidance provisions have been included to try to
make sure nothing slips through the net, despite the existence
of a widely targeted anti-avoidance rule in the legislation. For
example, if a loan is taken out to buy an asset other than UK
residential property but that asset is sold and the proceeds
reinvested into UK residential property, the original loan will be
within the scope of the new rules.
1.1.2Discretionary trusts – exit charges
1.1.1Collateral / loans
The legislation has been tightened up to ensure that any loan
which relates to the acquisition, maintenance or improvement
of UK residential property will be within the scope of UK
inheritance tax. The previous draft had contained some
loopholes.
There had, for example, been some uncertainty as to whether
the new rules would apply where the loan is made to an
individual who acquires the residential property in his own name
(rather than, for example, through a company). It is clear that this
is caught and that any trust or individual which is the ultimate
owner of the debt (whether directly or through a company) will
be subject to inheritance tax.
As promised, the exposure to inheritance tax in relation to
collateral which is provided in respect of a loan which is used
to acquire UK residential property will be limited to the amount
of the loan so that the full value of the collateral will not be
exposed to inheritance tax.
The previous legislation had the effect that where the new rules
apply to property held by a discretionary trust, there would be an
inheritance tax exit charge when the property in question was
disposed of or the loan was repaid, even on a genuine sale to a
complete third party.
This is no longer the case. Instead, if the company which owns the
property is sold, the proceeds of sale will remain within the scope
of inheritance tax for two years after the sale. On the other hand,
if the property itself is sold, the exposure to inheritance tax ceases
immediately and there is no two year shadow.
1.1.3Enforcement
The legislation imposes a charge over the UK residential
property if there is tax due under the new rules which is unpaid.
As currently drafted, this could work in quite a draconian way
where loans are involved as a charge could be imposed over
the property in respect of unpaid inheritance tax relating to the
loan, even though the owner of the property is not liable for the
inheritance tax on the death of the holder of the debt.
Hopefully, there will be some relaxation of this before the
legislation is finally passed.
1.2Trust protections
ŠŠ HMRC has also confirmed that, in the case of a life interest
trust, failure by the trustees to require a company which
they own to pay a dividend (and so depriving the life tenant
of income) will not constitute an addition by the life tenant.
1.2.1Tainting protected trusts
Even after an individual becomes deemed domiciled in the
UK as a result of having been UK resident for more than 15
years, he / she will not be taxable on the income or gains of an
offshore trust unless he / she receives a distribution from the
trust. The rules which normally tax a UK-domiciled settlor on
income and gains of an offshore trust are disapplied.
1.2.2Loans
Loans can cause particular problems when it comes to tainting
given the difficulty of knowing whether a loan is on arm’s length
terms. The legislation is therefore helpful in specifying what is to
be treated as arm’s length in these circumstances.
However, these protections are lost if an addition is made to the
trust by the settlor, or by another trust of which the settlor is also
the settlor, or of which he is a beneficiary at a time when the
settlor is deemed domiciled in the UK.
Where a loan is made to a trust, the loan will only be treated as
being on arm’s length terms if the trustees have to pay interest
at a rate which is no less than the “official rate” (currently 3 per
cent but reducing to 2.5 per cent from 6 April 2017) at least
annually. It is not enough that the loan agreement specifies that
interest must be paid annually. The terms of the loan agreement
must be adhered to and the interest must not be capitalised.
Given the catastrophic consequences of even a small addition
to a trust (the trust protections are lost in their entirety), this has
caused a great deal of concern. As a result of representations
which have been made, there have been a number of
clarifications and changes (some helpful and some not so
helpful):
If a loan is made by the trustees to the settlor, the interest
charged must be no more than the official rate of interest (but
could be less) and there is no requirement that the interest must
be paid annually. If the interest rate is less than the official rate
or the interest is not paid annually, the settlor will be in receipt of
a taxable benefit (see below).
ŠŠ It has been made clear that increasing the value of an
asset owned by the trust is treated in the same way as an
addition of property to the trust.
ŠŠ Except in the case of a loan, an inadvertent addition will
not taint the trust (where there is no intention to confer
a gratuitous benefit). It may be thought that one result
of this new provision is that there is no need to consider
the use of adjustment agreements to try to ensure that
transactions take place on arm’s length terms. However,
such agreements provide good evidence that there is no
intention to confer any gratuitous benefits and so may well
still be useful.
If the settlor has made a loan to the trust which is not on arm’s
length terms (as defined above) and which is repayable on
demand, the legislation specifically provides that the trust will be
tainted (and will therefore lose the trust protections) on the day
the settlor becomes deemed domiciled. Fixed term loans are not
a problem as long as they are repaid at the end of the fixed term
(or put on to commercial terms).
There is however a 12-month grace period for those settlors
who are becoming deemed domiciled on 6 April 2017 during
which loans which are made to a trust and which would
otherwise cause the trust to be tainted, can be sorted out.
ŠŠ Cash can be added to a trust in order to pay trust
expenses if the expenses exceed the available trust
income or, even if there is surplus income available, if the
expenses are properly payable out of capital rather than
income. It is still unclear whether cash can be added to
pay the expenses of a company owned by the trust as
opposed to the expenses of the trust itself.
During the 12-month grace period, offending loans can be
dealt with either by repaying the loan or by putting it onto arm’s
length terms (as defined). If the loan remains outstanding but
is converted to arm’s length terms, an amount equal to interest
must be paid with effect from 6 April 2017 and not just from the
date on which the loan is reorganised.
ŠŠ HMRC has confirmed that failure by a settlor to exercise
a power of revocation will not be treated as an addition
and will not therefore taint the trust. No comment has
been made in relation to other trust powers retained by
the settlor but there is no reason to think that the same
principles should not apply.
It is important to note that the grace period only applies to loans
which are made to a trust. It does not apply to loans which are
made by a trust and where the interest rate which is being
charged may be more than the official rate of interest. This is
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management of any investment portfolio if income and capital
can be mixed.
only a problem if the loan is made to the settlor or to another
trust set up by the settlor or of which the settlor is a beneficiary.
However, if there are any such loans, they need to be dealt with
before 6 April 2017.
Going forward, the only real benefit in keeping income separate
is that income which has arisen over a number of years could be
distributed to a non-UK beneficiary if it has been kept separate
whereas this would not be possible if the income and the capital
have been mixed.
The statutory arm’s length definition only applies to loans made
by or to a trust. It is not clear whether the same rules apply to
a loan made by or to a company which is owned by a trust.
Until we receive clarification on this (and guidance on all of the
changes is expected in May), the safest course is to assume
that the same rules apply.
For income tax purposes, the provisions taxing a UK resident
settlor on income matched with distributions received by a
spouse or minor child have been retained. If the settlor is a
remittance basis taxpayer, he / she will still get the benefit of
the remittance basis of taxation. This means that if the spouse
or minor child remits the benefit to the UK, the settlor will pay
tax.
1.2.3Taxation of trust income
The rules for taxing income of offshore trusts are being
changed for all trusts with non-domiciled settlors and not just
those where the settlor becomes deemed domiciled in the UK
as a result of having lived here for more than 15 years.
Rather surprisingly, this close family member rule has not been
included in the capital gains tax legislation and is one of the
measures which has been deferred.
Foreign income of the trust structure will no longer be treated
automatically as the settlor’s income. Instead, it will only be
taxed if the settlor receives a distribution and that distribution
can be matched against the pool of accumulated income in the
trust. UK source income will continue to be taxed as it arises.
Where the settlor is taxable on a distribution which is made to a
close family member, the settlor will have the right to require the
family member to reimburse him or her for the tax which he /
she has paid.
Income which has arisen prior to 6 April 2017 and which has
been retained in the structure will form part of the pool of
income which can be matched against future benefits.
One trap with the existing legislation is that, if the trustees make
a distribution to a non-domiciled beneficiary who pays tax on
the remittance basis and that distribution is matched against
trust income which has been remitted to the UK within the trust
structure, the non-domiciled beneficiary may be taxable in the
UK even though the distribution has not been remitted to the
UK.
It is clear that benefits received by a settlor before 6 April 2017
will not be brought into account for matching purposes as far
as income retained in the structure is concerned (although any
unmatched benefits can still be matched against future capital
gains and so having significant unmatched capital payments
where the settlor is becoming deemed domiciled in the UK is
generally not advisable).
It had been understood that the draft legislation would remedy
this anomaly but, so far, nothing has been added to the
legislation to deal with this point.
Any income which has previously been treated as the settlor’s
income but which has been retained in the structure will no
longer be taxed on the settlor if it is remitted to the UK by the
trustees. This means that the trustees could, for example, use
income to acquire a UK asset such as shares in a UK company
or a house for the settlor to live in without that being treated
as a taxable remittance (although the settlor may of course be
receiving a taxable benefit if he does not pay rent to live in the
house).
2Valuation of benefits
The Finance Bill contains a first draft of the promised legislation
which puts on a statutory footing the quantification of benefits
involving loans, moveable property and land.
The legislation is intended to deal with what the government
sees as two shortcomings in the existing rules:
This change in treatment does raise the question as to whether
there remains any point in keeping capital and income separate
within a trust structure established by a non-domiciled settlor.
Clearly, it will simplify the administration of the trust and the
ŠŠ Taxpayers being able to argue that the value of the benefit
is very low, even where capital values are high.
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assumptions as to what is paid for by the landlord and what is
paid for by the tenant.
ŠŠ Arrangements which are said to be on arm’s length terms
but where payment of any consideration by the taxpayer is
deferred until the arrangement comes to an end.
As with moveable property, the benefit is then reduced by
anything paid by the beneficiary to the trustees in the relevant
tax year for his occupation of the land and anything paid by the
beneficiary for the repair, insurance or maintenance of the land.
The legislation deals with three specific areas:
2.1Loans
The main purpose of this provision is to ensure that rent is paid
each year.
From 6 April 2017, the recipient of a loan will be treated as
receiving a benefit for each year the loan is outstanding equal
to the official rate of interest, less the amount of any interest
actually paid by the beneficiary to the trustees in the tax year in
question.
These new provisions do have the benefit of providing certainty
to taxpayers as to what their tax liabilities will be where they
receive benefits from the trust. They do, however, also mean
that tax may now be payable where this was not previously the
case or that there may be a significant increase in the amount
of any tax payable.
This means that if interest is rolled up until the end of the loan,
the beneficiary will still be treated as receiving a taxable benefit
each year, even though the loan could be argued to be on arm’s
length terms.
The changes only apply to benefits received after 5 April 2017
and so there may be situations (particularly where clients are
becoming deemed domiciled on 6 April 2017) where it is worth
considering, for example, granting fixed-term benefits before
that date.
2.2 Use of moveable property
This will apply principally to assets such as works of art, yachts
and aeroplanes.
The quantum of the benefit is based on a formula which
involves applying the official rate of interest to the price paid
by the trustees when they acquired the asset in question or, if
greater, the market value of the asset when it was acquired. This
means that the tax charge could be relatively low if the asset
was acquired many years ago.
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There will be a two year window for non-domiciliaries to extract
clean capital from overseas funds which contain a mixture of
capital, gains and / or income. It will, however, be necessary to
identify how much clean capital is contained in the fund. The
amount which is paid out as clean capital must not exceed the
actual amount of clean capital in the account as this will prevent
the attempted segregation from working at all and instead will
simply be treated as a proportionate part of each element of the
original fund. If it is difficult to calculate exactly how much clean
capital is contained in the account, it is therefore important to err
on the side of caution and to take out less rather than more.
The amount of the benefit is reduced by anything paid by the
beneficiary to the trustees for the use of the asset and also
by any amount paid by the beneficiary in respect of the repair,
insurance, maintenance or storage of the asset.
The beneficiary is only taxed by reference to the number of
days on which the asset is “made available” to the beneficiary.
There is no guidance in the legislation as to whether this
means the number of days on which the asset is actually used
by the beneficiary or whether it includes any days where the
beneficiary could have used the asset even though he / she did
not do so. HMRC will no doubt adopt the latter interpretation
although, with assets such as yachts and planes, it may well
be possible to argue to the contrary, especially if they are also
chartered to third parties.
HMRC has confirmed that mixed funds can be segregated
even where the account contains income / gains which arose
before the current mixed funds rules were introduced in April
2008. The legislation has not, however, been amended to
make this clear and so it may be that HMRC intend to deal with
this in further guidance rather than by making changes to the
legislation.
4Business investment relief
2.3Land
The amount of the benefit where land is made available
to a beneficiary is the open market rent based on certain
Cleansing mixed funds
The improvements to business investment relief do not go as far
as everybody had hoped. However, there are two helpful changes:
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ŠŠ Relief will be available for the acquisition of existing shares
as well as the subscription for new shares.
ŠŠ Relief will only be clawed back if the investor receives
a payment which is somehow linked to the original
investment. Under the existing rules, relief can be clawed
back if a payment is received from an associated company
which may have nothing at all to do with the original
investment.
5Deferred anti-avoidance provisions
The government had proposed a number of anti-avoidance
provisions, some of which would have applied to all offshore
trusts and not just those with non-domiciled settlors.
We still expect these to be included in a future Finance Bill
(presumably the Finance Bill relating to the tax year starting 6
April 2018). The measures which have not been included are
as follows:
ŠŠ Rules preventing the pool of accumulated capital gains in
an offshore trust being reduced by distributions to nonresident beneficiaries.
ŠŠ Provisions taxing a settlor on gains matched with
distributions to close family members who are either nonresident or non-domiciled and who do not therefore pay
tax.
ŠŠ Conduit rules designed to tax gifts to UK individuals
made out of distributions received by beneficiaries who
are either non-UK resident or who are non-UK domiciled
(and who do not therefore pay tax on the distribution) in
circumstances where the ultimate recipient would have
been taxable had he / she received the distribution direct
from the trust.
ŠŠ Matching of trust level income against distributions to the
settlor or a close family member of the settlor. This has
been proposed so that tax will still be payable even if the
motive defence applies which would otherwise prevent the
trust level income being taxed on the settlor when he / she
receives a benefit.
As mentioned above, these changes will not now apply for the
tax year 2017/18 and will only be introduced on 6 April 2018
at the earliest.
6Practical implications
Clearly, most people will have made their plans as to what action
should be taken prior to 6 April 2017. The draft legislation may
result in some refinements to what is being proposed but should
not require major changes.
It is only after 5 April that we will all understand the full
implications of the changes which are being made, not least as
HMRC will not release guidance until May 2017.
It will be important to check that there are no arrangements in
place which will result in a protected trust being tainted when
the settlor becomes deemed domiciled on 6 April 2017. The
good news is that there is a 12-month grace period to deal with
most loans (which are likely to be the most common source of
problems).
The deferral of some of the anti-avoidance provisions will also
mean that some actions which have been planned for the
period before 6 April 2017 can now take place at a later date –
so those who thought the pain would be over as they disappear
for a well-deserved rest on 6 April may still find that they have
plenty to do when they get back to the office.
Contact details
If you would like further information or specific advice please contact:
Robin Vos
Solicitor
Private client
DD +44 (0)20 7849 2393
[email protected]
march 2017
Macfarlanes LLP
20 Cursitor Street London EC4A 1LT
T +44 (0)20 7831 9222 F +44 (0)20 7831 9607 DX 138 Chancery Lane www.macfarlanes.com
This note is intended to provide general information about some recent and anticipated developments which may be of interest.
It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.
Macfarlanes LLP is a limited liability partnership registered in England with number OC334406. Its registered office and principal place of business are at 20 Cursitor Street, London EC4A 1LT.
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