Offshore Trusts – Watch out for Capital Gains Tax!

Offshore Trusts – Watch out for Capital Gains Tax!
Trusts have for many years been used in numerous tax planning exercises; the most tax efficient have historically been set up in tax free offshore locations. But what are the capital gains tax implications?

UK Resident Trusts

If the proposals in the current Finance Bill 2010 become law, two rates of capital gains tax (CGT) will apply to individuals, namely, 18% and 28%. UK resident trusts are, however, subject to CGT at the flat rate of 28%; to this extent UK resident trusts offer no CGT savings.

Offshore Trusts

Offshore trusts, on the other hand, are not within the charge to CGT even on assets located within the UK. It might therefore appear that offshore trusts offer an effective solution to avoiding CGT. In somewhat limited circumstances this may be true.

However, unfortunately, where an offshore trust is set up by a UK resident individual (the settlor) and the individual, his spouse, his children or his grandchildren can benefit under the trust, any capital gains made by the trust (whether on UK assets or offshore assets) are subject to CGT on the part of the settlor; thus, no avoidance of CGT arises. In effect the trust is treated as transparent.

Example 1

Harry Bloggins sets up an offshore trust for his three children and five grandchildren with £50,000. For the next three years, the trustees invest the monies producing capital gains of £10,000 £15,000 and £20,000 in each of the three years. Harry (not the trustees) is subject to CGT on the gains of £10,000 £15,000 and £20,000.

An offshore trust may offer CGT savings where none of the beneficiaries mentioned above can benefit under the trust. Thus, for example, an individual may set up an offshore trust for the benefit of siblings, nephews, nieces and/or parents. In such cases although CGT is not ultimately avoided it can be deferred. 

This is because, in such cases, until any trust property is distributed out, whether in the UK or offshore, to any of the beneficiaries no CGT charge arises; however, as and when payments are made the recipient beneficiary is subject to CGT at that time.

The effect is that trust investments can accrue tax free permitting a more rapid rate of growth in the trust assets. In addition, the trustees are able to time payments to beneficiaries so as to mitigate any CGT payable.

Example 2

A beneficiary, Tom, brother of the settlor, is subject to CGT at 28% in the tax year 2010/11 but anticipates that in the tax year 2011/12 his rate of CGT is likely to be only 18%.

The offshore trustees agree to make any distributions to Tom in 2011/12, not 2010/11.

Where a beneficiary is able to lose his UK residence status (e.g. leaving the UK for a minimum period of five tax years) the trustees are able to make distributions to the beneficiary without precipitating any CGT charge whatsoever.

Non-Domiciled Individuals

For individuals who are not domiciled in the UK (broadly, foreign nationals) but resident in the UK, offshore trusts are extremely attractive as such individuals can avoid any CGT charge by simply receiving and enjoying any distributions outside the UK.

Example 3

The trustees of an offshore trust make a capital distribution of £15,000 to one of its beneficiaries who is a Spanish national.

£10,000 is paid and enjoyed outside the UK and £5,000 is paid and enjoyed in the UK. A CGT charge is payable by the beneficiary on £5,000; however, £10,000 is enjoyed CGT free.

Practical Tip

Settlors and trust beneficiaries should liaise with trustees to ensure distributions to beneficiaries can be timed to mitigate any CGT charges and, where possible, beneficiaries should take distributions whilst resident outside the UK.

By Malcolm Finney