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Opportunities for offshore trustees

Depressed markets offer the potential opportunity for trustees to restructure and distribute assets tax efficiently.

From an investment and portfolio management perspective, the spread of COVID-19 and its impact on global financial markets can be concerning. The Bank of England has taken emergency action by reducing interest rates and the UK property market is seeing a slowdown with a potential for further market disruption.

Depressed markets, however, present certain restructuring opportunities for trustees and reduced interest rates may require certain actions to be taken. For those inclined to seize the moment, long-term tax savings could be the upside of market turmoil created by COVID-19.

Restructuring opportunities

While market values remain relatively low, this could be an opportune time for trustees to consider restructuring or breaking trusts and distributing assets to beneficiaries.

Non-UK resident trustees are not subject to UK Capital Gains Tax (CGT), except in respect of gains realised on UK real estate or on the disposal of an interest in a ‘property rich’ company. However, capital gains arising to trustees are ‘stockpiled’ to form a capital gains pool which is available to be ‘matched’ to capital payments made to UK resident beneficiaries. A distribution of an asset to beneficiaries is a disposal for CGT purposes and gains arising from that are also added to the trust pool creating a tax liability for the recipient UK resident beneficiary. Such tax consequences often prevent trustees from reorganising their investments or making capital distributions to beneficiaries to enable them to wind-up the structure.

The fall in markets due to the COVID-19 pandemic has seen the value of assets such as share portfolios decline thereby triggering less CGT. It is therefore a good time to think about transferring these assets to beneficiaries. With the future market recovery, the share portfolio then owned by the beneficiary should increase to their benefit.

The fall in markets due to the COVID-19 pandemic has seen the value of assets such as share portfolios decline thereby triggering less CGT.

Non-UK reporting funds

When the new rules on ‘protected status’ were announced, the UK Government and HM Revenue & Customs (HMRC) indicated that they would provide blanket protection for all non-UK income and gains within protected settlements. However, a technical defect was identified in the legislation which potentially exposed offshore income gains (OIGs) – i.e. capital gains realised on disposals of non-reporting offshore funds – to immediate UK tax on the settlor, regardless of whether the trust holds protected status.

In addition to that, and even though OIGs are calculated according to CGT rules, the gains are not taxed at CGT rates but instead at income tax rates up to 45% in the hands of beneficiaries if trust distributions are matched to OIGs.

This can make non-UK reporting funds held by offshore trustees of settlor and non-settlor interested trusts with UK resident beneficiaries potentially inefficient for UK tax purposes. For this reason, investments into non-reporting funds are usually not recommended and funds with a reporting status are preferred.

Trustees should consider reviewing their investment portfolios to sell non-UK reporting funds and invest in more tax efficient assets before the market has had a chance to fully recover. With this in mind, it is advisable that the trustees update their trust pools given that OIGs create a separate pool of gains subject to special matching rules.

De-enveloping UK residential properties

Due to various changes to taxation of UK residential properties held by offshore structures – such as the introduction of the Annual Tax on Enveloped Dwellings (ATED) and more recently Inheritance Tax (IHT) charges – offshore structures holding UK residential properties have become less attractive.

In many cases, personal ownership of the property directly by beneficiaries is more efficient than holding the property in an offshore structure. However, CGT costs to extract the property would previously have meant such action was unattractive, but with the UK property market slowing down the de-enveloping may now be something to consider for trustees and company administrators.

The extraction of the property out of a trust would be subject to IHT exit charges, which should also benefit from lower values.

Offshore trust tainting

Offshore trustees will be probably well aware of the importance of settlor interested trusts to retain trust protections where the settlor is deemed UK domiciled. Common pitfalls are where there are non-commercial loans made to, and by, trustees. Even if a loan is made on commercial terms, tainting can still happen on the occurrence of a ‘relevant event’. Such an event occurs whenever there is any variation of the loan which results in it no longer being commercial.

With the new official rate of interest reduced from 2.5% to 2.25% from 6 April 2020, the trustees should review their loan arrangements with settlors as soon as possible to avoid any inadvertent tainting.

Common pitfalls are where there are non-commercial loans made to, and by, trustees.

Would you like to know more?

If you have any questions about the above, or would like to discuss your specific situation, please get in touch with your usual Blick Rothenberg contact or one of the partners to the right.