Are offshore trusts still efficient for UK tax purposes?
The Autumn Budget on 30 October 2024 included confirmation of the most significant changes to the taxation of offshore trusts in decades. In some instances, these changes will mean that offshore trusts will become ineffective for UK tax purposes. However, the offshore trust still provides other non-tax benefits and, below, we discuss both the good and the bad in more detail.
What are the income tax and capital gains tax changes?
The headline change is that the “protected settlement” regime will cease to apply from 6 April 2025. This is the regime whereby offshore trusts created by non-UK domiciled individuals are afforded protection from the foreign income and gains (“FIG“) arising in the structure being taxed on that settlor in a “look-through” manner, including after the settlor has become deemed domiciled in the UK, even if they can benefit from the trust. We refer to the accumulated FIG in the structure as the trust’s “Income and Gains Pools“.
As a result of this change, from 6 April 2025, offshore trusts will become more vulnerable to the complex, and often punitive, UK anti-avoidance legislation as it becomes more difficult for a UK resident settlor to avoid taxation on the trust’s FIG by attribution, on an arising basis.
From 6 April 2025, there will only be three ways for a UK resident settlor to avoid such look-through taxation: (i) the settlor of the trust being able to benefit from the new “four-year FIG regime” being introduced from 6 April 2025; (ii) structuring the trust such that it is not settlor-interested; and/or (iii) successfully securing the application of the “motive defences” in relation to income tax and capital gains tax under the UK’s anti-avoidance legislation.
The “four-year FIG regime” will, from 6 April 2025, allow UK residents, who have been non-UK resident for at least ten consecutive UK tax years preceding their arrival in the UK, to benefit from a four-year period during which their designated FIG are exempt from UK income tax and capital gains tax. For those who are already resident in the UK on 6 April 2025, but have been UK resident for less than four UK tax years, they can access the four-year FIG regime for the remainder of their four year period.
UK resident settlors who are eligible for the four-year FIG regime will be able to mitigate the look-through taxation of most categories of FIG arising in offshore trust (and corporate) structures created by them. However, there are detailed rules on how distributions are treated for UK tax purposes and advice should be taken on how they are matched to available Income and Gains Pools. It is important to note that Income and Gains Pools are not reduced by capital payments or benefits received by the settlor (or any other eligible beneficiary) in the four-year FIG period and will remain available for matching to capital payments and benefits received by the settlor-beneficiary once the four-year period has expired (or by any other UK resident beneficiary who is not eligible under the four-year FIG regime).
To avoid the trust being settlor-interested for:
- income tax purposes, both the settlor and their spouse or civil partner should be excluded from benefit. There are additional anti-avoidance rules which treat the income in the trust as that of the settlor if it is paid to, or applied for the benefit of, a minor child of the settlor; so for tax efficiency the application of these rules would need to be managed where possible, albeit this will often present a conflict with the purpose of the trust to provide for family members; and
- capital gains tax purposes, in addition to the above individuals, the list of excluded persons would need to extend to any child of the settlor or the settlor’s spouse (minor or adult), all grandchildren, and the spouses or civil partners of any such children or grandchildren.
The “motive defence”, under which the settlor will not be liable on a look-through basis to income tax (under the anti-avoidance legislation known as the transfer of assets abroad code), applies if it can be shown that avoiding liability to tax was not one of the purposes for a relevant transfer into the trust or any associated operations (defined widely). While complex to secure, it can be an option for settlors in appropriate circumstances. A similar defence applies for capital gains tax purposes, provided neither the acquisition and holding, nor the disposal, of the relevant assets had a purpose of avoiding capital gains tax or corporation tax (i.e. it is a much narrower test). It should be noted, however, that these defences only apply to certain types of FIG in the structure and advice should be taken on their potential application, in particular to understand what they will not cover.
UK resident non-settlor beneficiaries who are eligible, and make a claim under, the four-year FIG regime in respect of FIG matched to capital payments or other benefits received by them from an offshore trust, will not be taxed in respect of those FIG for the duration of the four-year period. As above, however, the Income and Gains Pools will not be reduced by such capital payments or benefits received by the eligible beneficiary.
What are the UK inheritance tax (“IHT”) changes?
Under current law, where a trust has been settled by a non-UK domiciled (and non-UK deemed domiciled) (“non-dom“) individual, it is classified as an “excluded property” trust for IHT in so far as it holds non-UK situated assets (excluding indirect interests in UK residential property or “relevant loans” in connection with such). Accordingly, the trust (and the settlor in respect of such trust) will have no exposure to IHT in relation to the trust assets. This excluded property status is maintained even if the settlor later becomes UK domiciled or deemed domiciled, provided there are no additions to the trust fund after such a change of domicile to UK.
From 6 April 2025, the concept of domicile for tax purposes will be abolished and liability to IHT will be determined by residence, with worldwide assets becoming subject to IHT where the individual qualifies as a long-term resident in the UK (“LTR“): on the basis that they have been resident in the UK for at least ten UK tax years out of the previous twenty tax years, and for a further IHT “tail period” (three to ten years, depending on the duration of prior UK residence) after they cease to be UK resident. For further details on these IHT changes, please see “Non-dom reforms: the inheritance tax need-to-knows“.
Exposure to IHT for a trust and its settlor will be determined by the settlor’s LTR status. The result is as follows.
1. Excluded property trusts settled before 30 October 2024
- Liability to IHT will arise on the value of the trust assets (UK or non-UK situated) once the settlor becomes an LTR. This means that most types of lifetime trusts will become subject to the IHT relevant property regime, which involves ten-yearly anniversary charges (at a rate of up to 6%) and exit charges when assets leave the trust (based on a pro-rated 6% charge). This includes an IHT exit charge when the settlor ceases to be an LTR and the trust assets leave the relevant property regime; and
- By concession, for trusts in existence and fully funded as at 30 October 2024, the value of the trust assets will be exempt from the IHT “gift with reservation of benefit” (“GWR“) rules, which seek to reintegrate the entire trust fund into the settlor’s estate on death, if the settlor has retained a benefit in the trust (such as by being named a beneficiary or not being expressly excluded from benefit). The GWR rules can otherwise result in double IHT charges: both at trust level (at a maximum rate of 6% every ten years) and on the settlor’s death in their estate (at a maximum rate of 40%).
2. Excluded property trusts settled on or after 30 October 2024
- Liability to IHT on the value of the trust assets (UK or non-UK situated) will arise once the settlor becomes an LTR, with the same IHT consequences as explained above; and
- The value of the trust assets will not be exempt from the GWR rules and, if the settlor can benefit from the trust, the trust fund will be treated as part of their estate for IHT purposes on death (in addition to any IHT “relevant property” charges that may apply at trust level). For this IHT liability on the settlor’s death to be avoided, the settlor will need to be excluded from benefitting from the trust.
3. Qualifying interest in possession (“QIIP“) trusts
It is not only the settlor’s LTR status that can bring the trust into the IHT net; it will also be the LTR status of the individual with the QIIP (i.e. the life tenant) that is relevant. (“QIIP” trusts include trusts set up before 22 March 2026 under which a beneficiary has an interest in possession, and trusts created on death under which a beneficiary has an interest in possession that arises immediately.) The above will be the case for pre-30 October 2024 trusts where a QIIP ends, and also for QIIP settlements made on or after 30 October 2024. By concession, QIIP trusts that contained excluded property for IHT purposes immediately before 30 October 2024 will not be subject to charge when the QIIP comes to an end or on the death of the QIIP beneficiary.
4. Civil law usufructs
Usufructs will usually be treated as settlements for IHT purposes, typically an interest in possession trust.
Temporary Repatriation Facility (“TRF”)
As part of the non-dom reforms, the government will introduce transitional rules. For UK resident non-doms to whom the remittance basis of taxation applied for any UK tax year prior to 6 April 2025, one of these transitional measures is the TRF. The TRF will be available for three UK tax years (2025-26 to 2027-28 inclusive) and is designed to encourage UK resident non-doms to bring unremitted FIG into the UK at a reduced rate of UK tax. The TRF is anticipated to make up a significant percentage of the revenue the government hopes to generate from the non-dom changes. The TRF is covered in more detail in “Non-dom reforms: the four year itch“.
The TRF is mainly intended to interact with offshore trusts in respect of FIG arising to UK resident beneficiaries (including settlor-beneficiaries) in receipt of capital payments or other benefits from offshore trusts during the three-year TRF availability period, where such capital payments or benefits are matched to the trust’s pre-6 April 2025 Income and Gains Pools. This could, in some circumstances, assist with the settlor’s previously unremitted FIG, where the trust fund (and therefore the capital payment or benefit) is or derives from them, and the recipient is either the settlor-beneficiary themselves, who will claim the benefit of the TRF, or another beneficiary, who is not a relevant person in relation to the settlor.
Importantly, income distributions to UK residents after 6 April 2025 will not benefit from the TRF. Therefore, it is important for such income to be distributed to them, if able to benefit from the remittance basis in 2024/25, before 6 April 2025. The funds can subsequently be designated and taxed under the TRF, to enable their use in the UK to fund the beneficiary’s lifestyle.
A designation election for a tax year must be made before the end of the period of twelve months beginning with 31 January after the end of that tax year.
I am UK resident non-dom and have already created an offshore excluded property trust: how do these changes affect me?
It is important to take professional advice before 6 April 2025 on the application of the new non-dom rules, to provide you with analysis of your options and allow you time to take such action as may be needed to mitigate any adverse UK tax consequences. If the relevant analysis shows that significant UK tax charges will apply from 6 April 2025 (either within the trust, or for you personally) that cannot sensibly be mitigated in your circumstances, you may wish to consider unwinding the trust before that date or look into potential relocation options.
The questions you will need to address include the following.
- How will I be taxed on the FIG in the trust structure from 6 April 2025?
- Will I be liable to IHT in respect of the assets within the trust structure from 6 April 2025?
- What IHT exposure will the trustees have from 6 April 2025?
- Where the four-year FIG regime does not apply – can I benefit from the TRF and action that needs to be taken before 6 April 2025 to maximise the benefit of this?
Table A below captures the overriding considerations from 6 April 2025, looking at two cases.
| Case One: | Trusts with a non-dom settlor who is currently UK resident and will not qualify for the four-year FIG regime from 6 April 2025 (because the 2024/25 tax year is at least their fourth of UK residence). |
| Case Two: | Trusts with a non-dom settlor who is currently UK resident and will qualify for the four-year FIG regime from 6 April 2025 (because the 2024/25 tax year will be their third (or less) of UK residence). |
Table A
| Tax | Case One | Case Two |
| Income tax | If the trust is settlor-interested, all income in the structure arising after 5 April 2025 will be attributed to and taxed on the settlor on the arising basis. Income arising at company level may, in some cases, be exempt from UK tax if the motive defence applies. If the settlor and their spouse/civil partner are excluded from benefit, but income is paid or applied for the benefit of the settlor’s minor children, the settlor will be taxable on that income in the same manner as above. Loans into the trust by the settlor can cause the income of a settlor-excluded trust to still be attributable to the settlor, as loan creditor. | While the UK resident settlor is eligible for, and claims under, the four-year FIG regime, they will not be taxable on much of the non-UK income in a settlor-interested offshore trust provided they designate the applicable income under the regime. The income will still be added to the trust’s Income and Gains Pools. |
| Capital gains tax | If the trust is settlor-interested for capital gains tax (which the vast majority of offshore trusts will be, even if not settlor-interested for income tax), all capital gains arising in the structure after 5 April 2025 will be attributed to the UK resident settlor and taxable on them on the arising basis. Gains realised at company level may be subject to the motive defence and/or treaty relief. | While the UK resident settlor is eligible for, and claims under, the four-year FIG regime, they will not be taxable on the foreign gains in a settlor-interested offshore trust provided they designate the gains under the regime. The gains will still be added to the trust’s Income and Gains Pools. |
| IHT | If the settlor is an LTR and the trust is discretionary or a non-QIIP trust, it will be subject to the IHT relevant property regime which includes ten-yearly anniversary charges and exit charges (when assets leave the trust or otherwise exit the regime). For trusts from which the settlor can benefit – if the trust was created and funded before 30 October 2024, the trust assets will not form part of the settlor’s personal estate for IHT purposes; if the trust was set up or property added to it after this date, the trust assets will be chargeable to IHT on the settlor’s death under the GWR rules. | While the settlor is not an LTR: the trust’s assets will be excluded property for IHT purposes in so far as they consist of non-UK situs assets (excluding indirect interests in UK residential property or “relevant loans” in connection with such); and the trust assets will not form part of the settlor’s personal estate for IHT purposes. If the settlor stays in the UK beyond the four-year FIG eligibility period, their position will be as set out for Case 1. |
I am UK resident non-dom: can I create an offshore trust before 6 April 2025?
Yes, but you should think carefully about the tax efficiency of such a trust as this is not likely to be attractive from an IHT perspective if the trust will be settlor-interested. While the 20% IHT charge on creating a trust will not apply if non-UK situs assets are transferred into the trust before 6 April 2025, if you become an LTR under the new IHT rules from 6 April 2025 or subsequently, the trust will be subject to IHT ten-yearly anniversary charges and exit charges. In addition, if you can benefit from the trust, the trust fund will form part of your personal estate for IHT purposes under the GWR rules and be chargeable to IHT at a maximum rate of 40% on your death.
In relation to the trust’s Income and Gains Pools, these will be taxable directly on you if you cannot, or do not, claim under the four-year FIG regime. This might be acceptable and, in specific situations, beneficial, so a tax analysis will need to be carried out on a case-by-case basis.
I am non-UK resident and non-UK dom, but I intend to move to the UK: can I create an offshore trust?
Yes, but you should think carefully about how the trust will be taxed in the UK, especially if you intend to stay in the UK for more than nine UK tax years, at which point there will be IHT consequences both for you personally and for the trust. Similar considerations should also be borne in mind by those wanting to create a usufruct.
I am non-UK resident, but I created an offshore trust when I lived in the UK while non-dom: what happens if I come back to the UK?
There will be many settlors of offshore excluded property trusts who have since left the UK.
In the event that the settlor returns to the UK, they will need to determine their personal UK tax status both in terms of IHT and the four-year FIG regime for income tax and capital gains tax, and the impact this has on the UK taxation of the trust.
Detailed and early advice will be key so as to analyse planning options. Where an individual has an offshore trust, some questions to ask their advisers are as follows.
- Will I be treated as a temporary non-resident only, and what does this mean for me?
- Will I be eligible for the 4-year FIG regime?
- What will the IHT exposure be for the trustees and for me personally in relation to the trust assets and what can be done to mitigate this exposure?
- What is my personal liability to income tax and capital gains tax in the UK in relation to FIG in the trust and its underlying companies, and what can be done to mitigate this exposure? This analysis should be in-depth, to include consideration of costs, availability of the motive defences and applicable double tax treaties.
- Should I retain the current offshore trust and/or set up new trusts before my arrival in the UK? This will need to be assessed in light of the individual assets involved as the benefits of a trust may vary.
- What would be the best timing to receive a significant distribution from the trust? Can I benefit from the TRF in relation to such distributions?
- Is it efficient for the trustees to realise gains before 6 April 2025 while the trust remains a protected trust, or for these (and other trust) gains to be extracted through distributions after 5 April 2025, during the TRF availability period?
Closing thoughts
By removing the protected settlement regime, the government will lay open offshore trusts to the full force of the UK’s anti-avoidance rules applicable to settlors for income tax and capital gains tax purposes. These rules are notoriously complex and punishing, but the government has published a call for evidence with the aim of reviewing any ambiguity, undue complexity and inconsistency in the application of these rules. The need to understand where your structure fits into these regimes has never been more pressing. The IHT changes are just as far reaching for excluded property trusts, and also apply to usufructs.
That said, it is important not to rush to a hasty conclusion and, instead, take advice, make projections of estimated tax liabilities under the various scenarios and consult with family members where appropriate. For some, the new rules are punitive; for others, they offer a fantastic opportunity to restructure and clean out (under the TRF) the Income and Gains Pools for the future.
The analysis in this note is based on the new non-dom rules as announced in the Autumn Budget on 30 October 2024, as detailed in the government’s technical note published on 30 October 2024 and the draft legislation published on 7 November 2024. These have given clarity about the framework of the non-dom reforms, although technical changes may be introduced between now and the implementation of the rules.