In the Spring Budget on 6 March 2024, the Conservative government announced plans to change the way that non-UK domiciled individuals (“non-doms“) would be taxed. The new Labour government has confirmed that it will adopt many of the proposals set out in that Spring Budget, but with some restrictions on the transitional reliefs offered. For further information on the proposed new rules, please see our non-dom hub on the Wedlake Bell website.
Draft legislation is awaited and, in the case of inheritance tax (“IHT“), the government has been carrying out “further external engagement”. Further clarification is expected in the Autumn Budget on 30 October 2024, but clients should not wait before reviewing existing trusts.
How will the changes affect existing trusts?
We focus on trusts settled by UK tax resident non-doms currently classified as:
- “excluded property trusts” for IHT purposes; and
- “protected settlements” for income tax (“IT“) and capital gains tax (“CGT“) purposes.
Excluded property trusts
From 6 April 2025, exposure to IHT will be based on an individual’s residence status rather than their domicile. After ten years of UK residence, an individual will be subject to IHT on a worldwide basis. They will also remain exposed to IHT for ten years after ceasing to be UK resident (“the 10-year IHT tail“).
Whereas previously it was possible for non-doms to settle assets into trust before they became UK domiciled or deemed domiciled (“UK dom“) with the effect that such assets would be removed from their personal estates for IHT purposes (even after they became UK dom); from 6 April 2025, the IHT status of such trusts will depend on the residence status of the settlor at the relevant time. If the settlor has been UK resident for ten years or more, or is within the 10-year IHT tail, any excluded property trusts they have established will potentially be brought within the scope of IHT: the settled property will be treated as part of the settlor’s IHT estate where the trust is “settlor-interested”, and the IHT relevant property regime will apply at trust level resulting in ten-yearly anniversary charges and exit charges.
This is subject to any transitional relief that the government may introduce, given the recognition in their policy summary note (published on 29 July 2024) that trust structures will have been created to take account of tax rules applicable at the time, and thought needs to be given to how such structures may be brought into any new regime.
Protected settlements
Currently, UK resident non-doms can avail themselves of the “remittance basis” of taxation. This means that they are not subject to IT and/or CGT on their foreign income and gains (“FIG“), providing those FIG are not brought into or otherwise remitted to the UK. The remittance basis will be abolished from 6 April 2025. Instead, a “4-year FIG regime” will be introduced whereby individuals will not be exposed to UK tax on their FIG (whether or not remitted to the UK) for their first four years of UK residence, providing they have been non-UK resident for at least ten consecutive tax years prior to becoming UK resident.
Under current rules, trusts that are:
- non-UK resident;
- settled by non-doms prior to becoming deemed UK domiciled, where the settlor retains their foreign domicile under common law; and
- not “tainted” after the settlor has become deemed UK domiciled,
qualify as “protected settlements” and the settlor is not subject to IT and/or CGT on FIG arising within the settlement (except for offshore income gains), including after they become deemed UK domiciled. FIG arising in such structures are only taxed in the UK when a benefit or capital payment is received by a beneficiary (including a settlor-beneficiary).
From 6 April 2025, the protected settlement rules will be abolished: UK resident settlors of settlor-interested trusts will be taxed on an arising basis in relation to trust income and gains if they do not qualify for the 4-year FIG regime.
A temporary repatriation facility will be introduced whereby non-doms can, after 6 April 2025, remit to the UK previously unremitted FIG at a reduced rate of tax. The government has not yet confirmed the rate of tax, nor for how long the facility will be available. The government is also considering how FIG arising in trusts will be treated under the facility.
What do settlors need to think about?
There is no “one size fits all” solution but UK resident settlors may wish to consider the following points.
- Taking a distribution before 6 April 2025 if they are able to claim the remittance basis.
- Rebasing opportunities before 6 April 2025 or even 30 October 2024, depending on what view one takes regarding the possibility of increased rates of CGT coming into effect from the date of the Autumn Budget.
- The overarching purpose of the trust. Trusts can provide significant asset protection benefits which may outweigh the tax exposure.
- Whether the settlor intends to remain UK resident on a long-term basis. If the settlor is intending to leave the UK, paying UK tax for a set number of years may be acceptable in the context of the wider benefits the trust provides. The “portability” of the structure, in terms of its treatment in the jurisdiction to which the non-dom intends to move, should also be considered.
- The availability of the motive defences. At a very high level, there are motive defences available for both IT and CGT which may prevent the settlor being taxed on certain income and gains realised in trust or corporate structures on an arising basis under anti-avoidance provisions. The motive defences look at the reason why the structure was put into place (i.e. was there a UK tax avoidance motive). The government has announced its intention to carry out a review of relevant anti-avoidance provisions, with the outcome expected in the 2026/27 tax year. This leaves significant uncertainty about how these provisions (and the motive defences) may apply going forward.
- Excluding the settlor from benefit. For a trust (or a sub-fund) to be settlor-excluded for IT purposes, the settlor and their spouse/civil partner would need to be excluded from benefit. However, for a trust to be settlor-excluded for CGT purposes, the settlor, their spouse/civil partner, children and grandchildren would need to be excluded from benefit. Given that many trusts are created to pass wealth to future generations, this is unlikely to be practical in most cases.
- Varying underlying investments. If a settlor is willing to be excluded from benefit along with their spouse/civil partner, underlying investments could be varied to focus on income production.
- Investing in deferral products. Trusts could hold investments allowing for tax deferral (e.g. offshore bonds) for a specified period, perhaps until after the settlor becomes non-UK resident.
- Consideration of double tax treaties. Where a settlor is being taxed in another jurisdiction on trust income and/or gains, consideration should be given to any relevant double tax treaty relief.
Given the complex and bespoke nature of the analysis that will be required for each client, advice should be taken as soon as possible. Wedlake Bell’s Private Client Offshore team would be pleased to advise affected clients on the impact of the proposals in their particular circumstances, and on the options available to them.