CGT and Excluded Settlors: Reimbursement Risks for Trustees Post April 2025

From 6 April 2025, more non‑UK resident trustees may face a catch‑22: reimbursing an excluded UK‑resident settlor for capital gains tax (CGT) attributed to them can look like a prohibited benefit – yet not reimbursing carries its own risks.

This article considers what trustees can do, and the UK tax consequences for both the trust and the settlor. 

Unfortunately, the settlor’s statutory right to reimbursement is not straightforward if the settlor has been formally excluded—a common response to the new rules. Trustees must take into account the provisions of the trust, the terms of the exclusion, the governing law and local practice, and the risk of beneficiary challenge if any payment is made.

Before turning to the mechanics, we recap the key changes from 6 April 2025 for “settlor‑interested” trusts, and why the impact differs for income versus gains.

Post‑5 April 2025 recap: what has changed?

From 6 April 2025, UK rules broadly attribute post‑April 2025 non‑UK income and all gains arising within an offshore trust (including gains of underlying companies) to a UK‑resident settlor where the trust is “settlor‑interested.”

Previously, the “protected settlements” regime typically deferred tax for non‑UK domiciled but UK‑resident settlors until value was matched to a distribution. Post 6 April 2025, unless the motive defences apply, a UK resident settlor can be taxed (though the rules in relation to income vs gains are different, as set out below).

It is important to note that attribution has long applied to UK‑domiciled, UK‑resident settlors with an “interest” in a settlement. What is new from April 2025 is the extension of attribution to all UK‑resident settlors if the trust is settlor‑interested. Within the legislation sits a statutory right for a UK‑resident settlor to be reimbursed by the trustees for UK tax charged on trust income or gains under the attribution rules.

Income vs gains: different “settlor‑interested” tests

The “settlor‑interested” concept is narrower for income tax and broader for CGT.

• For income tax, a settlement is generally settlor‑interested if the settlor or their spouse/ civil partner (and, in certain cases, minor children) can benefit. Broadly, a trust that excludes the settlor and their spouse or civil partner, but permits benefits to adult children, is typically not settlor‑interested for income tax.
• For CGT, the test is broader. If the settlor’s children (adult or minor) or remoter descendants can benefit, the trust is usually settlor‑interested for CGT purposes.

A practical point: a settlor must be actively and irrevocably excluded from benefit to avoid being treated as able to benefit. Merely omitting the settlor from a class of beneficiaries is not the same as a formal exclusion.

An example: an excluded settlor and CGT

Mr A created the Everest Trust, a non‑UK resident discretionary trust, before becoming UK‑resident. With effect from 6 April 2025, Mr A is fully excluded from any benefit and from any power to direct benefits to himself or to his current spouse, Mrs A (his second wife). Mr A’s adult children from his first marriage (also UK‑resident) remain potential beneficiaries. Mrs A has an adult son from a previous marriage. Mr A remains UK‑resident and has been so for more than four years. All assets are held at trust level.

Income tax

If the exclusion is effective under the governing law, the trust should no longer be “settlor‑interested” as regards Mr A for income tax. Income arising in the trust would not be assessed on Mr A under the settlements code; instead, UK‑source income is taxed within the trust (as applicable) and non‑UK income may be available to be matched to distributions to UK‑resident beneficiaries (subject to the motive defence).

CGT

Because Mr A’s children remain potential beneficiaries, the trust is still settlor‑interested for CGT. Gains arising post‑6 April 2025 are attributed to Mr A.

Investment implications

Seeing that income would not be attributed to Mr A, the trustees considered tilting the strategy toward income. However, when an opportunity arose to sell a trust asset at a large gain, the offer was too good to refuse.

Outcome

Mr A is now liable to a significant CGT bill (e.g., at 24% of the gain) and asks the trustees to reimburse him.

The trustee faces a conundrum: does reimbursing Mr A for CGT amount to benefitting an excluded person?

Is the right to reimbursement in conflict with a fiduciary duty?

There are two opposing views on this question.

It might be argued that where the settlor has been excluded from benefit, reimbursement may be characterised as a prohibited “benefit” and therefore inconsistent with the trustee’s fiduciary duties.

Alternatively, an enforceable legal obligation to reimburse the settlor would make the settlor a 'creditor' of the Trust and it would no more be a benefit to discharge this obligation than to pay other trust liabilities.

The correct interpretation will depend on the facts; including:

Trust instrument

A careful review is needed to see whether there is a power or direction in the trust documents that requires reimbursement.

Terms of the exclusion

Well‑drafted exclusions may carve out a right to reimbursement for tax or other liabilities.

Governing law and situs

In some trust jurisdictions, the UK statutory reimbursement right may be treated as an enforceable legal obligation; in others it may not be. Local law advice is essential to determine whether reimbursement is recognised as a legally enforceable debt.

Family dynamics and litigation risk

 If family tensions are high, trustees may wish to take a cautious approach and, where appropriate, seek court directions before making any payment.

If an excluded settlor is reimbursed, is that taxable?

Settlors and trustees need clarity on whether a reimbursement payment to the settlor is itself taxable as a benefit. The CGT code provides for taxation where a non‑beneficiary receives a capital payment from a non‑UK trust. However, HMRC has confirmed in a statement of practice, that reimbursement of tax is not regarded as a capital payment for CGT purposes, nor as receipt of a capital sum for income tax. The Statement of Practice refers both to the settlor’s statutory right and to a payment in reimbursement. Even where a non‑UK trust does not recognise the statutory right, a payment made to reimburse UK tax should not, on that basis alone, be treated as a taxable benefit.

What if the settlor chooses not to be reimbursed?

If the settlor decides not to ask for a reimbursement, that doesn’t solve the problem. A settlor failing to exercise a valid reimbursement right could amount to a “transfer of value” and therefore be taxed as an addition to the trust fund.

This could result in an upfront IHT charge of 25% (if paid by the settlor) or 20% if paid by the trustee. Whilst primary liability would fall to the settlor, the trustee could become co-liable if the tax is unpaid, so this issue cannot be ignored.

Motive defence to the rescue?

Where structures involve underlying non‑UK companies, attribution of gains or income to a UK settlor can be switched off if the statutory “motive defence” applies, however these complex defences apply differently in respect of both income and gains. 

In essence, if the Trust was created (and subsequent steps and transactions) were not designed for a UK tax avoidance purpose, attribution may not arise. The analysis is fact‑sensitive and should be undertaken separately for each entity. The motive defences are valuable but advice is needed on their application and reporting obligations.

The Motive Defences can also be lost if subsequent steps or re-structuring are undertaken with UK tax planning in mind, so advice on the motive defences should be sought before such steps are taken, to prevent the defences being lost.

Is an excluded settlor really excluded?

As this article suggest. the nature of the statutory right of reimbursement raises a number of questions for non-UK trustees, on which there remains some uncertainty:

• What is the correct characterisation of a right of reimbursement under the UK tax code? Is it a statutory intervention into the administration of the trust (ie does it permit the trustees to confer a benefit they might not otherwise be able to confer), or is it a statutory cause of action conferred on a settlor to recover a sum of money from a third party (who happens to be a trustee)?
• If the second characterisation is correct (which we prefer), the settlor arguably remains fully excluded, because their right of reimbursement extends only to a quantifiable tax liability that is imposed on them by statute. It is outside the terms of the trust.
• So far, perhaps so easy from the settlor’s perspective. But this raises difficult questions for the non-UK trustee:
  • If the settlor’s right is a statutory cause of action under UK law, is in enforceable against the Trustee? Trustees generally have powers to pay trust expenses and compromise claims made against them as trustees. But they need to be satisfied that it is a proper use of trust resources to make payments to third party creditors or claimants, on the basis that there is a proper claim.
  • Whether that right is enforceable under local law will be a question on which the Trustee may need advice. In particular, thought would need to be given as to whether what is essentially a right of indemnity under UK tax law is tantamount to a foreign revenue law, which common law jurisdictions tend not to enforce (absent treaties or express statutory provisions). That is to say, unless specifically authorised by the trust instrument, is the Trustee entitled to pay a foreign tax liability at all?
• Ideally, the terms of the trust instrument would address this peculiarity of the UK tax regime to avoid any doubt that reimbursement is compatible with exclusion from actual benefit, and that the Trustees are permitted to pay (indirectly) a foreign tax liability.