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The non-dom tax reforms: non-resident trusts and entities

On 5 December 2016, the Government published various fragments of the Finance Bill 2017, plus a response to the August 2016 consultation concerning the taxation of non-UK domiciliaries. These documents mean that we now have greater clarity about how the taxation of non-resident trusts and entities will change on 6 April 2017.

The changes will go further than was immediately apparent when the non-dom tax reforms were first announced, and will amount to a major overhaul of the tax rules that apply to offshore structures.

Speed read

In the consultation paper that was issued in August 2016, the Government threatened to resile, in part, from previous statements made by it regarding the tax treatment of non-resident trusts created by foreign domiciliaries, where under the new regime the settlor has become deemed domiciled for all tax purposes. This issue has been the subject of much behind-the-scenes lobbying since August. The Government has now confirmed that it will not, after all, water down or cut back the “protections” for such trusts.

However, it is now clear that these “protections” will form part of a package of tax reforms regarding non-resident trusts, which will have a wider impact than was initially understood, and will also affect trusts that do not have deemed domiciled settlors. There will be new rules: 

  • on the circumstances in which gains of a non-resident trust can be taxed on a UK resident but foreign domiciled settlor;
  • on the circumstances in which such gains can be “washed out” of the trust, where distributions are made to nonresident beneficiaries or to UK resident beneficiaries who are using the remittance basis;
  • preventing, in certain circumstances, tax advantages from being obtained by a distribution being made to one beneficiary who then makes an onward gift of the distributed sum to another; and
  • on how various forms of “benefit in kind” from a non-resident trust should be valued, for the purposes of determining the amount of income tax or capital gains tax (CGT) that should be charged on the benefit.

These changes, if enacted, will affect the treatment of trusts with UK resident settlors/beneficiaries who are foreign domiciled but not deemed domiciled; and to some extent will even affect the tax position of beneficiaries who are both UK resident and UK domiciled.

Overall this package of reforms seems reasonable, as a matter of policy. The main concerns at this stage are the amount of legislative drafting work which, it appears, still needs to be done over the next three months, if the reforms are to be implemented on time; and the very real risk of drafting errors being made and, due to the lack of time for checking and consultation, finding their way into the finished legislation.


In previous briefings, we have discussed the Government’s tough stance on individuals who, under the new regime, will be deemed domiciled on the basis of tax residence in the UK, a UK domicile of origin and a birthplace within the UK (what the Government terms “formerly domiciled residents”). There has been no change of policy on the tax treatment from 6 April 2017 of non-resident entities established by such individuals. Existing anti-avoidance legislation will apply to these entities with full force, as if the individual in question were, in fact, a UK domiciliary. Such entities are not considered further in this note.

The focus of this briefing is the treatment under the forthcoming regime of non-resident trusts and other nonresident entities established by non-doms who, in 2017/18 or a later tax year, will be UK resident and deemed domiciled for all tax purposes under the now-familiar “15 out of 20 years” test. Generally, this is expected to be rather benign, by virtue of what the Government calls “protections” for trusts established and funded before the onset of deemed domicile. These “protections” are a cornerstone of the non-dom tax reforms but, as explained below, there has been some worrying governmental vacillation about the circumstances in which they will or will not apply.

The protections racket

The “protections” will mean that qualifying trusts will be subject to a tax regime which is different from, and considerably more favourable than, the regime that applies to non-resident trusts created by UK resident and domiciled individuals. As discussed below, existing anti-avoidance provisions which mean that non-resident trusts and underlying companies are typically transparent for income tax purposes, vis-à-vis their settlors, will to a large extent be switched off where the settlor has become deemed domiciled under the “15 out of 20 years” rule, provided that the conditions for protection are met.

Taking advantage of the regime for “protected” trusts, and meeting the conditions attached to these “protections”, will be crucial in ensuring that arrangements that were created in reliance on the existing rules are not pitched on 6 April 2017 into a tax regime which is much harsher than expected; and also in securing that despite the introduction of the new deemed domicile rules, the UK remains an attractive place for foreign domiciliaries to be resident, including for longer-term residents who may not yet be ready to leave.

The latest papers from the Government have assuaged some serious concerns about the conditions attaching to these “protections”. To understand these concerns, a brief history lesson may be in order.

The saga so far

We must briefly cast our minds back to the July 2015 Summer Budget for the origins of these reforms. At that time, it came as something of a surprise when the Government announced its intention to modify the taxation of non-UK domiciliaries (or as the Government persists in calling them, “non-domiciles”; not content with amending the tax code, the Government is also intent on amending the English language).

This announcement was followed by an initial period of consultation, with the first consultation document being published on 30 September 2015.

The coverage of trusts in that document was brief, to say the least. However, a clear statement was made that income and gains of a trust created by a foreign domiciliary before becoming deemed domiciled under the “15 out of 20 years” test would not be taxed on the settlor, unless he/she had added property to the trust after the onset of deemed

The original intention was for draft legislation to be available at the time of the March 2016 Budget, which would have given affected individuals slightly more than a year to plan for the introduction of the new regime, with certainty as to what the forthcoming rules would say. However, for a variety of reasons, including a certain referendum, this was not to be. Following a number of delays, a further consultation document was published on 19 August 2016.

The proposals in the August 2016 consultation document were far more developed than those which had previously been discussed – and significantly more onerous in terms of the conditions which would need to be met, to avoid arising basis taxation of trust gains, where the settlor has become deemed domiciled after the creation of the trust.

The Government repeated that the protection from arising basis taxation would be lost if assets were added after the onset of deemed domicile, but also stipulated that protection from taxation of trust gains on an arising basis would be lost if there was a benefit to the settlor or a close family member. In either case the loss of protection would cause the trust to become transparent, vis-à-vis its deemed domiciled settlor, for CGT purposes – on a permanent basis.

This caused consternation, as the statement was obviously inconsistent with what had been said before, and the proposed approach would have meant that to keep non-resident trusts tax efficient, it would be necessary to avoid benefits to the individuals who were most likely to be their principal beneficiaries.

However, quite shortly after the publication of the consultation document, rumours began to circulate that the Government might be prepared to change its mind about this aspect of the reforms…

The Government has now published its response to the second consultation, along with draft legislation for certain parts of the Finance Bill 2017. The current position can be summarised as follows:

Inheritance tax (IHT)

Where IHT is concerned, the proposals in relation to trusts have remained stable throughout this process.

Essentially, trusts holding non-UK assets which have been established and funded by non-UK domiciliaries at a time when they were not yet deemed domiciled will continue to be protected from IHT, on the basis that the assets enjoy “excluded property” status. Such trusts will not generally be subject to IHT charges at ten-yearly intervals or on the death of the settlor, as can be the case with trusts established by UK domiciliaries. In other words, there will generally be no changes to the IHT regime for such trusts.

This protection from IHT will be conditional on the settlor not having been domiciled for IHT purposes when the trust was established and funded, under either the current IHT deemed domicile rules or the new “15 out of 20 years” rule. As discussed below, it appears that an individual who is already deemed domiciled for IHT purposes under the current “17 out of 20 years” rule is still able to create a trust now which should qualify, from 6 April 2017, for protection from arising basis taxation with respect to its income and gains; but the trust’s assets will not be “excluded property”, so will not be exempted from IHT.

The one important exception to the IHT protection described above is for trusts which have non-UK assets that derive their value from, or are otherwise connected with, UK residential property. Such assets may be deemed, in effect, to be UK-situated, bringing them within the scope of IHT. For example, shares in or receivables due from non-UK companies that own UK residential property will be deemed to be UK-situated, and the same may also apply to investments of a trust that have been made available to a bank as security for a loan used to acquire UK residential property. From 6 April 2017, trusts with such assets will be exposed to IHT charges at ten-yearly intervals and, potentially, on the death of the settlor.

Income tax

We have yet to see the draft legislation dealing with the taxation of non-resident trusts for income tax purposes. The Government has stated that the draft income tax provisions will be published no later than the date for publication of the Finance Bill 2017. 

This may mean that this part of the legislation may not see the light of day until a couple of weeks before it comes into force, which would be very concerning indeed. However, it is rumoured that, in fact, the required draft income tax legislation will be published either later this month or in January.

Protection from arising basis taxation on foreign income

Our understanding is that the legislation will provide for the settlor/transferor charges under the “transfer of assets abroad” rules and the income tax rules on settlements to be dis-applied in respect of non-resident trusts, and also non-resident companies held by trusts, where the trust was created before its settlor became deemed domiciled under the “15 out of 20 years” rule, and where the settlor is now deemed domiciled under that rule.

In plain English, this means that a UK resident settlor who has become deemed domiciled under the “15 out of 20 years” rule, but who created and funded the trust before he/she was deemed domiciled, will not be taxable on the trust’s foreign income on an arising basis. Where foreign income is concerned, there will be no “tax transparency”.

However, a transparency rule will typically apply to any UK source income of the structure, which will be imputed to the settlor and will be taxed on him/her accordingly. This reflects the status quo.

The conditions for protection from arising basis taxation on foreign income of the trust will look at whether the settlor was deemed domiciled for all tax purposes under the “15 out of 20 years” test when the trust was created. A deemed domicile in the UK for IHT purposes, e.g. under the current “17 out of 20 years” test, will not count. There may therefore be an advantage to the creation of a trust, before 6 April 2017, by a long-term resident foreign domiciliary who is already deemed domiciled for IHT purposes. To avoid an IHT “entry” charge it may be necessary for the individual to sell assets to the trust instead of giving them.

The protection from arising basis taxation of trust income will depend on no assets being added to the trust after the settlor’s acquisition of deemed domiciled status. The protected status will be lost permanently if property or income is provided to the trust after that date (probably subject to certain exceptions). However, payments to the settlor or close family members will not trigger a loss of protection. 

Taxation of benefits received by settlor or family members 

Instead of a UK resident but foreign-domiciled settlor being taxed on the structure’s foreign income as it arises, he/she will be taxed on any benefits received by him/her or close family members, where those benefits are not already subject to income tax in the hands of the recipient. This seems to mean that the settlor will be taxed if the recipient is a close family member who is non-UK resident, or a remittance basis user and the benefit is received outside the UK; whereas if the recipient is a UK resident arising basis taxpayer, the recipient – rather than the settlor – will be taxed.

Although the response to the consultation document does not say this, we think it is safe to assume that a settlor tax charge can only arise on this basis if, and to the extent that, there is foreign income that has accrued within the trust structure and which is available to be “matched” to the benefits received.

The response to the consultation document indicates that this rule will apply to all UK resident but foreign domiciled settlors – not merely those who are deemed domiciled under the “15 out of 20 years” rule. Where the settlor is a remittance basis user, and the benefit received by him/her or the close family member has not been remitted to the UK, there will be no immediate tax charge on the benefit (although a tax charge will arise if the benefit is later remitted).

However, where the settlor is deemed domiciled under the “15 out of 20 years” rule, the remittance basis will of course not apply, so if he/she is UK resident there will be an immediate tax charge on the benefit, even if it is received outside the UK. That will seemingly be the case even if the close family member who has received the benefit is non-UK resident.

Income of non-resident companies outside trusts

The protection from an immediate liability under the “transfer of assets abroad” rules will not apply to income received by a non-resident company which is personally owned by a deemed domiciliary (as distinct from being owned by a trust settled by such an individual before the onset of deemed domicile). Such a company will, typically, be “tax transparent” in relation to the deemed domiciled shareholder.

Capital gains tax

We already have draft legislation for the CGT changes.

Protection from arising basis taxation on gains

Amendments will be made to the existing legislation to ensure that non-resident trusts created by UK-resident foreign domiciled settlors who have subsequently become deemed domiciled under the “15 out of 20 years” test will not, generally, be “tax transparent” for CGT purposes.

This protection will be subject to essentially the same conditions as will apply for the purposes of income tax. It will be conditional on no assets having been added to the trust after the settlor’s acquisition of deemed domiciled status. The protected status of the trust will be lost permanently if “property or income” is provided to the trust after that date (subject to certain exceptions). However, payments to the settlor or close family members will not trigger a loss of protection.

Under the draft legislation, the exceptions that will allow “property or income” to be provided to the trust without a forfeiture of protection include one for payments or transfers made to allow tax costs or administration expenses to be met, where such expenses exceed the trust’s income for the relevant year. This is a sensible measure, bearing in mind the large number of “dry” trusts which are in existence.

There is a lack of clarity, at present, about the position if the settlor has funded the trust by loan, and such loan is repayable on demand. This situation may be reasonably common. If the settlor becomes deemed domiciled and omits to call for repayment of the loan or to charge interest on the loan, could that be considered an addition of “property” to the trust? It seems very doubtful that it should be, but HMRC’s views on this point are not known.

Taxation of benefits received by settlor or family members

If a distribution is received by the settlor or a close family member (defined broadly as the settlor’s spouse or civil partner and any children or step-children who are under the age of 18) on or after 6 April 2017, the distribution will be attributed to the UK resident settlor if the recipient of the distribution is either non-UK resident or a remittance basis user and does not remit the distribution to the UK in the year of receipt.

The settlor will be taxed to the extent that the distribution is matched with trust gains, according to his or her status in the relevant year. This means that if the settlor is a remittance basis user and the distribution is not remitted to the UK, there will be no immediate tax exposure; if, on the other hand, the settlor is deemed domiciled or elects not to use the remittance basis for the relevant tax year, then tax will be payable by him or her on an arising basis. The settlor will be entitled to recover the tax paid either from the beneficiary who received the distribution, or from the trustee of the trust. Oddly, the relevant clause appears to give the settlor the choice as to which of these parties he/she will pursue for reimbursement.

Anti-“washing out” provisions

The existing CGT legislation generally allows capital gains to be “washed out” of non-resident trusts, without tax, through the making of distributions to non-resident individuals, or non-UK distributions to remittance basis users, so that the gains in question cease to be available to be “matched” to other beneficiaries.

The Government perceives a need to tighten up the rules on this, to prevent what it sees as opportunities for avoidance. With effect from 6 April 2017, a distribution to a non-resident individual will not generally be matched against the pool of gains.

This new rule will apply to payments made to non-UK residents after 6 April 2017, and also payments made before that date which remain unmatched (i.e. payments made before 6 April 2017 where there were insufficient trust gains available for matching). The effect will be that the pool of trust gains will not be reduced by the payment to the non-UK resident beneficiary; instead, gains will remain available for matching with payments to UK resident beneficiaries or non-UK resident close family members of UK resident settlors (see above).

These anti-“washing out” provisions will from 6 April 2017 apply to all non-resident trusts, regardless of the domicile status of the settlor (i.e. regardless of whether he or she is UK domiciled, deemed domiciled or non-UK domiciled).

There are particular rules which will apply to payments to beneficiaries who are only temporarily non-resident or are “migrating” beneficiaries; and to payments made in a year when a trust is being brought to an end (where payments are being made to both UK resident and non-UK resident beneficiaries).

Where a beneficiary is within the scope of the temporary non-residence provisions (i.e. he/she is a non-UK resident for fewer than six tax years) a payment to such an individual will be treated as having been received by the beneficiary in the year of his/her return to the UK – so that the payment will be available for matching with available gains in the year of return or in subsequent years.

Where a UK resident beneficiary receives a payment and then subsequently becomes non-UK resident before the payment is matched with trust gains (this is what the Government means by a “migrating” beneficiary), the payment will not subsequently be matched. In other words, there is no “washing out” in these circumstances.

Finally, there is specific provision for cases where a trust is brought to an end, and payments are made to both UK-resident and non-UK resident beneficiaries. In this case, the gains will be attributed to the beneficiaries proportionally according to the amounts they receive, regardless of their residence status (as would be the case under the current rules). This is a welcome feature of the proposed new regime, which may in some situations encourage trusts to be wound up in a single tax year rather than being progressively run down over longer periods.

Measures relevant to both income tax and CGT

Lastly, the Government is proposing the inclusion of measures in the Finance Act 2017 which, it appears, will apply for the purposes of both income tax and CGT, and which will have effect in relation to all non-resident trusts – not merely those with settlors who have become deemed domiciled for all tax purposes.

Anti-“recycling” provisions

Under existing law it is possible, at least in principle, for a non-resident trust to make a distribution to a beneficiary who is not taxable on it (either because he/she is non-UK resident, or because he/she is a remittance basis user and the distribution has not been brought into the UK) and for that beneficiary to give the sum that he/she has received to another individual (who would have been taxed on the sum, had he/she received it directly from the trust).

The Government believes that, in the absence of anti-avoidance measures, this kind of planning could become more prevalent from 6 April 2017. The perception is that it could be used to circumvent settlor tax charges, with distributions being made to individuals other than close family members, who may be non-resident, subject to an “understanding” that the sums in question will in due course be given to the deemed domiciled settlor. This perception is probably right.

The Government will therefore introduce measures that will have effect for both income tax and CGT, which will restrict such planning. A draft clause has been included in the Finance Bill 2017 clauses dealing with CGT. The basic thrust of the draft clause is that if a distribution is made to a beneficiary who is non-resident or a remittance basis user, and there is a gift by that beneficiary to a UK resident individual (who need not be the settlor, or indeed a beneficiary of the trust), the gift may be treated as a distribution from the trust received by its recipient and taxed accordingly.

Generally, such deeming will only apply if the gift occurs within three years of the distribution, but there will be no time limit if the distribution is made pursuant to “arrangements” under which it is intended that all or some of the distribution will be passed on to the donee. The drafting of the clause is complex and it is not clear that it entirely addresses the potential for double taxation where a distribution has been made to a remittance basis user, or to a nonresident who subsequently becomes resident in the UK.

Valuation of “benefits in kind”

A proposed change that is likely to have wider application concerns the value of certain "benefits in kind" from trusts.

Under current law, for income tax and CGT purposes the issue of whether the provision of a loan by a trust or the making available of a chattel to a beneficiary is a taxable benefit and if so, what the value of that benefit is, depends on what interest or "rent" would be paid under an arm's length arrangement between unrelated parties.

This is not always easy to determine, and expert evidence may be required. This requirement can be inconvenient for both HMRC and taxpayers. Obtaining agreement on the market value of benefits can, in fact, be all but impossible, as certain kinds of arrangements which are quite common in a trust context, such as a loan under which interest may be rolled-up indefinitely instead of being paid, or a "lease" of high-value artworks, are otherwise extremely rare and there are no real arm's length comparables. It is proposed therefore that statutory valuation rules be introduced so that:

  • The value of an interest-free loan will be deemed to be the interest payable on that loan at the official rate (currently 3%).
  • The value of an interest-bearing loan under which interest is rolled-up, instead of being paid, will likewise be the interest payable on the loan at the official rate. No account will be taken of the accrual of additional indebtedness to the lender. This principle already applies to loans from companies to their employees and directors.
  • The value of enjoyment of artworks or other chattels will be deemed to be a multiple of the official rate and the acquisition cost of the chattels. This is likely to increase, quite dramatically, the tax cost for beneficiaries of having "rent-free loans" of high-value artworks from trusts.

The implications of these changes will be far-reaching. It is likely that most, if not all, trust structures that have a connection with the UK will need to be reviewed in light of these reforms, and many will be affected one way or another.

As will be obvious from the foregoing, that there remain significant gaps in the detail of how the new rules will operate. We will continue to monitor the position and update or provide new briefings as necessary. However, it would not be wise for affected individuals to wait until the form of the new regime is completely settled before taking action, particularly as the implementation of any significant plan of action will take time, which is in short supply before the new rules come into effect. If you believe you are or will be affected by the Government’s proposals, we strongly recommend that you contact the authors of this briefing or your usual Charles Russell Speechlys contact.

These articles were written by our International Private Client lawyers. For more information please get in touch with Dominic Lawrance on +44 (0)20 7427 6749 or via Dominic.Lawrance@crsblaw.com.

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