Trusts form an important part of tax planning in the UK and can offer a wide range of opportunities for the right person. In order to advise a client correctly regarding the setting up and maintenance of a trust, it is important to establish if the trust itself is treated as a UK resident trust or a non-UK resident trust.
As people become more internationally mobile, it is not unusual for trustees to move in or out of the UK and this can have an effect on the tax treatment of a trust. It is therefore important for professional advisers to be aware of the rules so that they can advise and identify when a trustee move may affect the tax treatment of a trust.
As part of the then Government’s trust modernisation programme, the Finance Act 2006 introduced a common residency test for both income and capital gains tax. Prior to this, the rules for income tax and capital gains tax had been developed separately and there was a lack of consistency. The modernisation programme sought to remove such inconsistencies.
Changes were implemented on 6 April 2007 and, from that date, the trustees of a settlement were collectively treated as a single entity when establishing the residency of a trust. The trustees of a UK resident trust pay UK income and capital gains taxes on the other income and gains in the trust, irrespective of where in the world they arise.
Trustees of a non-UK resident trust only pay UK income and capital gains taxes on the income and capital gains arising in the UK – the tax liability can therefore be significantly lower, or completely mitigated if they don’t hold UK assets. This is separate from gains under investment bonds which are taxed under the chargeable events legislation and a UK-based settlor could be taxed even if the trustees are non-UK resident.
Whilst the residency of a trust can be deliberately changed, it is possible for the tax residency of a trust to change inadvertently. This may be costly to rectify.
Establishing the trust’s residency
The first step is to identify the residency of a trust. The residency at any time is determined by the residence status of the trustees at that time and can be affected by the residency and domicile of the settlor.
The test to determine the residency of a trust states:
- If all the trustees are either UK resident or non-UK resident then the residency of the trust will follow the status of the trustees.
- If at any time the trustees are a mixture of UK residents and non-UK residents then the trust is resident in the UK only if any settlor was resident or domiciled in the UK at the ‘relevant time’.
The definition of the ‘relevant time’ will depend on the type of trust being considered. If this is a will trust then it is the date of the settlor’s death and if it is a trust set up during the settlor’s lifetime then it is the date when any settlement is made to the trust.
Agency, branch and permanent establishment
At the time of introducing these changes, a new provision was included. This specified that non-UK resident non-corporate trustees would be treated as being UK resident if at any time during their trusteeship they acted through a branch or agency based in the UK. Non-resident corporate trustees would be treated as UK resident if they operated through a permanent establishment based in the UK.
Either of the above may change the residence status of the trust as a whole. In practice, this problem is most common where there is a corporate trustee rather than an individual trustee.
In deciding whether management of trusts is part of the corporate trustee’s business through a permanent establishment, HMRC will look at where the core activities are physically being carried out. If these core activities are being carried out in the UK through a permanent establishment, they will generally treat the corporate trustees as being UK resident.
Th rules governing the residency of a trust make it relatively easy for the status of a trust to change between being a UK resident trust and a non-UK resident trust.
A trust that changes from UK resident to non-UK resident is deemed to be exported and, if a non-UK resident trust becomes UK resident, it is deemed to be imported.
Exporting a trust
The below case study looks at when a trust could be exported.
- James, a UK resident, settles money into a trust and appoints three trustees to manage the trust.
- At the time of the trustees’ appointment two trustees, Tom and Barbara, were non-UK resident, being family members who reside in Spain. The third trustee, Andrew, is a UK resident.
- As there is a mixture of UK resident and non-UK resident trustees, the fact that James was a UK resident when the money was settled means the whole trust is treated as being UK resident and UK income and capital gains taxes are charged on the income and gains, wherever they arise.
- A number of years later, Andrew is asked to move abroad by his employer.
- Andrew’s move means that all three trustees are non-UK resident and therefore the trust itself becomes non-UK resident.
This trust is therefore being exported and anti-avoidance legislation means that the trust is subject to capital gains tax. The assumption is that, generally, all the assets of the trust are deemed to be disposed of and then immediately reacquired at their market value. As the charge has been caused by the trustees then they will need to meet this tax from the trust assets.
This charge will be assessed in the tax year that the trust is exported and the trustees have 12 months in which to notify HMRC.
In these circumstances, this complication could have been avoided by simply having a new UK resident trustee appointed before Andrew’s change in residency.
There is a relief available where the change in the trust’s residency is caused by the death of a trustee. Using the example of Jerry’s trust, had Andrew died rather than moved abroad then the body of trustees would still have become non-UK resident. However, if a new UK resident trustee is appointed within six months of Andrew’s death then the export charge will not apply.
Importing a trust
As well as exporting a trust, a trust can be imported to the UK where a non-UK resident trust becomes UK resident. Let us look at another example.
- Megan is a non-UK resident and she settles money into a trust.
- She appoints three trustees to manage the trust; Peter and Lois, who are both UK residents, and Brian who is non-UK resident.
- As the trustees have mixed residency the residency of the trust is based on Megan’s status at the time of the settlement. As she was a non-UK resident, the whole trust is treated as non-UK resident and therefore UK tax only arises on the income and gains arising in the UK.
- A few years later, Brian is offered a job in the UK and moves, becoming a UK resident.
- As all the trustees are now UK resident, despite Megan being a non-UK resident, the trust becomes a UK resident trust and UK tax now applies to all the income and gains, irrespective of where they arise. This could make Brian’s move a very expensive one for the trust.
There is no tax charge for making a trust UK resident. However, if the trust is then subsequently exported again to remove it from the UK tax regime then an export charge will arise.
This could have been avoided by a new non-UK resident trustee being appointed before Brian moved to the UK, as it would maintain a mixture of non-UK resident and UK resident trustees. The residence of the trust would then still depend on Megan’s status at the time of the settlement.
Again there is a relief where the residency is changed due to the death of a trustee. In this example, if Brian had died the trustees would all be UK resident; however, by appointing a new, non-UK resident, trustee within six months of Brian’s death, the trust would remain non-UK resident.
The rules around exporting, importing and re-exporting a trust can be complicated and can lead to unintended consequences, as well as unwanted tax liabilities.
These examples highlight the potential pitfalls that trustees could experience when one or more of them change their country of residence. This could generate a tax liability or expose the trust to more UK tax. The trustees and their advisers should maintain records of the residency status of all the trustees involved and, if any changes are planned, the implications should be fully assessed to ensure that action can be taken to minimise the effect on the trust.
Canada Life offers a wide range of trust solutions that can form part of an excellent financial planning strategy and benefit your clients and their families.