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Loans and tainting protected trusts

Loans and tainting protected trusts

Key points

  • Existing offshore settlor interested trusts will be “protected” under new deemed dom rules
  • But protection will be lost if further value is settled into trust
  • Non-commercial loans owed by trusts may jeapordise protection
  • HMRC has agreed a transitional period for changing loan arrangements

The new legislation that introduces a deemed domicile status for individuals for income and capital gains tax will operate from 6 April 2017 but the legislation has not yet been finalised and a number of important questions on how the new rules will work remain.

HMRC has confirmed this week how one aspect of the new rules will operate in respect of “protected trusts”. The deemed domicile provisions created the potential for individuals to be taxed in the UK on income and gains arising in non-UK trusts under the present anti-avoidance provisions, where in the past the individuals could rely on the remittance basis of taxation to avoid being charged tax. It was recognised that the new legislation could have an unfair impact on individuals who had significant interests in offshore trusts that had been established legitimately under the old rules and existed for many years.

The government addressed this point by creating the concept of a protected trust. The existing anti-avoidance provisions that attribute income and gains to the UK resident settlor of an excluded property trust will not apply. Instead, the settlor will be taxed on trust income and gains from 6 April 2017 to the extent that the settlor or his immediate family receive a benefit.

However, a condition of a trust benefiting from “protected” status is that no further settlement is made into the trust by the settlor who has become deemed domiciled. This raises a specific issue for trusts that have received loans from settlors that are not on commercial terms; for example, loans that are interest free, have no fixed terms, etc. The continuation of a beneficial loan owed by a trust after 5 April 2017 will have the effect of settling value into the trust. The simplest example would be an interest free loan, which, if it continues, would result in the equivalent of an amount of interest at a commercial rate being settled into the trust.

HMRC has confirmed this interpretation of the new rules but has explained that there will however be a transitional provision so that the condition is not regarded as met where, before 6 April 2018, the loan is either repaid in full together with any outstanding interest or made subject to fully commercial terms, including a commercial rate of interest payable at least annually for the year ending 5 April 2018 and subsequent years. In addition, interest at a commercial rate or a sum in lieu thereof must have been paid in respect of the year ended 5 April 2017 by 5 April 2018.

This confirmation of the position by HMRC reinforces the need to examine the status of any settlor loans and to review other potential sources of settlements that could arise after the settlor has become deemed domiciled. For example, if a settlor provides consultancy advice but is not remunerated will this be regarded as a settlement?

There is a specific exclusion for transactions at market value between the settlor and the trust, which would imply that any services provided gratuitously by the settlor could be enough to trigger the loss of protected status for the trust.

Trustees need to be extra vigilant in policing any arrangements or transactions with settlors who are about to become deemed domiciled and no doubt there will be many specific situations that require careful consideration.