Trustees need to act now to ensure protected trusts retain that status after 5 April 2017.
Finance Bill 2017 No.2 includes legislation to protect trusts settled by individuals before they became deemed UK domiciled from the full impact of the changes to the taxation of non-domiciles. Our previous article How Do You Avoid Tainting Protected Trusts? set out the importance of ensuring that such trusts are not “tainted” by an addition of value after 5 April 2017.
Once the settlor has become deemed UK domiciled, a trust can be tainted where property or income is provided directly or indirectly for the purposes of the settlement by the settlor, or by the trustees of any other settlement of which the settlor is a beneficiary or settlor. In particular, a loan to a protected trust where the interest is below the amount which would be charged on arm’s length terms could taint the trust; the legislation defines arm’s length by reference to the official rate of interest.
There is a transition period which allows existing loans to be put onto an appropriate basis before 5 April 2018. Where an individual became deemed UK domiciled on 6 April 2017, a loan will not taint the trust provided that the loan becomes a loan on arm’s length terms before 6 April 2018. It is also necessary for interest to be paid before 5th April 2018, as if those arm’s length terms had been in place for the whole of 2017/18.
The steps which need to be taken in respect of a loan are not complex, however, the practical difficulty is likely to arise in ensuring that all of the loans which could taint the trust have been identified.
This legislation applies to loans to and from the trustees of the protected trust. But a trust could also become tainted if a “cheap” non-arm’s length loan was made to an underlying company of the trust, since that would be a provision of property, and the legislation does not specifically cover this. The HMRC guidance on protected trusts (issued on 31 January 2018) does not address this directly, however, it seems prudent to ensure that loans to underlying companies are also put onto the correct basis before 5 April 2018. While a trust is not tainted where property is provided with no intention to confer gratuitous benefit, this exclusion does not apply where property is provided under a loan. Therefore, a loan to an underlying company which is not on the defined arms’ length terms does appear to create a risk of tainting.
If a company owned by the settlor makes a loan to a protected trust or an underlying company of a protected trust, then if it is not on arms’ length terms this could be an indirect provision of property by the settlor, depending on the circumstances. Similarly, the trustees of another trust might add value to the protected trust where there is a loan from that trust or its underlying companies to the protected trust or its underlying companies.
It is also possible that an interest-bearing loan from a trust to a settlor could taint the trust, although this is more unusual.
There could therefore be a reasonably substantial exercise to identify all of the loans which have the potential to taint a protected trust. Trustees will need to start work on this in good time to be able to ensure that interest payments are made before 5 April 2018.
An individual who is not yet deemed domiciled can settle a trust which can be a protected trust. Here, there are no transition rules for loans, and so loans will need to be considered and put on arms’ length terms before the date on which the settlor does become deemed domiciled. This will be an important issue to consider if the settlor will become deemed domiciled on 6 April 2018.
If you would like to discuss this or any other tax issues, please contact us.