Inheritance Tax and offshore trusts: anniversary and exit charges

Inheritance Tax and offshore trusts: anniversary and exit charges

The window for offshore trusts to disclose UK tax liabilities to HMRC under the Requirement to Correct (RTC) has now closed. Michelmores’ Tax, Trusts and Succession team dealt with a number of RTC disclosures for different trusts. Two common themes emerged in relation to Inheritance Tax (IHT) that it would be worth offshore trustees taking note of in future.

First, the recent changes to the treatment of UK residential property held by offshore trusts mean that many offshore trusts will now be exposed to UK IHT.  Prior to 6 April 2017 it was common for non-UK domiciled settlors to be advised to hold UK residential property through an offshore company and trust structure. The non-UK domiciled settlor’s UK home was typically owned by an offshore company the shares of which were owned by an offshore trust of which the settlor was a beneficiary.

This structure was employed to take advantage of the excluded property rules at the time which meant that IHT did not apply to the underlying UK real estate.

The rules have changed so that IHT does now apply to trusts holding UK residential property in the form of entry charges, 10-year anniversary charges and also exit charges on outright distributions to beneficiaries. Additionally, depending on the values involved, there may be reporting requirements even if there is no IHT to pay.

The rules have also changed in relation to loans made to allow trust beneficiaries to purchase, maintain or improve UK residential property which may bring the benefit of such loans within the UK IHT net.

Second, loans to UK resident beneficiaries are UK situs assets for the purposes of UK IHT.  Therefore the benefit of the loan held in trust may mean 10-year anniversary charges apply whilst the loans are outstanding.  Exit charges will apply as well if the loans are released to the beneficiaries from trust and no longer have to be repaid. This is the case whether or not the loans are related to UK residential property and subject to the new rules described above.

Offshore trustees need to be alive to the implications of UK IHT on UK residential property held in trust, including loans to UK resident beneficiaries made in relation to that property, and on loans to UK resident beneficiaries generally.
The amount of IHT the trustees are liable to pay may not be substantial but if the liability is not met at the time of the chargeable event, interest and penalties may accrue which can turn a small tax bill into a much bigger one.
Individuals, including non-UK domiciliaries who own UK residential property or those who have made loans in relation to UK residential property, also need to consider these points as part of their own estate planning given that the rate of UK IHT on individuals is much higher than for trusts.

Potential settlors too need to take advice on their domicile status before establishing a trust.  Domicile is a common-law concept which does not necessarily exist in other legal jurisdictions which the settlor might be familiar with.  It is separate from and can be different to tax residency and nationality.  An individual can also be deemed to be UK domiciled for tax purposes depending on how long they have been resident in the UK.  Where a settlor is UK domiciled, UK IHT liabilities will arise regardless of where the trust assets are situated.

For more information on this topic, please contact Edward Porter.