Matthew Hutton MA, CTA (fellow), AIIT, TEP, highlights a question on the tax treatment of certain types of income from an offshore trust.

Context: the question (from the Trusts Discussion Forum)

The recent thread on settlor-interested offshore trusts has got me thinking about another related situation for which I would be grateful for members’ views (and in particular the impact of ITA 2007 s 734 on the situation). 

An offshore trust was settled a number of years ago by a non-dom settlor. The offshore trust is sole shareholder of an offshore company. The offshore company has underneath it a number of foreign investments which generate both income and capital gains, all of which are collected in the offshore company and kept as retained profits in its accounts. 

The offshore company is then wound up, with the trust receiving a significant amount of proceeds from the wind-up. The proceeds would then go into the TCGA 1992 s 87 pool (although the rebasing election could mean that there is in fact not much of a gain that could be attributed) and the trust then makes a capital payment out to which TCGA 1992 s 87 applies (which may in fact be the crux of the matter - if the rebasing election is made, does that mean that TCGA 1992 s 87 ‘applies’ only to the post 6 April 2008 gain?). 

My question is, what about the income tax position? In particular:

1. If a payment goes to a beneficiary who is resident in the UK and either also domiciled here, or at least not claiming the remittance basis, can an income tax charge arise?
2. Is this situation different if the settlor is also the beneficiary in receipt of the capital payment?

(Trusts Discussion Forum 14.5.09, posting by Janet Paterson of Creaseys LLP)

Two responses from the Trusts Discussion Forum

Case 1

I assume the following:

1. The non-UK resident trust is not settlor-interested for either income or CGT purposes.
2. The trust has no income or capital gains accruing directly to it.
3. The underlying company receives both investment income and makes capital gains.
4. A capital payment is made by the trust after the underlying company has been liquidated.
5. The recipient beneficiary is UK resident and domiciled.
6. Inapplicability of motive test etc.
7. Liquidation of underlying company post 6.4.08.
8. Settlor non-UK domiciled.

The liquidation of the underlying company produces capital gains on the part of the trust which will be in addition to capital gains previously apportioned to the trust (under TCGA 1992 s 13) re the underlying company investment gains.

Thus, a capital payment to a UK resident and domiciled beneficiary will result in a matching of trust capital gains under TCGA 1992 s 87 and no income tax consequences arise.

Any rebasing affects not only capital gains of the trust but also any apportioned underlying company gains (under TCGA 1992 s 13). However, such rebasing is of no relevance if the capital payment is to a UK domiciled beneficiary (as assumed above).

Case 2

I assume the following:

1. Exactly as above, but trust is settlor-interested (settlor non-UK domiciled but UK resident) and capital payment made to settlor.
2. TCGA 1992 s 86 is inapplicable as settlor non-UK domiciled.
3. ITTOIA 2005 s 624 and ITA 2007 s 720 are both in point, but as a non-UK domiciled settlor ITTOIA 2005 s 648 and ITA 2007 s 726 preclude a charge unless income remitted.

As above, the liquidation of the underlying company produces capital gains on the part of the trust which will be in addition to capital gains previously apportioned to the trust (under TCGA 1992 s 13) re the underlying company’s investment gains.

Thus, a capital payment to the UK resident but non-UK domiciled settlor/beneficiary made in the UK will result in a matching of trust capital gains under TCGA 1992 s 7 and no income tax consequences arise.

Any rebasing affects not only capital gains of the trust but also any apportioned underlying company gains (under TCGA 1992 s 13). Such rebasing is of relevance if the capital payment is to a non-UK domiciled settlor/beneficiary and may mitigate any resultant CGT charge on the settlor/beneficiary.

(Trusts Discussion Forum 20.5.09, posting by Malcolm Finney of Pythagoras Training)

On the basis of Malcolm Finney's assumptions, it seems to me that the UK resident and domiciled recipient beneficiary would be liable to income tax under ITA 2007 s 731 in priority to a charge under TCGA 1992 s 87 due to the way that ‘capital payment’ is defined in TCGA 1992 s 97 as being ‘any payment which is not chargeable to income tax on the recipient’. ITA 2007 s 734 does not come into play since there is, we are told, income and gains within the company (unless the amount of the benefit exceeds the income).

Generally, there seems to be the potential for worrying overlaps, for settlors particularly, between the income tax anti-avoidance provisions and those for CGT.  For example, if a settlor receives a capital distribution into the UK, and that distribution is made out of capitalised income, I think it is highly arguable that this gives rise to both an income tax charge and also a CGT charge under TCGA 1992 s 87. The argument would run that it is the income of the trust itself which is chargeable on the settlor on a remittance basis and not the capital payment that gives rise to the charge; simply the source from which the trustees chose to make the payment. The possibility of a double charge appears all the more starkly if one considers the situation where trustees make a loan to the settlor in the UK out of capitalised income.nThe bringing in of the funds to the UK gives rise to an income tax charge and the benefit of the loan would give rise to an ongoing CGT charge.

(Trusts Discussion Forum 20.5.09, posting by Gareth Jones of Speechly Bircham LLP)

THE 8th ESTATE PLANNING CONFERENCE: CURRENT ISSUES 2009

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Matthew Hutton MA (Oxon), CTA (Fellow), AIIT, TEP

Matthew Hutton is a non-practising solicitor (admitted 1979) who has specialised in tax for over 30 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30 September 2000, he now devotes his professional time to writing and lecturing.

Among his publications are the annual Tolley’s UK Taxation of Trusts, Trusts & Estates 2008/09 (Tottel, part of the Tax Annuals series), Tolley’s Tax Planning for Private Residences (3rd Edition 1999) and Post Death Rearrangements: Practice and Precedents (FT Law & Tax 5th Edition 1995). He is also co-author of the looseleaf Stanley: Taxation of Farmers and Landowners (Butterworths). In September 2008 Matthew launched his new eBook Hutton on Estate Planning.

Matthew is the general editor of Private Client Business, published by Sweet & Maxwell. He also writes for other journals.

Matthew has since 1977 been a partner in his family’s farming business and he belongs to the Taxation Sub-Committee of the Country Land and Business Association Ltd. He is a longstanding member of what are now the Succession and CGT & Investment Income Sub-Committees of the Chartered Institute of Taxation (CIOT) Technical Committee (and was Chairman between 1997 and 1999). Matthew is a Member of the Stamp Taxes Practitioners Group.

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