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The trust belt

Our panel of industry experts analyse the uses of offshore trusts in depth

What are offshore trusts?
What are the main types of offshore trusts used by UK residents?

Kennedy: This generally means that the trustees are non-UK-resident and, moreover, that the trust is treated as non-resident for tax purposes. The rules which apply differ slightly between income tax and capital gains tax. A trust is non-resident for CGT purposes, provided all or a majority of the trustees are not resident or not ordinarily resident and the general administration is carried on abroad. Income tax rules look solely at the residence of the trustees and for UK domiciled settlors requires all the trustees to be non-resident. However, where a beneficiary is entitled to income of right, then that income is taxed as his.

Hall: An offshore trust, like an onshore trust, is a legal instrument that confers certain obligations on the trustees responsible for its management. People will use trusts to wrap around an offshore bond to increase its tax efficiency and to provide more certainty over the treatment of the assets at the time of their death. As well as individuals, offshore trusts are also commonly used by corporations to assist with many types of business dealings. The main types of trust used by UK residents are Absolute Trust, Discretionary Trust, Excluded Property Trust, Flexible Power of Appointment Trust and Probate Trust.

Why are offshore trusts useful in generational Planning?
Kennedy: UK trusts can be useful for succession and probate planning, so what does an offshore trust add? Many offshore centres concentrate on the notion of protection with their trust law written accordingly. In particular, protection from creditors and from forced heirship, by which I mean where states (including UK) impose power over an individual’s ability to make testamentary gifts. Using trusts this way can run contrary to public policy or the law of the home country and potential legal action is always a threat. This is delicate ground where, on a number of occasions, courts have found facts negating the trust as a sham.

Hall: It is advisable for everyone to make a will that states how and to whom an estate should be distributed on death. For the assets held in it, a trust can provide similar controls on death to a will. However, a trust is a much more powerful and flexible legal instrument than a will and, as a consequence, the beneficiaries of a trust will have more onerous responsibilities than the executors of a will. The right type of offshore trust can be useful in generational planning by helping to limit the amount that reduces the estate on death through the payment of UK inheritance tax.

McLeod: Parents and grandparents have concerns over children and grandchildren receiving or inheriting too much too early. (The children or grandchildren may not always agree.) A trust could be created to hold the assets until the children are older and presumably wiser. A child or grandchild might be involved in a risky business venture or an unstable marriage, or be incapable for some other reason of managing his or her own financial affairs. Family wealth can be placed into a suitable trust to take account of, and avoid, the real or imagined risks. The residence of the trust is largely irrelevant if wealth protection is the sole consideration.

Do offshore trusts still have a role in tax planning?

Kennedy: For the UK domiciled, a plethora of anti-avoidance legislation has largely brought to an end most of the tax advantages that were achieved with offshore trusts, specifically in the 1980s. Nowadays, legislation seeks to attribute both trust income and gains to either settlors or beneficiaries and sheltering is almost impossible outside of a few discrete contexts. Legislation is complex, its grasp wide and the potential administration a nightmare. For the average client, it is not likely to be a tax-planning option and a simple offshore life policy is often more sensible. Even for the non-domiciled, much of the requisite tax planning can be achieved without an offshore trust.

Hall: One of the main reasons that individuals and corporations invest offshore is to take advantage of the tax treatment applied to offshore bonds. If assets held in an offshore bond are also held in trust, under current UK taxation practice it is possible to mitigate, or avoid altogether, certain taxes due when wealth is transferred. The main way in which trusts are used is to reduce the amount of inheritance tax payable on death so that the heirs actually inherit the money the relative or friend intended.

McLeod: The Inland Revenue, the forerunner to the present Her Majesty’s Revenue and Customs, has for many years, waged a long-running war against offshore trusts and legislation has been tightened up to such an extent that there are few planning opportunities for UK-resident and domiciled individuals. However, significant tax planning opportunities remain for non-UK-domiciled individuals. Anyone using an offshore trust for tax planning purposes can expect its structure and operation to be scrutinised by the HMRC. That said, a properly structured and implemented tax planning strategy should be able to withstand the closest examination. Professional advice is essential.

How do they help in mitigating inheritance tax? How has the pre-owned asset tax affected the role of offshore trusts?

Kennedy: There is no special regime for offshore trusts and the residence of a trust is not material for IHT purposes. The territorial limits of IHT are expressed in terms of domicile not residence. For the UK domiciled, offshore trusts do not avoid IHT in any differing way to onshore trusts. Remember also, that any professional who assists in establishing an offshore trust for such clients has a legal duty to report it to the Revenue. Even for the non-domiciled, it is not the residence of the trust that is material but the ‘residence’ of the property within that trust, although sometimes an offshore company within a trust can assist.

Hall: Under current UK taxation legislation, there are still ways in which inheritance tax can be reduced perfectly legitimately. The pre-owned asset tax legislation effectively removed some of the traditional method but certain discounted gift schemes using offshore bonds are still a popular choice of IFAs when recommending IHT plans for their clients. The significant factor to bear in mind is the way in which the trust is actually structured, as the pre-owned asset tax legislation reduced the flexibility of some types of trust.

McLeod: A gift to a trust, either onshore or offshore, is a transfer of value for inheritance tax purposes. The structure of the trust rather than its residence status determines its inheritance tax effectiveness. Provided that the gift with reservation provisions’ can be avoided the gift will be either a potentially exempt transfer or a chargeable transfer. Excluded property trusts offer significant tax planning opportunities for UK-resident non-domiciles and are offered and administered by every offshore trustee company. Pre-owned asset tax was aimed at UK trusts holding the family home. Although it has had some impact on offshore trusts, most of those affected have been restructured to avoid the tax.

Do the costs of offshore trusts and quality of regulation vary significantly between offshore centres?

Kennedy: Undoubtedly so – and it is an important issue. The client is after all passing their assets to a faceless offshore entity. The concept of a protector often found in offshore trusts, acts as a conduit between settlor/beneficiaries and the trustees. Often they must consent to actions of the trustees but still useless if dealing with a rogue firm. Many jurisdictions, particularly Jersey and Guernsey, have gone to great lengths to step up the regulation of trust companies in the past few years while some jurisdictions still appear almost totally unregulated. Trust providers range from international names to back-street brass plate offices. Like most things in life, you probably get what you pay for.

Hall: There are usually no additional costs attached to wrapping a life bond in a trust if the bond and the trust are provided by the life company and most life companies will be able to provide most of the standard trust wrappers.

However, trustee services usually incur costs. The main offshore life companies used by UK investors will generally offer trusts written under the law of England and Wales, the Isle of Man or Ireland. These will not vary all that much, but the robustness lies in the way in which the trust is structured and that in turn typically relies on obtaining strong counsel’s opinion.

McLeod: Jersey, Guernsey and, to a somewhat lesser extent, the Isle of Man are the most popular locations with UK-connected settlors. They have trust law systems which, while not identical to the UK, are familiar in structure and operation to UK lawyers and tax planners. They are geographically close to the UK, which reassures users. Many trustee companies operating in these jurisdictions are subsidiaries of UK-based banks or accountancy firms. Caribbean countries are developing expertise in trust administration, no doubt with one eye on the US market. Costs do not vary significantly and regulation is largely left to the courts in all jurisdictions.

Is there a role for offshore companies in generational and tax planning for UK residents?

Kennedy: On the face of it, a company is a separate legal entity. Accordingly foreign income and gains accruing to an offshore company ought, you would think, to be free from UK tax. In fact, directly owned non-trading offshore companies really have no part to play in offshore tax planning for the UK domiciled. Tests concerning control of the company, coupled with general anti-avoidance legislation and even benefits-in-kind rules, all seek to ensure that a UK-domiciled person would be rarely advised to use a directly owned offshore company as part of a tax planning strategy. The non-domiciled may benefit, but generally in conjunction with a trust.

Hall: Some offshore life companies have their own trust services company which can act as professional trustees. This is a significant advantage to investors looking to wrap their bond in a trust, as the duties and responsibilities of any trustees are considerable and can be quite onerous. Through providing both the trust wrappers themselves, as well as the trustee services, offshore life companies can offer their clients the peace of mind that comes with knowing their assets are being managed by experts. Of course, with generational planning, this comfort is essential, as it will be too late for the investor to do anything about it if the trustees fail to meet their obligations.

McLeod: A company does not offer the same degree of flexibility as a trust in the context of generational wealth and tax planning. Offshore companies can be used in tax planning strategies, particularly where trading income is being generated outside the UK.

The company can often be owned by an offshore trust. However, such arrangements are expensive to establish and administer and are used only where significant amounts are involved.

There is a considerable array of tax-avoidance legislation to be sidestepped and professional advice is essential.

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