Make sure you don’t ‘taint’ your protected trust

Following the changes to the taxation of non-UK domiciled individuals from 6 April 2017, certain offshore trusts enjoy protected status. If you have a settlor interested offshore trust (i.e. where you or certain family members can benefit), you need to take care to preserve this protected status – or face potentially significant tax costs.

Protected status brings an important and valuable advantage: the settlor of a protected trust will only be directly taxed on UK source income of the trust. Foreign income and capital gains will only be taxed when benefits are provided to beneficiaries.

If the trust loses its protected status, it will become transparent for income tax and capital gains tax purposes: the settlor will be taxed on the trust’s income and capital gains no matter where the underlying asset is situated.

Protected status is lost if the settlor becomes UK domiciled as a matter of general law. Protection is also lost if the trust becomes ‘tainted’: this occurs if the settlor is deemed UK domiciled (the 15 out of 20 year rule) and value is added to the trust by the settlor, whether directly or indirectly (or by the trustees of another settlement involving the same settlor).

Once protected status is lost, it cannot be recovered. If you are a non dom settlor of a protected offshore trust, it’s vital that you take advice before entering into any transaction where you or a trust connected to you could be viewed as adding value to that protected trust.  

As you might expect with new rules, there are some exceptions. Value or property can be added to a protected trust without tainting in specific situations. These include transactions between the settlor and trustees on an arm’s length basis where there is no gratuitous intent, transactions dating from before 6 April 2017, and payment of certain trust administration and tax expenses.

Again as you would expect, there are important details involved in these exceptions. For example, it’s important to use an appropriate interest rate for any loans between the settlor and trustees.

As the consequences of tainting are so severe, both settlors and offshore trustees should always take advice in relation to any transaction involving loans and where trustee (or other) fees are to be met by additions from the settlor. Regular reviews should also be carried out of a UK resident settlor’s actual domicile status to ensure that protections are still available.

Download our factsheet for more details or please get in touch with your normal adviser for help and advice.

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