The UK’s March 2024 budget: Offshore trusts - have reports of their demise been greatly exaggerated?

A new landscape

Following the March 2024 Budget, there are meaningful changes to the taxation of non-UK domiciliaries (so-called “non-doms”) on the horizon.  A large number of individuals will be affected, including those who have settled or who plan to settle offshore trusts.

The proposed changes are discussed in detail here. The changes include the abolition of the so-called “trust protections”, from 6 April 2025. It is also very likely that there will be changes to the rules on what counts as “excluded property” for IHT purposes. These reforms will cause many existing offshore trusts settled by UK resident non-UK domiciliaries to become less tax-efficient. In a nutshell:

• From 6 April 2025, a UK resident but non-UK domiciled settlor of an offshore trust will no longer be protected from income tax by reference to foreign income received by the trust, where the trust is settlor-interested. In broad effect, the trust will become transparent for income tax purposes. Generally, the receipt of foreign income by the trust will result in income tax for the settlor – the exception being where the settlor is within the first four tax years of UK residence.
• From 6 April 2025, a UK resident but non-UK domiciled settlor of an offshore trust will no longer be protected from CGT by reference to chargeable gains realised by the trust, where the trust is settlor-interested. In broad effect, the trust will become transparent for CGT purposes. Generally, the realisation of gains by the trust will result in CGT for the settlor – the exception being, again, where the settlor is within the first four tax years of UK residence. It is possible that such exception will only apply where the gains are in respect of non-UK assets.
• From a future date (possibly 6 April 2025, but perhaps later), it appears that non-UK assets of a trust will be non-“excluded property”, and therefore exposed to IHT, at any time when the settlor’s own non-UK assets are non-“excluded property”. The status of the settlor’s own non-UK assets will be determined by a residence-based test. Under the proposals, non-UK assets of an individual will cease to be “excluded property” once the settlor has clocked up 10 tax years of UK residence. The current Government has proposed that this rule should not apply to trusts settled before 6 April 2025, but the Labour Party have indicated that they do not support any “grandfathering” of the existing IHT rules in relation to pre-6 April 2025 trusts. At present, there is great uncertainty about the future treatment of trusts for IHT purposes. Only one thing can be said with confidence, which is that the existing IHT rules are unlikely to be left alone.

Despite the expected loss of the “trust protections”, and the high probability that the IHT rules will be reformed, offshore trusts will continue to have a role to play in a number of scenarios.

Scenarios in which offshore trusts may still be useful

The scenarios in which offshore trusts are likely to continue to be attractive post April 2025 include the following:

Non-UK resident settlors of trusts for UK resident beneficiaries

• Offshore trusts settled by non-UK resident settlors for UK resident beneficiaries will be unaffected by the loss of the “trust protections”, and indeed should be unaffected by the changes to the “excluded property” rules, provided that the settlor remains non-UK resident.  Consequently, such trusts should continue to be treated in the same way for income tax, CGT and IHT purposes as under existing rules.
• That said, before creating an offshore trust non-UK resident would-be settlors would be well-advised to consider the alternatives for providing for UK resident family members. For example, it may be more tax efficient to retain personal ownership of the assets and make gifts to UK resident family members who would hold the assets directly, given the scope for tax on distributions or benefits received by UK resident family members from offshore trusts.  However, in some circumstances, there may still be strong arguments in favour of the assets being in trust (for example asset protection or succession planning) which may override the disadvantage of UK resident family members being exposed to tax under the “matching” regimes.  Furthermore, it appears that the “matching” regimes will be disapplied post April 2025 where a UK resident beneficiary has recently become resident in the UK and qualifies for the new four-year special tax regime (“FYR”) (discussed here).

Where a UK resident settlor and their spouse can be excluded, and chargeable gains minimised or avoided  

• If a UK resident settlor and their spouse are willing to be irrevocably excluded from benefit from a non-UK resident trust, income of the trust (and any underlying non-resident companies) won’t be taxable on the settlor.  In these circumstances, a non-UK resident trust will continue to secure income tax deferral for UK resident settlors going forwards, despite the loss of the “trust protections”.  (This is subject to a technicality regarding the “transfer of assets abroad” legislation, the details of which are beyond the scope of this note).
• However, eliminating or reducing exposure to tax on chargeable gains of a trust or underlying company is more difficult, as this requires the exclusion of a much wider class of persons, including the settlor’s children, grandchildren and their spouses.  In practice, that is rarely feasible.  If that isn’t possible, consideration should be given to whether there is scope to alter the trust’s investment strategy to minimise the scope for the settlor to be taxed on gains.  For example, it may be possible to switch to an income-focussed investment strategy or, in some cases, to avoid realising chargeable gains entirely - e.g., by investing exclusively in non-reporting funds generating “offshore income gains” (OIGs).  OIGs are taxed as income, and are outside the rule under which chargeable gains of an offshore trust structure can be attributed to the settlor.
• Where a settlor is liable to CGT on chargeable gains of a trust or underlying company, there is a statutory entitlement to recover the tax payable from the trustees.  In principle, this may help to ease the burden on settlors, although where the settlor has been excluded, there can be a question whether the statutory right of recovery is enforceable.

Where transparency is actually desirable

• There are circumstances in which it may be beneficial for income and gains of a trust to be attributed to its UK resident settlor, so that the trust is effectively “transparent” for income tax and CGT purposes.  This may be the case where the income and gains of a trust are taxable in more than one jurisdiction and, under the terms of an applicable double tax treaty, the tax liability needs to fall on the same person in each jurisdiction for treaty relief to be (fully) available.  For example, if the settlor is a US person and the trust is a “grantor trust” for US purposes (i.e., it is treated as tax transparent for US purposes), the settlor will be taxable on the income and gains of the trust for US tax purposes.  However, if the trust is UK resident, the UK resident settlor will be taxable on the income of the trust but not on trust gains.  This “mismatch” may result in a reduction in available relief, which could be avoided post April 2025 by use of a non-UK resident trust (see briefing note here).

These are just some of the scenarios in which offshore trusts may continue to make sense, even after the proposed changes have been brought in.