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How the IR can stop you using offshore trusts |
Regular readers will know that one of our favourite topics are the
various offshore opportunities available to you. Because of the better
global communications, easier transport, ability to work remotely, and
the often cheaper overseas property prices many UK nationals are
looking to flee the UK and set themselves up offshore in one way or
another.
As well as the personal lifestyle benefits, one of the main driving
forces is often the desire to avoid UK taxes, on future income.
If you become non UK resident bymoving offshore avoiding UK taxes
becomes much easier, however, another section of UK nationals are
looking to use offshore opportunites to avoid UK taxes whilst
continuing to live in the UK. This is something the UK taxman doesn't
like, as whilst there's not much they can do about non UK residents, if
you live in the UK they'll do what they can to stop you reaping the
offshore benefits.
What exactly are the offshore benefits?
Most of you will already know how the offshore angle can benefit you, however, just to recap you're looking at the following;
- No UK tax on overseas income
- No UK tax on any gains made (either in the UK or offshore)
So in other words an offshore company/trust could invest in Bulgarian
property with no UK taxes on overseas rental income or any CGT on a
future disposal. Given that UK taxes could knock out 40% of your
returns this is a pretty big incentive. There are also other benefits
such as increased privacy and ringfencing assets offshore away from
potential creditors.
How do the anti avoidance rules work?
In terms of income tax, the key provisions are in S739-741 ICTA 1988, which
provide for wide-ranging anti-avoidance powers designed to prevent the avoidance
of Income Tax by individuals using offshore companies/trusts.
S739 would firstly need to be considered, and this applies to an individual
who transfers assets, or who procures or is associated with a transfer by
somebody else.
The conditions for application of Section 739 are:
- There must be a transfer of assets by an individual
- As a result of the transfer income becomes payable to a non-resident
person.
- The transferor must have power to enjoy that income in some way, or receive/be
entitled to receive a capital sum.
- The transferor must be ordinarily resident in the UK in the year of liability.
If all of these conditions are fulfilled, the income which becomes payable
to the offshore company/trust is deemed to be that of the individual who
made the transfer, to the extent he has power to enjoy that income.
The first point to consider would be whether there would be a 'transfer of
assets' by you. The UK tax authorities take a wide view of what constiutes
a transfer of assets.
For example S739 may apply where an individual transfers cash to establish
a non- resident trust, or subscribes for the share capital of an offshore
company, or where an individual transfers assets such as shares or property
to a new or existing non-resident trust or other person or company abroad.
It can also apply where intangible assets are transferred; for example a
UK individual may transfer his services to an offshore company.
The view of the IR is that a transfer may be made by way of sale or purchase
of assets, or by way of gift.
However, one problem is that S739 doesn't just apply where an individual
transfer assets, rather it applies where an individual either transfers,
or is associated with the transfer of assets. In particular, if the operations
were contemplated as a single scheme they could be associated .
What constitutes an associated operation is complex, and is essentially a
factual matter, however the legislation states that an this includes
'... an operation of any kind effected by any person in relation to any
of the assets transferred or any assets representing, whether directly or
indirectly, any of the assets transferred, or to the income arising from
any such assets, or to any assets representing, whether directly or indirectly,
the accumulations of income arising from any such assets...'
It's therefore given an incredibly wide scope to essentially include any
actions undertaken by you in relation to the trust assets in connection with
the generation of income arising to the trust.
It's also worthwhile noting that associated operations can also have a separate
Inheritance tax consequences and in this case the IR define associated operations
as two or more dispositions, of which
- one is effected with reference to the other
or
- one is effected with a view to enabling the other to be effected
or
- one facilitates the effecting of the other.
Whilst the Inheritance tax definition is not directly relevant, it does give
a good indication of the underlying purpose of the associated operation rule.
On the basis that the conditions above were satisfied, any income arising
to the non resident trust can be taxed by S739, whether UK source income
or foreign source income.
Note that one of the above conditions is that the UK resident must have power
to enjoy the income arising to the non-resident (eg as a shareholder of
an overseas company or as a beneficiary of a non-resident trust,). Even
if you did not actually receive any income from the trust it is the potential
to enjoy the income that is important. As such you would not have to actually
receive any of the income at all.
The alternative provsion is S740.
This applies where assets have been transferred abroad and a UK resident
other than the settlor obtains a benefit. In order for this to apply the
following conditions would need to be satisfied:
- There must be a transfer of assets.
- As a result of which (alone or in conjunction with associated operations)
income becomes payable to a non-resident person.
- As a result of the transfer, an individual other than the transferor
receives a benefit, which is not otherwise chargeable to Income Tax.
- The recipient of the benefit must be ordinarily resident in the UK in
the
year of charge.
Section 739 is different from S740 in that it taxes non-transferors on benefits
received.
Benefits chargeable by Section 740 include payments of any kind, for example
cash (capital distributions), the use of property (e.g. occupation of a
house), interest free loans, etc. Where the conditions are satisfied, the
individual receiving the benefit is liable to tax on the amount or value
of the benefit, (although the charge can be limited by the amount of past
or future available 'relevant income' of the trust).
In practice S740 may not apply to a simple holding of shares in an
offshore company of receiving cash distributions from an offshore
trust, as it only charged tax on the benefits
received provided they are not otherwise charged to income tax. As such S740
would not apply to dividends from an offshore company or income distributions
from an offshore trust, given they would be taxed in any case.
Even if there is a liability under S739 or S740 what impact this would have? It clearly applies
so that income of the offshore trust is attributed to a UK resident person
but S743 (2) appears to limit this in that it states:
(2) In computing the liability to income tax of an individual chargeable
by virtue of section 739, the same deductions and reliefs shall be allowed
as would have been allowed if the income deemed to be his by virtue of that
section had actually been received by him.
This therefore allows the same deductions and reliefs as if the income was
yours. The wording of this provision suggests that your actual deductions
and reliefs can be offset against the deemed S739 income, and that if the
trust satisfied the conditions for interest relief this relief should be
allowed against either S739 income.
If this was the case, this could be a useful let out. Take the
example of a UK individual raising finance to purchase overseas
properties via an offshore trust/company structure. These financing
costs could be significant, particularly if an interest only mortgage
was used. Based on this any 'net'
deemed income may in any case be minimal.
Another aspect that should be considered is that the legislation in S739
S740 applies unless you can show that the exemption in S741 applies.
In order for this to apply you would need to demonstrate either:
- that avoidance of taxation was not the purpose or one of the purposes for
which the transfer was effected
or
- that the transfer and any associated operations were genuine commercial
transactions and weren't designed to avoid tax (note this is UK tax)
Actually persuading the IR that you can take advantage of this exemption
can in practice be difficult.
S739 and S740 are essentially the main income tax avoidance rules
and will catch many UK residents looking to use an offshore company or
trust unless you can take advantage of the exemption or minimise the
deemed income to an acceptable level.
There are some separate CGT provisions designed to catch UK residents
who use offshore trusts and companies to dispose of assets free of UK
taxes. We'll look at these next month...
Next month 'How the IR stops you using offshore companies/trusts to crystallise tax free gains'
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