Trusts Transformed: The four-year foreign income revolution

Income tax and capital gains tax

A significant change is to the existing rules that allow certain individuals that have added assets to a trust (known as settlors) to not be taxed in relation to these assets going forward, provided that the trusts were drafted accordingly.

Currently a trust settled by a UK resident but not-UK domiciled or UK “deemed domiciled” person (typically someone that was born abroad, to non-UK domiciled parents and has not been UK resident for 15 UK tax years or formed an intention to reside in the UK permanently or indefinitely) may defer UK tax by investing in non-UK assets, with the effect that UK tax may only be payable in the event that distributions or benefits are received by UK residents.  This may be achieved by ensuring the trust qualifies as a “protected trust” under the existing rules or by various other options (such as claiming the “remittance basis” of taxation, which will be abolished).   The current rules may essentially allow certain non-UK domiciled settlors to live in the UK after settling a trust and never be subject to UK tax upon the assets of the trust.

Under the new rules, settlors that are UK resident are now expected to be generally subject to UK income tax and capital gains arising from trust assets from 6 April 2025.  This is subject to an exemption that may be claimed by individuals moving to the UK within the first four tax years of UK residence.  This allows someone that has not been UK resident at all in the previous 10 UK tax years (regardless of nationality or a prior domicile status) to receive non-UK income and gains tax free and without charge (and even bring such income and gain to the UK in that four year tax period without tax charge, which is an improvement on the current system) – which applies to trust income and gains as well as personal income and gains and may similarly benefit a non-settlor beneficiary receiving a distribution in that initial four year tax period.

A couple of additional helpful provisions are that settlors should be able to set personal losses against trust gains that they are taxed upon and they should have a right of reimbursement from trust assets for trust income (so the tax is essentially paid from the trust).

Inheritance tax for the settlor

The inheritance tax treatment of a trust under the new rules is closely tied to whether the settlor is a “long term UK resident” and will be assessed on a rolling basis.  A long-term UK resident is typically someone that is UK resident currently (under the UK’s Statutory Residence Test) and has been resident in the UK for at least 10 out of the last 20 UK tax years.  The global assets of a long-term UK resident are subject to inheritance tax.  This is a major departure from the current “domicile” basis of taxation upon which inheritance tax is applied and means that the global assets of people with no prior connection to the UK moving to the UK are likely to come with the scope of UK inheritance tax more quickly.

Leaving the UK will not mean that this long-term residence status is immediately lost and a “tax tail” will apply.  The status will remain for a further period of tax years, being at least three tax years, where the UK residence period was more than 10 tax years and up to 13 tax years, and with the length of the tail increasing thereafter.

Inheritance tax for trust structures

Currently trusts settled by individuals that are neither UK domiciled nor deemed domiciled (“excluded property trusts”) are not subject to UK inheritance tax on non-UK situs assets.  They may remain outside the scope of inheritance tax on non-UK situs assets even if the tax status of the settlor changes (e.g. they became deemed domiciled under the existing rules, which will shortly cease to apply), provided the settlor does not add further assets.

Trusts that have been or are settled by a “long term UK resident” may be subject to UK inheritance tax upon the trust assets from 6 April 2025.  A trust will be subject to UK inheritance tax if it either holds UK situs assets or its settlor is a long-term UK resident at the relevant time.  As such the UK IHT status of such trusts will flow with the movements of the settlor should they cease to be or again become UK tax resident in the future.

A trust subject to UK inheritance tax will be charged a tax rate of up to 6% of the trust’s asset value over a ten-year period, with the relevant charge arising on the 10 year anniversary of the trust.  The rules are already fairly complicated, and these will be further complicated by trust assets potentially more regularly falling in and out of the scope of charge over time as the status of the settlor may change.  For instance, it is expected that a proportional charge will result if a settlor ceases to be a long term UK resident (i.e. at the point that a trust will cease to be subject to inheritance tax, as the settlor is treated as non-UK resident, there will be an “exit charge” at up to 6% of the trust fund, based upon the amount of time since the last charge date and the length of the settlor’s UK residence).

Slightly different rules will apply to trusts set up on or after 30 October, with these newer trusts being more likely to fall within the UK’s complex gift with reservation of benefit (“GROB”) rules.  These rules are expected to apply to “new” trusts if there is any possibility that the settlor might benefit (with benefit being broadly defined), with the effect that where there is potential for a settlor to benefit from the trust assets, those assets will be treated as belonging to and being within the estate of the settlor.  This has the potential for double tax charges where there have also been trust tax charges, which would be a very unfortunate outcome (potentially worse than if there was never any trust at all).  Under the new rules that should apply to trusts where the assets were settled before 30 October, it is possible for a settlor to be potentially capable of taking benefit without necessarily engaging these GROB rules.

Review your trust now

It is recommended that potentially impacted trusts are reviewed, with consideration given to how the UK tax charges would apply to them and whether changes might be beneficial.  The new rules most obviously apply to trusts with one or more living settlors who currently live in the UK or who may move to the UK in the future.

The review above is necessarily high level and there will be additional complexities in certain cases, such as where there is historic untaxed income and/or gains in a trust or the trust is not discretionary in nature (so that the rules may apply slightly differently).  A review may result in nothing more than comfort that you understand the application of the new rules.   However, it could result in a recommendation that a structure is amended or replaced, or discussions around whether it may be beneficial for affected parties to consider becoming non-UK resident.

There is now window of a little less than four months to consider these matters and it is likely that the period up to April 2025 will be busy.  If you may be impacted by these changes, please contact a member of our Wealth Preservation team for advice.