How protected is your trust?

On 6 April 2017, significant changes were made to the UK taxation of non-UK domiciled individuals (non-doms) and their trusts. On the one hand, long-term UK resident non-doms lost the ability to elect to be taxed on the ‘remittance basis’, with the effect that they became taxable on all their worldwide income and capital gains arising from that date, regardless of whether such income and gains are remitted to the UK or not.

On the other hand, settlor-interested non-UK resident trusts that meet certain conditions qualified for ‘protected’ status from that date, which means that capital gains and foreign income received by the trust are only attributed to a UK resident non-dom settlor by being matched to the receipt of distributions or other benefits.

Losing protection

Protected status can be lost for various reasons. Most trustees are aware of the danger of a settlor adding value to a trust once they become UK deemed-domiciled, as the addition of even a small amount of value will result in the loss of all trust protections. This is why, for example, it is essential that where a UK deemed-domiciled settlor makes a loan to a protected trust, the trust must actually pay interest on the loan at least annually, at the HMRC official rate of interest (currently 2% but set to increase to 2.25% from 6 April 2023) or higher.

But there is another way in which trust protection can be lost, which is less well-known, and which can be harder to identify. If the settlor acquires a UK domicile of choice under general law, the trust will cease to be protected and the settlor will be taxed on all trust income and gains, regardless of their source and whether or not they actually receive any benefit from the trust.

This can be a problem because it is often difficult to identify whether domicile status has changed. In simple terms, domicile can change if an individual moves to a new country ‘permanently or indefinitely’. In practice, it can be difficult to know if this has happened, and asking the settlor is often not helpful because most people only have a vague sense of what domicile actually means.

Be alert to changing domicile status

Trustees therefore need to be alert to potential warning signs, so that appropriate actions can be taken. The first point to consider is how long the settlor has lived in the UK. For example, an individual who has lived in the UK for the last, say, 12 years is at greater risk of having settled permanently than someone who has been resident for five years.

Another warning sign relates to the purpose of a stay. Many non-doms come to the UK to work, or to educate their children. If their plan is to leave when that purpose ends, they are very unlikely to acquire a UK domicile of choice. However, if they remain in the UK after that purpose ends, their domicile status could well change. A decision to stay in the UK on retirement could well be an indication of a decision to settle permanently.

Be prepared for HMRC to take an interest

HMRC is well aware of this issue, and we are beginning to see larger numbers of domicile enquiries being raised. These follow a similar pattern and involve HMRC asking large numbers of very detailed questions, which can be time-consuming, expensive and stressful to deal with. Rather than waiting for an enquiry to be raised it may be better to take control of the situation and put together a file of documents to demonstrate an individual’s circumstances and intentions. This can make it much easier to deal with an enquiry if it comes, but more importantly it can help trustees and settlors alike make sure that domicile status itself is protected or, if it does change, that the implications are properly understood and addressed.

Accidentally becoming UK domiciled can have serious and potentially costly consequences. Asking settlors the right questions can ensure that action is taken to stop this happening where possible, and make sure that where domicile does change, it can do so without leading to expensive surprises later.

For more information, please get in touch with AAndrew Robins or your usual RSM contact.