Excluded Property Trusts have traditionally been used as a trust-based inheritance tax planning arrangements for individuals who are resident in the UK but who are not yet domiciled within the UK. However, recent changes to the legislation have resulted in further possible inheritance tax charges for this form of trust.
In this article, Leila Allger, Head of Private Client Tax at Throgmorton UK Limited (An Apex Group Company) discusses the benefits and uses of Excluded Property Trusts and the new changes that accountants need to be taking into consideration.
What are Excluded Property Trusts?
An Excluded Property Trust (EPT) is designed for individuals who are not domiciled in the UK and who want to protect their assets from inheritance tax (IHT). Therefore, the settlor must not have become deemed domicile under the 15 out of 20 year rule, when creating the trust.
Property situated outside the UK can be considered ‘excluded property’ if the owner is domiciled outside of the UK. For example, an Italian villa owned by a French domicile would be considered excluded property.
Where property is held within a settlement (settled property) and that settled property is outside the UK, the property would be regarded as excluded property providing the settlor was non UK domiciled at the time the settlement was made.
What are the tax benefits of EPTs?
Capital Gains Tax: There are significant Capital Gains Tax (CGT) benefits to using EPTs as there can be capital growth within the fund and this will be tax free, even if the individual were to settle the trust as a UK resident settlor. Recent legal changes dictate that if the settlor then were to become deemed domicile, capital gains arising in the trust would still not be taxable on the settlor. However, there would need to be consideration as to potential tax consequences when there is a distribution/benefit to a UK resident beneficiary.
Income tax: Foreign income arising in the trust may be ‘protected foreign income’. The protection ensures that income which arises within the trust is not taxable on the settlor or his close relatives on an arising basis. This is also the case once the settlor is deemed domicile. But there has to be specific consideration as to the type of investment, to ensure it is tax efficient, and there are potential tax consequences to consider if the income is distributed to a beneficiary.
Tainting: Once the individual becomes deemed domicile, they are unable to add any new property or income, directly or indirectly to the trust. To do so would risk losing all of the tax protections afforded above and therefore there could be UK taxation issues.
Protection of assets: It is important to remember the advantage of EPTs for individuals from a non-tax perspective, is that these assets are protected for a family or individual on a long-term basis.
Please note that the above considerations may change should any of the trustees be UK resident.
What are the recent changes to EPTs?
EPTs have been a regular target of Government consultations, reviews and legislation. These latest changes are a further attempt to tighten the rules to counter the potential for abuse of these trusts.
Draft Finance Bill 2019-20 clarifies that non-UK assets cannot be excluded property where the settlor was actually UK domiciled or deemed domiciled (as a long-term UK resident) at the time there are new additions to the trust (this is opposed to considering the domicile of the settlor at the time the settlement was first created).
The legislation further proposes that non-UK assets transferred between trusts will not be treated as excluded property where the settlor was UK domiciled or deemed domiciled (as a long-term UK resident) when the transfer occurs.
What do accountants need to do in response to these changes?
Accountants advising Individuals considering settling non-UK assets into trust and offshore trustees should take advice to ensure that they preserve the excluded property status of assets currently held in trust and do not inadvertently fall foul of the new rules. Offshore trustees should also notify affected clients of the changes.
There are still strong tax benefits of using an EPT, however your client’s circumstances will play a determining role in whether this trust arrangement is the most suitable solution under the new legislation.