When it comes to trusts and taxation, things can get complicated quickly, especially when dealing with non-UK trusts that have UK-resident beneficiaries. This complexity arises due to potential tax implications for both the trust and the beneficiaries, such as income tax, capital gains tax, and inheritance tax. It’s important to consider the residence status of the trustees, the source of trust income, and the residency status of the beneficiaries to ensure compliance with UK tax laws and to optimise tax planning within the framework of international tax regulations.

Understanding Non-UK Trusts

A non-UK trust is one where all the trustees are non-UK residents. In our scenario, we’re looking at a trust that was:

1. Started by someone who was not a UK resident or domiciled (and who has since passed away)
2. Has all its assets outside the UK
3. But now all UK resident beneficiaries

The main question is: What happens when these UK resident beneficiaries receive a capital payment from the trust?

Capital Distributions and Deemed Disposals

When a trust makes capital distributions to beneficiaries, it’s considered a ‘deemed disposal’ for tax purposes. This means that even though the trust isn’t actually selling anything, the tax system treats it as if it had. The reason for this is that the beneficiaries become ‘absolutely entitled’ to the assets, effectively taking ownership from the trustees.

If the assets are worth more now than when they entered the trust, this results in a capital gain. Normally, the trustees would be responsible for any tax on this gain. However, things work differently for non-UK trusts with UK beneficiaries.

The ‘Matching’ Rule: Section 87

In the UK, there’s a rule known as Section 87 of the Taxation of Chargeable Gains Act 1992. This rule comes into play when:

• A non-UK trust makes capital gains
• The original settlor (the person who set up the trust) can’t be taxed
• The trustees can’t be taxed

In this situation, the UK resident beneficiaries become liable for tax on these gains when they receive capital distributions from the trust.

How It Works in Practice

Let’s break this down with a simple example:

Imagine a non-UK trust has made £100,000 in capital gains over its lifetime. It has now decided to distribute £200,000 worth of assets to its UK resident beneficiaries. Here’s what happens:

• The distribution is seen as a ‘capital payment’ to the beneficiaries.
• The tax system ‘matches’ this capital payment with the accumulated gains of the trust.
• The beneficiaries are treated as if they’ve received a portion of the trust’s gains, proportional to their share of the distribution.

So, if a beneficiary receives half of the £200,000 distribution (£100,000), they would be treated as receiving half of the trust’s £100,000 accumulated gains (£50,000) for tax purposes.

The beneficiary would then need to report this £50,000 as a capital gain on their UK tax return and pay capital gains tax on it at their applicable rate.

Important Considerations

1. Pro-Rata Distribution: The capital gains are ‘spread out’ among beneficiaries according to how much they receive in capital assets. This means that larger distributions carry a larger share of the tax burden.
2. Tracking Gains: The trustees need to keep careful records of the trust’s gains over time, as these will determine how much of each distribution is taxable to the beneficiaries.
3. Beneficiary Responsibility: UK resident beneficiaries need to be aware that receiving a distribution from a non-UK trust may result in a tax liability, even if the distribution itself seems like a gift.
4. Complexity: These rules can become very complex, especially if there have been multiple distributions over time or if the trust has a mix of UK and non-UK beneficiaries.

Planning and Professional Advice

Given the complexity of these rules, it’s crucial for both trustees and beneficiaries to seek professional advice. Here are some key points to consider:

For Trustees:

• Keep detailed records of the trust’s gains and distributions.
• Consider the tax implications for beneficiaries when planning distributions.
• Communicate clearly with beneficiaries about potential tax liabilities.

For Beneficiaries:

• Be aware that receiving a distribution may result in a tax liability
• Seek advice before accepting large distributions
• Ensure you understand your reporting obligations to HMRC

For Both:

• Regular review of the trust’s structure and beneficiaries’ circumstances can help optimise tax efficiency.
• Consider whether restructuring the trust or changing its residence might be beneficial.

When receiving capital payments from non-UK trusts, UK resident beneficiaries should be aware of potential tax implications. The ‘matching’ rule under Section 87 means that UK beneficiaries may face tax liability even if the trust itself isn’t subject to UK tax. Trustees should maintain detailed records and consider tax implications for beneficiaries when making distribution decisions. You can consult with our tax advisor or trust specialist, which is advisable due to the complexity of trust taxation, especially with international elements. Always consult with a professional for the most up-to-date and specific advice for your situation, as tax laws can change.