Tricks In Treachery

DAVID JEFFERY explains why care must be taken when a non United Kingdom domicile transfers assets to the United Kingdom.
SOME OF THE most treacherous legislative provisions in the Income Tax Acts are sections 739 to 746, Taxes Act 1988 (all statutory references in this article being to that Act unless otherwise stated), particularly when they are applied to persons who are not domiciled in the United Kingdom but are ordinarily resident there.
Most readers will have some feel as to the scope of section 739. Broadly speaking if there is a 'transfer of assets' (a term which includes just about any transaction you can imagine, and more besides) and income arises to a 'person' (this term includes a trustee or a company) resident or domiciled outside the United Kingdom, in consequence of this transfer of assets or 'associated operations' and an individual ordinarily resident there has 'power to enjoy' (again a term of the widest scope) that income, then it is to be attributed to him, so that he will be taxable on the attributed amount.
The scope of section 739 is limited by section 741 which stipulates that a bona fide commercial transaction not intended to avoid tax (and tax in this context almost certainly includes inheritance tax - see also subsection 1A(b) of the section) will not be caught by the charge. There is another exception which applies to the non-domiciled individual. In normal circumstances, a non-domiciliary is not charged to tax on overseas employment income and income within Cases IV or V of Schedule D unless the income is remitted into the United Kingdom. So to be consistent with this rule, it is stipulated in section 743(3) that an individual will not be attributed with taxable income under section 739, unless he would have been taxable on that income if it had accrued directly to him.
Relevant to non-domiciles
Section 739 is directly relevant to everyday tax work on behalf of the non-domiciled. It means that the familiar segregation of overseas capital and income (to enable only capital, and not income, to be brought into the United Kingdom) can apply to income arising to assets held within non-United Kingdom trust and/or company structures as it applies to income arising directly to a non-domiciliary from his overseas assets. Trustees can, for example, operate abroad split capital and income bank accounts as effectively as the beneficiaries personally.
Apart from these legislative exceptions, the well-known case of Vestey v Commissioners of Inland Revenue 54 TC 503, ruled that income which arises to a non-resident or non-domiciled person can be taxed only on the transferor (i.e. of the transfer of assets giving rise to that income), and then only if the transferor or his spouse is not excluded from benefiting from that transfer of assets. This limitation established a need to deal with structures such as trusts where the settlor and spouse are both excluded from benefit, but where capital payments and other benefits not taxable as income are receivable by beneficiaries ordinarily resident in the United Kingdom. The forerunner of what is now section 740 was introduced in Finance Act 1981 in order to plug the gap and, if anything, gives rise to more problems for non-domiciliaries and their advisers than section 739 itself.
Left-over income
Section 740 is directed at income not caught by section 739. It applies to income which arises from transfers of assets where someone ordinarily resident in the United Kingdom (not the transferor) receives a non-income 'benefit provided out of assets which are available for the purpose by virtue or in consequence of the transfer or of any associated operations'. Non-income benefit includes not only capital payments but also benefits in kind, such as rent-free occupation of United Kingdom accommodation. Again, section 741, the escape for bona fide commercial transactions not intended to avoid tax, applies to section 740 as it does to section 739.
There is a fundamental difference between the charges to tax under section 739 and under section 740. Section 740 taxes a donee on non-income payments or benefits received by him to the extent that such payments or benefits can be matched with non-distributed income arising to the non-United Kingdom person (usually an offshore trust or company), whereas under section 739, the transferor is taxable on income which arises to the non-United Kingdom person whether or not it is paid out. At first sight, section 739 is the more onerous because a section 740 charge is limited to what is actually received, and not to the total amount arising.
Treatment under section 740
Given this fundamental difference of approach, how are non-domiciliaries treated under section 740? Section 740(5) indicates that a non-domiciled donee will not be taxed on any payment or benefit not received in the United Kingdom (note that the term 'received' is extended to include so-called 'constructive remittances' within section 65(6) to (9)). On the face of it, the advice to a non-domiciled non-transferor beneficiary is straightforward: make sure your capital payments are received and retained outside the United Kingdom, and are not brought in. However, this puts him at a fundamental disadvantage compared to a transferor who is taxable under section 739: a non-domiciled transferor can receive capital in the United Kingdom and not be taxed (provided that the capital is not tainted by income). So under section 740 the donee may be significantly worse off.
All this is because section 740 does no more than match capital receipts with overseas income. To receive the capital in the United Kingdom is in effect to have received the income with which it has been matched. It does not matter that the income has been rigidly segregated from capital, and that the capital sum received in the United Kingdom has actually come out of pure capital. Section 740 can therefore catch the unwary, and I have seen situations where the overseas trustees are totally unaware of the section 740 charges which have been building up. A typical case is illustrated in the following Example.
Example

A non-domiciliary living abroad sets up a Jersey trust for the benefit of his adult son and grandchildren who live in the United Kingdom. Some of the funds are applied by the trustees in purchasing a house in the United Kingdom, probably through an underlying offshore company, to be occupied rent-free by the United Kingdom-resident beneficiary. The remaining funds are invested by the trustee, and the income therefrom accumulated.

On the face of it, a charge to tax under section 740 arises, whether or not the beneficiary is domiciled in the United Kingdom. It may be that the settlor of the trust had no tax avoidance motive in mind when he made his transfer of assets (being the settlement of funds on the trustees). Suffice it to say that the Revenue is averse to accepting the section 741 defence, particularly where overseas trust/company structures have been set up in recognised tax havens.
Mitigation tactics
The wide ambit of section 740 does make tax planning difficult, but there are some means of mitigating or avoiding the charge.
Who should be the settlor?
Section 739 can be more straightforward than section 740. If, in the above example, the father had given funds directly to his adult son living in the United Kingdom, who had then decided to create the offshore trust for himself, then the son would be the transferor, and would fall within the scope of section 739 rather than section 740. As such, he could segregate income arising abroad, and not remit it, and there would be no income tax on the benefit of his rent-free occupation of the property. It often makes sense to arrange matters so that the income of the offshore structures is potentially within section 739, rather than section 740. One would need to be sure that the father is not indirectly the settlor, as the provider of funds for the settlement, and also that the various steps cannot be associated.
Who should receive trust distributions?
It follows that, if the father as settlor were to have retained an interest in the trust, and he would like to gift funds to his son in the United Kingdom, then the trustees could make a distribution to the settlor abroad. Later on he could make a personal gift to his son preferably (for inheritance tax reasons) outside the United Kingdom. The son could then remit.
Also prior capital distributions can be made to non-resident beneficiaries of the trust. In this way accumulated income will be matched with those earlier distributions, so that the United Kingdom resident beneficiary could avoid the benefit of rent-free occupation being matched with the non-distributed income of the trust.
One trust or two?
In the above example, a separate settlement could have been used to buy the property, distinct from the settlement which would be investing the remaining funds. I understand that the Revenue would not in normal circumstances try to match a capital payment or benefit received by a beneficiary of one trust with income accumulated within a separate trust.
Income stripping
There is one other option open to the trustees, which is to strip out the income of the trust as it arises. This can be illustrated further, using the following facts.
An Israeli-resident non-domiciliary creates a Jersey trust in favour of his adult granddaughter who is resident (but not domiciled) in the United Kingdom. The trustees use a proportion of the settled fund in purchasing, through an underlying offshore company, a house for granddaughter to occupy rent-free in the United Kingdom. The trustees invest the balance of the funds in income-yielding overseas investments.
If the income arising to the trustees accumulates, then the benefit of rent-free occupation of the property will be matched with that accumulated income and taxed on granddaughter. So the response should be to strip out all income from the trust as it arises (i.e. in the same tax year) by paying that income to the beneficiary outside the United Kingdom. She will then either spend that income abroad or retain it there within a personal bank account.
This will leave her free to receive in the United Kingdom non-income payments or benefits from the Jersey trust or company. Assuming that the investment of cash funds (in excess of the price paid for the house) takes place within the underlying company, the income would be distributed as a dividend to the trustees and that dividend then paid outside the United Kingdom to the beneficiary.
These suggestions are sometimes easier to write about than to implement in practice. They require that the offshore trustees (who will invariably act as or provide the directors of the underlying company) must not only be technically aware, but also must ensure that these distributions to the beneficiary are made within the tax year in which the income arises. If that distribution is not made within the tax year then it could be said of that tax year that there is non-distributed income which could be matched with the non-income payments or benefits received by the beneficiary in the year concerned. These are points not always remembered in busy offshore trust offices.
Four final points
The settlements legislation
Income arising to trustees of settlements, whether or not resident in the United Kingdom, may in some circumstances be attributed to the settlor under the 'settlements legislation', in particular by section 660A, subject to the exemption for non-domiciliaries in section 660G.
Capital gains
Capital payments and benefits received by beneficiaries of foreign settlements can sometimes be taxed on those beneficiaries under section 87, Taxation of Chargeable Gains Act 1992, although not if the beneficiary is domiciled abroad.
Schedule E
Rent-free occupation of company-owned properties may sometimes have Schedule E implications which should be borne in mind. These are, however, beyond the scope of this article.
Relevant income
Finally, for the sake of clarity, I have referred to non-income payments and benefits being matched with 'non-distributed income' of the trust. The legislation actually refers to 'relevant income' and its precise wording, particularly at section 740(2) and (3), needs to be carefully considered before advising clients in particular situations. In particular, it must be income which can directly or indirectly be used for providing a benefit to the individual to be taxed under the section.
David Jeffery MA, MSc is a director of WJB Chiltern (Isle of Man) Ltd, taxation consultants of PO Box 238, Douglas, Isle of Man IM99 2EP. He can be contacted on tel: 01624 618467.

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