Using a non resident trust and company to reduce tax
For the reasons stated in our previous article, offshore companies that are directly owned by UK residents are not actually that common in practice. Instead, offshore companies owned by offshore trusts are used more frequently. Such arrangements are often popular from a non-tax angle due to the practical advantages of owning the trust investments through one or more wholly owned offshore companies. This gives the trustees the benefit of limited liability.
The residence of the company is not a key issue in these circumstances as the only persons legally entitled to exercise control of the company are the non-resident trustees. However, following on from the Wood v Holden case, care would need to be taken to ensure that the company really is run by either the trustees or directors. If they were to stand aside and let a settlor/beneficiary give all the instructions, it could be contended that the company residence is the same as that of the settlor or beneficiary.
Provided the beneficiaries were non-resident, they would suffer no UK taxation charge on distributions from the trust, and the company/trust would also suffer no UK tax charge if the assets held were overseas assets. If the beneficiary is a UK resident, the main problem would be the UK anti-avoidance legislation. There are limited ways of escaping this, and if one of the exemptions applied (for example, the motive test), this could be claimed on the tax return. The motive test is an important aspect of one of the key anti-avoidance rules that attributes the income of offshore trusts and companies to UK resident individuals. The anti-avoidance provisions will not apply if the transfer overseas was not made for the purpose of avoiding tax or if there was a real commercial reason for transferring assets to an overseas company or trust.
Therefore for an individual to take advantage of this rule, and claim that income from an offshore company or trust should not be attributed to them, they would need to show that there was no tax avoidance motive in the transfer of any asset overseas and essentially that the companies were located overseas for sound commercial reasons. This can be a difficult provision to satisfy.
In order to be non-resident for income tax and capital gains tax purposes under the current rules the trustees would all need to be non-resident if the settlor was UK resident.
Example
Peter, a UK resident and domiciled individual wishes to purchase a business and property in Ibiza. One option would be to establish a trust, and transfer funds to the trustees. They would then either purchase the property directly, or via a wholly owned company.
The transfer of funds from Peter would, however, be a problem from an inheritance tax perspective. As Peter is UK domiciled, the settlement is an immediately chargeable transfer, taxable at 20% for amounts above £325,000 (this assumes that he has made no previous gifts). However, the advantage of using a discretionary trust route is that the property would then be excluded from his estate for inheritance tax purposes. The drawback is that the trust would be subject to a separate regime of UK taxation. For inheritance tax purposes, the trust is subject to UK inheritance tax if Peter was domiciled in the UK when the transfer was made. This would undoubtedly be the case.
In these circumstances one option to exempt the trust from UK inheritance tax would be for the transfer to the trust to be of 'relevant business property'. The transfer to the trust would then be exempt from UK inheritance tax, and the trust itself would not suffer an ongoing inheritance tax charge, as business property relief (BPR) would exclude the property from the inheritance tax charge. Relevant business property includes a sole trader business, assets used in a partnership and shares in unquoted trading companies. Therefore in this case it would be far better for Peter to purchase the business and property directly and subsequently transfer this to the trust/company.
Provided any transfer was made shortly afterwards, there would be unlikely to be a capital gains tax charge as any increase in value would be minimal.
The trust would then be exempt from UK inheritance tax as the assets transferred would qualify for Business Property Relief.
USING AN OFFSHORE COMPANY AND TRUST: NON-UK DOMICILIARIES
Many non-UK domiciliaries choose to use this structure to minimise their UK tax liabilities.
Example
Paul is a non-UK domiciliary and wishes to purchase a property in the Isle of Man (IOM). He decides to use an offshore company to own the property with 100% of the shares in the company owned by a non-resident IOM trust. The tax implications are as follows:
Capital Gains Tax
As non-residents the trust and company will not be subject to UK capital gains tax. Provided the beneficiaries are non-UK domiciled, any distribution to the beneficiary should be taxed on the remittance basis (provided they are subject to the remittance basis on their income and gains).
Income Tax
Any income distributions would be taxed on the remittance basis (provided this is claimed). There are anti-avoidance provisions in place so that income earned by the trust is not subject to UK income tax on beneficiaries, unless it is remitted to the UK (again provided the remittance basis is claimed). Inheritance Tax
The Isle of Man trust is only subject to UK inheritance tax on UK assets, as it was established by a non-UK domiciled individual. By using the offshore company to hold any UK property, there will be no UK inheritance tax on the property, as the trust will hold shares in an IOM company, which are treated as non-UK assets for inheritance tax purposes.
PERSONAL SERVICE COMPANIES
With the advent of email and the internet many people trading through UK companies are wanting to move abroad. One way for them to 'have their cake and eat it' is to use an offshore employment company.
Using this they would move overseas and become an employee of the offshore company. The offshore company would charge the UK trading company for the services provided to the UK company.
The UK company should be able to claim this expense as a tax deduction and the offshore company would receive income on which no tax would be payable. Funds could then be extracted from the offshore company by way of a dividend.
Multinationals use this on a larger scale and use offshore employment companies as a vehicle to provide expatriate staff, who work outside both their home country and the offshore jurisdiction, with almost tax-free remuneration.
Example
Paddy runs his own business through a UK company (Paddy Ltd). He is fed up with the British climate and taxes and decides to move overseas.
He settles in the Bahamas and establishes a company in Panama. He still provides services for Paddy Ltd and invoices the company accordingly. Assuming he is the only employee, and the company has profits of £200,000 before paying him, he may decide that the market rate for his services is £150,000 and raise an invoice for this amount from the Panamanian company.
The UK company's taxable profits will be reduced to £50,000, and the £150,000 received by the Panamanian company will not be taxed.
An alternative scenario would be for Paddy to remain an employee of the UK company and perform his duties overseas.
As discussed previously, a non-UK resident individual performing employment duties offshore will not be subject to UK income tax. National insurance should also not be due provided the individual is not UK ordinarily resident. As above, the company should also be allowed a tax deduction for the salary paid.
Note that in both of these situations it is absolutely essential that a market rate is used. HMRC has some complex rules known as the transfer pricing rules that could otherwise apply.
TRANSFER PRICING RULES
These rules apply where a UK resident is dealing with a non-resident and are intended primarily to prevent companies from manipulating prices to reduce UK taxable profits.
Without these rules it would be easy for a multinational group to arrange for its overseas companies to charge increased amounts for parts, stock or services so as to reduce taxable profits in the UK. Therefore when a UK resident is dealing with offshore entities, an 'arm's length' rate must be used. This means that if you move offshore and invoice a UK company or charge a salary, the rate you charge must be the same as what would be charged by an unconnected third party providing those services. You would also need to retain evidence of the third party rate, in case HMRC ever enquires into the matter.
Under self assessment it is for the company to establish and support the fact that an arm's length basis is used. However, HMRC accepts that there may be circumstances where establishing the arm's length rate will be difficult. The transfer pricing provisions therefore provide for a procedure known as 'advance pricing agreements' (APAs).
An APA is a written agreement between a business and HMRC which determines a method for resolving transfer pricing issues in advance of a tax return being made.
It's important to adhere to the provisions of the APA as not only are there potential penalties at stake, but the tax authorities could also restrict the deduction the UK company can claim if it is felt that you have charged an excessive amount.
Advanced offshore arrangements should be carefully considered. They frequently involve a complex interaction of many taxation issues, and professional advice will need to be taken.
In this book we look at a variety of tax planning strategies that arise from the terms of the UK's double tax treaties. This book is updated for the 2022 changes....keep reading
For many people the family home is the most valuable asset they have. As such protecting its value will be of key importance. In this tax guide we look at the key tax planning opportunities for the family home and private residences....keep reading
This brand new (December 2022) edition of our best selling offshore tax planning book tells you what you need to know to take advantage of offshore opportunities and slash your UK tax bill. It's a pretty comprehensive look at plenty of UK and offshore tax planning techniques including residence, domicile, emigration, using offshore companies and trusts, buying property overseas and much more....keep reading
Inheritance tax is a particularly nasty tax as it's a tax on your capital that you've accumulated from your after tax earnings. In this book we look at some of the top ways you can legally reduce your inheritance tax liability....keep reading
This book looks at a number of tax planning issues for company owners and considers both corporate and personal tax planning opportunities available. It is updated for the latest changes for 2022/2023....keep reading
Buy-To-Let ("BTL") landlords have to consider Income Tax, Capital Gains Tax, Inheritance Tax and Stamp Duty Land Tax on their property holdings. In this book we look at tax planning techniques that all BTL landlords can consider to reduce the amount of these taxes they pay....keep reading
This guide is essential reading for anyone providing digital or online supplies of goods and services. It looks at the international tax treatment from both an income tax/corporate perspective as well as VAT/GST....keep reading
The aim of this guide is to give context to the considerations for 99% of international tax planning scenarios. Without understanding the information contained here, you will find it very difficult to apply or structure any kind of tax planning to your international transactions/assets....keep reading