We are starting 2021 with purpose, hosting our first breakfast seminar in conjunction with Hotchkiss Associates.
Tax & investment considerations for new and long-term Isle of Man residents is free to attend; reserve your seat by confirming your attendance to firstname.lastname@example.org or call us on 660220.
In anticipation of this valuable seminar, we hope you enjoy our series of technical articles written by Paul Hotchkiss of Hotchkiss Associates and introduced by Natalie.
Trusts were made popular in Medieval times when landowners would appoint someone (who today we would call a trustee) to manage and maintain their land whilst off fighting in The Crusades.
These formal agreements were used to ensure the landowner got their land back on their return.
On a technical level, a trust separates the concept of legal ownership from beneficial ownership.
The trustee(s) legally owns the trust asset. The beneficial owner retains the benefit of the asset, for example, the use of the land or investment.
As you will read, trusts can be complicated, and for all their potential benefits, it can be easy to get wrong without professional assistance from experts such as Hotchkiss and Thornton.
To trust or not?
Clients often ask me the question of whether they should set up a trust.
The reasons can be many and varied: succession, asset protection, tax planning.
For Isle of Man residents, one would have thought setting up a trust is straightforward – find some willing trustees, engage a lawyer to draft the trust deed and hand assets over to the trustees: happy days.
The tax aspects are simple: Manx income tax on income at 20% and that’s it. Or is it?
Proceed with caution, your problems might start sooner than you think and can undoubtedly begin before income is generated.
The tax impact cannot be underestimated, overlooked or forgotten. When setting up a trust, what factors do we need to take into consideration?
1 – Domicile?
Put assets into trust if you are UK domiciled or deemed domiciled, and you might face an immediate inheritance tax (IHT) charge at 20% of their value. Domicile is critical, so you need to understand your status every time you put assets into trust; get it wrong, and you will pay tax.
2 – Location of assets settled?
Even if you are not UK domiciled and not UK deemed domiciled, if you settle UK situated assets into trust then you may suffer an immediate IHT charge.
Such assets can include UK investments, bank accounts, debts and shares and take care with Eurobonds.
3 – Who owns the assets to be settled?
If you own assets jointly with your spouse (e.g. money in a joint bank account), then settling that asset on trust will be a gift by both of you so you will be both settlors for UK tax purposes.
This can cause complications down the line, and you may need to remember where the assets came from.
4 – How assets should be owned by the trustees?
Own assets directly and tax charges can arise. This is very important, and the reason why trustees tend to own assets through an IOM company is to (a) limit their liability but (b) to avoid owning assets in specific jurisdictions directly (the UK is a prime example).
If UK assets are held directly, then IHT charges can occur periodically (e.g. every ten years).
5 – Residence status of the beneficiaries?
If your beneficiaries are solely Manx, then the trustee’s position might be straightforward. The problem with beneficiaries is that they sometimes change residence.
Changing residence can bring tax charges for the trustees but also the beneficiaries themselves. When your great-grandchild who is a beneficiary goes to Eton, the trustees need to be aware.
6 – Trustees?
Individual or corporate? Being a trustee carries with it a significant responsibility and can be onerous.
Corporate trustees are geared up to deal with most if not all the issues that trustees face so are a good choice; however, you need to have an eye on trustee fees and changes of personnel.
Take advice from suitably qualified lawyers and tax advisers and get to know your trustees.
What about a new arriver to the Island?
If you have a UK domicile of origin and have just arrived here, don’t even think about a trust.
You will keep your UK domicile for at least three years after you acquire a Manx domicile of choice. But when will that be?
This is where it gets tricky, and sometimes it is impossible to know when this new status is achieved.
It is best to take advice but don’t fall into the trap of setting up a trust after three years of residence: get the timing or your status wrong, and it will cost you.
Any assets you put into the trust will potentially result in an immediate IHT charge of a maximum of 20% of the asset value.
With care, some assets can be settled without a tax charge arising, e.g. exempt gilts or business property. Much depends on why you are setting up a trust, and in my view, it is best to wait until your status is irrefutably settled (and you may never be sure!) or abandon the idea and think of something else to achieve your objectives.
Long established IOM residents
If you and your spouse were born in the UK but have lived on the Island for many years, the idea of a trust can be quite compelling. Your reasoning may be succession, asset protection or tax planning.
If one spouse settles assets for the family, the tax position can be simple. The trustees will pay Manx income tax on income at 20%, no capital gains tax and no inheritance tax should arise.
However, there are a few pitfalls.
If trust assets are held directly by the trustees, then the trustees need to make sure they do not inadvertently own UK investments. This can happen very easily.
Investment managers often hold investments through their nominee companies. This looks like the assets are held legally and beneficially by a company, but they are not.
Trustees can become liable to IHT periodically if the assets the investment manager chooses are UK situs.
A further complication can arise if a beneficiary moves to the UK.
In these circumstances even if the beneficiary receives nothing from the trustees, if the trustees hold UK investments and receive dividend income, they will be subject to income tax on those dividends and need to file an income tax return with HMTC whilst the assets held are UK situate.
The trustees may not know where all the beneficiaries are resident, and the trustees may not wish to pay for tax advice to find out.
These reasons are why many trustees own their investments through an IOM company: the assets they own are the shares in the company itself, and those shares are outside the scope of IHT. Note it does not matter about the situs of the assets the company owns.
Furthermore, the trustees will not be liable to UK income tax on dividends. This can fix the problem but can also complicate the position.
A change of residence of beneficiaries, including the settlor or their spouse, will potentially bring a whole host of UK tax rules into play.
An example would be the scenario where a trust is established, the status quo is maintained for years, and all the beneficiaries are Manx resident.
One day the settlor, who was born in the UK of UK parentage dies, the children have moved to the UK, and the settlor’s spouse no longer wishes to remain on the Island. So he or she moves. It happens all the time.
From a tax perspective, the alarm bells should start ringing. Now the trust structure, which was reasonably benign from a Manx income tax perspective, falls firmly into the UK anti-avoidance rules.
Income and capital gains made historically can be brought into the charge to UK tax on distributions, and if you are the settlor, all income and gains might be taxed on an arising basis. You will have just walked into a minefield.
Manx born and bred
If you and your spouse are Manx born and bred, then the issues you may have to consider are much more straightforward.
You are both likely to have a domicile of origin on the Island, as will your children. Changes in residence for any beneficiary can have an impact but beneficiaries are likely to be non-UK domiciled and therefore in a better position than a family who have relocated to the Island.
Setting up a trust can make sense, but you will still need to be aware of the 6 points set out above.
For IOM tax purposes, trusts are generally best set up through the operation of your will. Depending on the objective, there may be reasons to establish a trust during your lifetime, but such action needs careful planning and thought.
The reason for a will trust is threefold: firstly, few people want to give up control of their assets to trustees during their lifetime (the idea of asking for money from an independent trustee who might say no may not sit well) and secondly, an individual’s domicile status is much clearer when they die: harsh but likely to be true and thirdly the trust will be more tax-efficient if there are likely to be UK resident beneficiaries.
What about trusts set up before you move the IOM?
It would be best if you spent a little time assessing your IOM tax position where trusts are set up in overseas jurisdictions e.g. Guernsey or Jersey.
Generally, the income tax division will only tax distributions made to the extent of income arising in the trust. However, you need to have an eye on the Manx general anti-avoidance rule (Schedule 1) or be careful about living off the trust fund.
If you are benefitting significantly from the trust structure and paying little or no Manx income tax, the income tax division may want to look at the structure in some detail.
If you are a beneficiary, settlor or trustee of a trust which is for the benefit of Manx residents, there is a great deal to think about, and you should take advice.
This will especially be so if you are acting as an individual trustee or where there are changes taking place such as the change of residence of beneficiaries, the death of a settlor or his or her spouse.
However complex a trust is, what is important is the end result and the purpose it is trying to serve.
How does this structure effect your ability to meet your future plans and/or life objectives?
What income might be produced?
What assumptions can be made around capital growth?
What investment portfolio is most suitable?
How long might the fund last?
What about the next generation of potential beneficiaries if it’s a family trust?
Financial Planning, including planning with trusts, can be easier to comprehend when using clear visuals.
Teaming technical expertise with financial planning and investment advice can get you to where you want to be financially.