When a US person moves to the UK they can bring with them connections to US personal or family trusts that lead to significant UK tax issues and tax bills. We frequently come across US expats who are UK resident beneficiaries of US trusts and have not declared interests in US trusts or distributions they have received to HMRC. In this article we look at five common UK tax issues we see for US expats and their trusts.
1. Making your trust UK resident
If you are the trustee of a family trust, your own personal trust or a foundation or charity, then you may make that trust UK resident by virtue of your own UK residence status – UK residence trusts pay tax on all income and gains at the very top rates as well as US tax (subject to tax treaties and foreign tax credit). A trust may only require one UK resident trustee to make the whole trust UK resident. More commonly where a trust was settled and funded only by a non-UK resident and non-UK domicile individual it would take all the trustees to be UK resident however this can happen more commonly than you might think. If you are a trustee and live in the UK it would be prudent to check the residence status of your trust.
2. What type of trust do you have
Trusts drawn up under US laws do not always correspond with equivalent types under UK laws. We see numerous types of US trusts, Family Trusts, Annuity Trusts, Life Insurance trusts, Revocable Living Trusts, Grantor Trusts and Non-Grantor Trusts and they all have different US tax treatments. Meanwhile we will need to determine how best to match a foreign entity to UK law and it could be treated very differently. As a starting point, is the trust even a trust at all under UK law, is the trust a substantive trust or a bare trust, where a bare trust is effectively transparent for income and capital gains tax but a substantive trust is not. Is the trust an interest in possession or is it discretionary, this will change how income is taxed. Is the trust subject to the relevant property regime or a qualified interest in possession for inheritance and capital gains tax. All these questions can usually be answered by reviewing the trust deed, the original document drawn up to create the trust.
3. Receiving a distribution
When a UK resident beneficiary receives a distribution from a US trust, we first have to determine whether it is income or principal (also referred to as capital). An income distribution will generally be wholly taxable in the UK and chargeable to income tax, sometimes with no foreign tax credit for US tax. A distribution of principal is much more complicated. For US purposes it is likely that there is no tax at all on a distribution of principal because the US trustees have been paying capital gains tax. It’s not uncommon for US expats to describe the money they received as an “inheritance”, which were it true would be tax free in the UK. Unfortunately a distribution of principal will first be matched to accumulated income and then to accumulated capital gains of the trust, determined under UK tax rules. The outcome is usually an unexpected and potentially significant UK tax bill.
4. Below market rate use of trust property
US expats also need to take care because use of trust property can also result in a deemed distribution, called a ‘capital payment’ for UK tax purposes. If your family trust owns a property in Florida or the Bahamas and you use that property for holidays say, then the market value rent equivalent, is the value of your deemed distribution and it is chargeable to UK tax. If you have received an interest free loan from the US trust in order to buy a UK property, then the interest HMRC determine you should have paid will be your deemed distribution each year. These distributions will be attributed to income or gains of the trust and chargeable to UK tax. Any structures of this nature should be reviewed by a UK tax adviser.
5. Even the US resident trustees could owe UK tax
If a US discretionary trust has a UK resident beneficiary then any UK source income it receives will be chargeable to UK tax at the trust’s rate. This is not the usual situation, where certain income such as dividends on UK shares would normally be exempt from tax for a non-resident trust. Additionally, any directly held UK situs property such as UK real estate, UK shares, or debts, including loans to a UK resident beneficiary could be captured by the UK IHT regime, which has a 10 year charge to tax on the value of relevant property and exit charges. There have been a number of changes to the IHT rules on UK residential property and loans that require particular care. As such, any non-UK trust should seek UK tax advice if they have UK resident beneficiaries.
Ingleton Partners have helped numerous US expats tackle the UK tax issues, pitfalls, and complexity of dealing with their US trust arrangements – including providing advice, making disclosures to HMRC and completing tax returns. Invariably, these structures have been set up solely for US estate tax or probate planning and are being caught by complex UK tax rules completely unintended. Please contact us if you think any of these issues might apply.
