A sweeping new tax regime that will create a minefield for U.S. citizens living in the United Kingdom is due to go into effect on April 6, 2008. And as the deadline approaches, U.K. lawyers and accountants are working feverishly to assess the options, particularly for those who will be hardest hit: foreign residents who are the beneficiaries of foreign trusts.
In many cases, the answer could be: foreign trusts making significant capital distributions to beneficiaries before April 6, 2008; winding up trusts; "importing" trusts to the United Kingdom; or even having foreign beneficiaries leave the United Kingdom.
But, of course, each trust must be assessed on its facts. For this reason, it is a matter of utmost urgency that practitioners alert affected beneficiaries about the pending law and consult U.K. professional advisors as soon as possible.
If action is needed, little time is left.
For over 200 years, the United Kingdom offered one of the most hospitable tax regimes for foreign residents, known as resident non-domiciliaries (RNDs).
RNDs were protected from tax on non-U.K. income and gains provided that these sums had not been brought into the United Kingdom. Planning techniques enabled RNDs to bring overseas income and gains into the United Kingdom tax-free. And trusts not based in the United Kingdom provided total protection from tax on gains even if the trust owned U.K. assets or the gain realized by the trust was remitted to the United Kingdom.
All these advantages will be swept away on April 6, 2008, when recently published draft legislation is scheduled to go into effect.
Indeed, the law will have an adverse impact in general terms on U.S. citizens residing in the United Kingdom. And the new provisions for RNDs who are beneficiaries of trusts look particularly severe. It cannot be stressed enough: All such trusts need to be reviewed immediately to determine the best course of action.
The changes we expect to see are:
Any person who has been a tax resident in the United Kingdom for seven of the previous nine tax years (which means anybody who has been living in the United Kingdom continuously on or before April 5, 2002) will be able to claim protection from U.K. tax on foreign assets only if they pay an annual levy of £30,000. This liability is payable in addition to the tax they are already paying on their U.K. income as well as taxes they will pay on any amounts remitted to the United Kingdom. Also, anti-abuse legislation has blocked all strategies RNDs traditionally have used to bring funds into the United Kingdom tax-free.
The most worrying development is that the legislation provides that the provision of a "capital payment" to a RND beneficiary will trigger a potential liability to U.K. Capital Gains Tax (CGT) regardless of whether the benefit is remitted to the United Kingdom or not. The term "capital payment" is widely defined to include any form of benefit. In addition to actual payments of principal from the trust, it also can include, for example, the provision of rent-free accommodation, interest-free loans or the provision of a guarantee. This legislation allows in some circumstances for previously provided benefits to be matched against future gains realized by the trust. There's therefore the potential for effectively retrospective taxation with these provisions.
How will these provisions impact U.S individuals?
The decision whether to pay the £30,000 is a tough one. There is a great deal of uncertainty as to the extent to which it will be possible for this sum to be fully credited against U.S. tax liabilities -- making the effective cost of paying the charge substantial. Also, even if the £30,000 is paid, U.S. trust beneficiaries still may be required to pay taxes.
Yet not paying the charge definitely will create difficulties. There are a large number of areas where the U. S. and the U.K. tax regimes are not aligned in terms of tax exemptions and in the treatment of entities (such as certain forms of trusts and limited liability companies.) Despite its recent renegotiation, the U.S./U.K. income tax treaty has a number of deficiencies that do not appear to deal effectively with all these issues.
The position in relation to the provision of benefits provided to trust beneficiaries looks to be particularly severe insofar as this would be one example in which the United States would typically tax the trustees (or the settlor) on gains realized, whereas the United Kingdom taxes something different: the provision of the benefit. The likely result: double taxation.
While it's possible that this legislation will be amended before Parliament enacts it, there is no cause to hope for such a deus ex machina. Indeed, Parliament is unlikely to even consider the matter until after April 6, 2008 -- by which time it'll likely be too late to take any action should the legislation be enacted as currently drafted.