Taxation of Offshore Entities
Use of offshore entities to reduce taxation
Trusts and companies can be used to retain income or profits, thus deferring a tax liability until distributions are made, which could be at a time when the client's basic rate to tax has fallen
Offshore companies incorporated and managed and controlled in a law tax jurisdiction could hold the assets or undertake a specific activity. This allows the client to benefit from the non-resident status of the company
Anti Avoidance Legislation must always be taken into consideration
Anti-Avoidance Legislation: Legislation that has been introduced in order to minimise the opportunities to minimise taxation via the use of offshore centres particularly where the transaction has no purpose other than the minimisation of taxation
An example of how offshore trusts and companies have been used together to reduce a taxation liability is where funds are settled into a trust and then loaned on a commercial basis to an underlying company for the specific purpose of enabling the company to purchase a property to be rented out. When the rent is received, the cost of repaying the loan to the trust can be offset as an expense against the rent receipts thus reducing the taxable income of the company
Over the years, anti avoidance legislation has been introduced in onshore jurisdictions which is designed to reduce the opportunities available to residents or domiciled individuals to avoid taxation via the use of offshore entities by preventing certain types of financial activity from receiving favourable tax treatment
Every time one tax loophole becomes unavailable, tax specialists work hard to identify new opportunities. The UK Government has a difficult task in keeping up with the strategies that are devised, it has to balance legislation with rules that encourage wealthy people olive and remain in the UK and incentivise businesses to operate from within the UK
Taxation of Companies
Companies incorporated in the UK are usually considered to be resident in the UK
Foreign incorporated companies are considered to be resident wherever the central management and control actually abides (established by De Beers Consolidated Mines Ltd v Howe)
Significance of a company's residence
UK resident companies are subject to corporation tax on the whole of its chargeable profits on a worldwide basis
Companies that are not resident in the UK are liable to corporation tax only if they carry out a trade in the UK through a permanent establishment
Non resident companies may also be liable to UK income tax on non trading income
Management and Control
Where it is the case that management and control must be outside the UK for a structure to be tax efficient, it is very important that service providers explain this concept to the client
Providers must ensure the client understands that will not be able to take part in the management or decision making of the company
Offshore directors who simply follow client's wishes run the risk of allowing their client to become a shadow director. If such client is resident in the UK, it could be argued that the company is managed and controlled from within the UK and that the company should therefore be paying corporation tax on the whole of its profits on a world-wide basis
In some circumstances offshore directors have good reason to involve or take advice from the client, eg if they are an expert on the business the company is engaged in, and the client's opinions, contacts and general assistance to the directors
It is acceptable for directors to involve their clients, however the terms of such an arrangement should be documented, perhaps as a consultant where they are properly remunerated and not the client
Offshore directors will have taken some confront from the decision in the case Wood v Holden (2006)
Corporation tax
Taxable profits include profit form taxable income such as trading profits and investment profits and capital gains (known as chargeable gains)
Offshore service providers often appoint tax advisers to deal with the tax authorities and to complete corporation tax returns on their behalf
Companies resident in the UK are subject to corporation tax on the whole f their worldwide income and gains
Companies non-resident in the UK only pay corporation tax if it carries out a trade in the UK through a permanent establishment
Amount of tax payable is usually a percentage of the taxable profits
Taxation of trusts
Normally considered to be resident wherever the majority of its trustees are resident
If all trustees are resident outside of the UK, the trust will be considered UK resident
If there is a mixture of resident and non resident trustees, the trust will be resident unless the settlor was non-resident and non-domiciled
Trusts resident in the UK are liable to income tax on their worldwide income
Non resident trusts are treated differently depending on the type of trust and depending on the residence status of settlor or beneficiaries
Offshore trustees must ensure that the assets are properly vested in them and that they are in control of them
Trustees will need to consider their dealing with settlor beneficiaries in order to avoid any problems arising
Eg it may be better to charge the client a market rent for the use of a property thereby introducing funds into the trust
When a beneficiary receives distributions from the trust assets, this does not usually result in a liability on the trustees however it may result in a tax liability for the beneficiary
Trustees should consider the impact of taxation when decided whether to make distributions (and whether to distribute capital or income)
Beneficiaries should be informed they may be subject to tax on the distribution and be advised to take their own tax advice
In general capital distributions to beneficiaries will be free of liability to income tax whilst income distributions are likely to result in a liability. That said the tax authorities can view regular capital distributions as income, it is very important to keep income and capital separate
IHT tax charges
Gifts to discretionary trusts are chargeable lifetime transfers and immediately subject to an IHT charge of 20% over the nil rate band
IHT at the usual death rate will be payable if the donor does not survive for seven years after settling the trust
IHT would be due on the individuals death in respect of UK assets, if the individual was deemed domicile, IHT would be due in respect of their worldwide assets
If an asset is given away to an offshore trust but an interest is kept in the asset (eg a settlor settles their house into the trust but continues to live in it rent free) then this is known as a gift with reserving and is not a PET, and would still form a part of their estate upon death
Excluded property trusts
Those created by non-uk-domciled individuals with non-UK situs assets. Such trusts receive favourable IHT treatment
Non UK situs sets will be exempt from IHT to the extent that these assets are held within such a trust, in addition the ten year anniversary charge to IHT and the exit charges cane avoided depending on the extent that non UK assets are held in the trust
Ten year anniversary charge
The assets of discretionary (and some other trusts) may give rise to IHT charges every 10 years and a charge when the property leaves the trust
To the extent that an excluded property holds non UK situs assets these charges will not arise
Offshore administrators should diarise the consideration of what steps may need to be taken prior to the 10 year anniversary of trusts under their administration to reduce the IHT charge that becomes payable
Taxation of partnerships and foundations
Partnerships
Partners of a general partnership are required to pay income tax on their share of the partnerships profits
A nominated partner completes a partnership tax return showing each partners share of the profits or losses
With limited partnerships, limited partners are taxed on their share of the profits as if they had carried out the activity of the limited partnership alone
Although an LLP is regarded as a corporate body for tax purposes, it is treated in the same way as a general partnership. LLPs are transparent for tax purposes which means that they are not taxed in their own right
For CGT purposes the partners are charged on the disposal of their interests in chargeable assets of the partnership where gains arise
Instead each member is assessed for tax as if they were members of general partnership. They are treated as having carried on the activities of the LLP in proportion to their membership
Foundations
Incorporated bodies
UK law does not specifically deal with entities such as foundations
It is not yet clear whether HMRC will tax foundations as corporate bodies or as settlements for each of the mai
Tax advisers have stated that it is likely that the residence of foundations will be determined as if they were companies (where they are managed and controlled