REV BN 33: Countering Avoidance of Capital Gains Tax Using Offshore Trusts
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Who is likely to be affected? 1. UK resident and domiciled beneficiaries who receive benefits from offshore trusts. General description of the measure 2. The measure will protect substantial revenues at risk from an avoidance scheme designed to allow beneficiaries to receive payments from offshore trusts tax free by exploiting anti-avoidance legislation introduced by the government in 2000. Operative date 3. The measure is effective for capital payments made by trustees to beneficiaries from 9 April 2003. Current law and proposed revisions 4. The `beneficiary charge' is a Capital Gains Tax (CGT) charge on UK resident and domiciled beneficiaries of offshore trusts. It applies when they receive payments from trustees of offshore trusts to whom capital gains have arisen. The capital gains arising to the offshore trustees go into a pool, and when a payment is made to beneficiaries the pool is reduced by the amount of that payment. The beneficiary is then charged on the payment to the extent to which there is an equal amount in the pool to frank it. 5. There are provisions accompanying the beneficiary charge that apply an additional increase in tax charge to beneficiaries receiving payments from offshore trustees. This charge applies where there is more than one complete tax year between the gain arising to the trustees and the payment being made to the beneficiaries. 6. An anti-avoidance rule that accompanies the beneficiary charge is that if trustees transfer assets (e.g. cash) to another trust, gains in the pool of that trust go across to the other trust, so that capital payments from that other trust can frank those gains and thus trigger the beneficiary charge. 7. In Finance Act 2000 the government introduced legislation to counter avoidance schemes, known as `flip flops', which sought to avoid the beneficiary charge. One of the effects of the new legislation was to switch off the anti-avoidance rule described above in circumstances when the trustees make a transfer of value to another trust at a time when they have outstanding borrowing. Trustees to whom capital gains have arisen in the past, and who wish to distribute the proceeds to beneficiaries, are now attempting to trigger the FA 2000 legislation deliberately, by carrying out flip flop-style transfers, in order to trigger this `switch off' and thus allow a tax free distribution of the proceeds from the second trust. The Government does not accept that these new flip flop schemes work in all cases, but is putting the matter beyond doubt by introducing remedial legislation. 8. The Government is also taking the opportunity to correct a small anomaly arising from a CGT simplification measure introduced in Finance Act 2002. The FA 2002 measure enables a UK resident individual who is the settlor of a trust, and is chargeable to CGT on amounts attributed in respect of capital gains arising to the trustees, to set personal losses against those amounts. As a result amounts attributed to the settlor are equal to untapered gains. 9. The new measure counters the new scheme by building on the Finance Act 2000 legislation. Under the FA 2000 legislation, for trusts to which the beneficiary charge applies, a floating gains pool is created, and payments to beneficiaries from any of the trusts that are party to the flip flop transfers can frank gains in that pool and thus trigger a charge. This new measure extends this pool so that capital gains already realised by trustees go into it. Trustees will not be able to get round the new measure by carrying out a series of transfers between the same or to other trusts, because in those circumstances payments from any of the trusts that are party to the series of transfers will frank the gains in the floating gains pools. 10. The existing increase in tax provisions are also being extended so that they will apply to gains going into the newly extended floating gains pool. 11. The Government is also introducing a further measure to reduce avoidance possibilities created by the use of these highly artificial schemes. Currently, payments to all beneficiaries (including beneficiaries who are not chargeable under the beneficiary charge, for example because they are not domiciled in the UK) can frank gains in gains pools. But from 9 April 2003, the newly extended floating gains pool will be computed differently, so that only payments to beneficiaries who are charged to tax will reduce the pool. This rule will only apply to the floating gains pools and not to normal gains pools where there have been no flip flop transactions. 12. These new measures will also apply where beneficiaries receive payments or benefits from UK resident trustees and either offshore trustees previously acted, or funds have been transferred to a UK resident trust by offshore trustees. 13. In respect of the Finance Act 2002 simplification measure, the Government is introducing a small change to ensure that, where a beneficiary is chargeable under the Finance Act 2000 anti-flip flop legislation, and the amount charged is reduced by an amount already charged on a settlor, the amount by which it is reduced is the tapered amount rather than the untapered amount. Further advice 14. If you have any questions about this change, please contact the Public Enquiry Unit on 020 7438 6420 to 6425.
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