Trusts are commonly used in the US for estate planning and to avoid the lengthy probate process. In our globally mobile world, the UK tax implications of such setups are often overlooked.
If the settlor, beneficiary, or trustee of these trusts is a UK tax resident, it is crucial to address any tax implications early on.
In the UK, we have complex rules for taxing distributions from overseas trusts, whether they are income or capital distributions.
The first step in determining whether these rules apply is to review the US trust deed (and any amendments) to see if a trust is created under UK tax law. Just because there is a US trust, does not necessarily mean that it will be considered a taxable trust in the UK.
If no trust is created, there will generally be no UK tax implications although there may be registration requirements in some circumstances.
If a trust is created, the tax implications can be complex and costly, both in terms of tax payable and professional fees for record-keeping and tax calculations. Keeping high-quality records early on can significantly reduce long-term fees.
Revocable trusts
Revocable trusts often do not create a settlement under UK tax law initially, but they may include clauses that create a trust upon the settlor’s loss of mental capacity or death. In the UK, changes in mental state rarely impact tax so can often be overlooked.
Distributions from a deceased US citizen
There is also a misconception that distributions from a deceased US citizen are simple inheritances for UK tax purposes. Many US trust deeds state that upon the settlor’s death, further trusts are created. Therefore, distributions from these subsequent trusts are considered distributions from an overseas trust, not simple inheritances.
Overseas Trusts
Once it has been established that a trust is created, understanding the UK tax implications of this can be complex.
If the beneficiary is entitled to income as it arises within the trust this is called an Interest in Possession and the beneficiary is taxed on the income earnt within the trust structure whether received or not. The income keeps it source which can be helpful for claiming foreign tax credits where these are available.
If the trust is not an interest in possession trust then it will be a discretionary trust. All distributions of income from a discretionary trust are taxed as such and do not keep their underlying source. This can be problematic for the claiming of foreign tax credits.
Capital distributions from overseas trusts are taxed according to how the distributions are ‘matched’ to underlying pools of undistributed income, offshore income and gains, and finally capital gains. This is highly complex and can be very difficult to quantify, especially if trust accounts have not been maintained.
Impact of the changes to the non-dom regime
Historically, non-UK domiciled individuals could use the remittance basis of taxation. This meant that any distributions not remitted to the UK were not taxed and as long as the distributions were kept out of the UK, could largely be ignored.
However, from 5 April 2025 the non-dom regime is abolished and is being replaced by the 4-year foreign income and gains regime. Once a beneficiary has been a UK tax resident for more than four tax years out of the previous ten, any distributions from offshore trusts will be taxable in the UK, whether remitted or not. This change may bring forward the point at which dealing with the trust is required.
Further, the changes in inheritance tax from 5 April 2025 have led to more complex situations for trusts where the settlor is considered a long term UK resident (i.e. having been UK tax resident for 10 out of the last 20 tax years).
Next steps
For any UK resident who is a settlor, beneficiary, or trustee of an overseas trust, understanding the tax implications is essential for proper planning. There are various planning opportunities available once the position is understood, and we can provide advice accordingly.
