INTM603320 - Transfer of assets abroad: Non-domiciled and deemed domiciled settlors from 6 April 2017: Definition of PFSI for purposes of ITA07/S727

For the purposes of determining what income comes within the charge to tax at ITA07/S727, as set out in Rule 2 of ITA07/S728(1A), protected foreign-source income (PFSI) is defined in ITA07/S729A.

There are two definitions of what constitutes PFSI:

  • one relates to the income arising in a non-resident trust, and
  • the other refers to income arising in an underlying company of a non-resident trust.

PFSI in a non-resident trust

Looking first at what constitutes PFSI in a non-resident trust, there are a number of conditions that must be met:

  • if the income had arisen to the individual, then it would have been treated as relevant foreign income as defined in ITTOIA05/S830
  • for the purposes of the transfer of assets abroad legislation, the person abroad receiving the income is the trustee of a settlement
  • the trustees are not UK resident for the tax year in question
  • when the settlement was created, the settlor was not UK domiciled and if the settlement was created on or after 6 April 2017 then the settlor was not UK deemed domiciled
  • no property or income is provided (directly or indirectly) for the purposes of the settlement by the settlor (or the trustees of any other settlement of which the settlor is a beneficiary or settlor) at any time in the period beginning with 6 April 2017 (or, if later, the date on which the settlement was created) and ending at the end of the tax year in question at a time when the individual is domiciled or deemed domiciled in the UK.

The condition referred to in the fifth bullet point above is referred to as tainting and ITA07/S721B looks at what constitutes the addition of property for the purposes of the tainting of a trust (see INTM603360 for further information on tainting).

It should be noted that this condition only applies to individuals who have become UK deemed domiciled under Condition B of ITA07/S835BA (see INTM603220), and it does not apply to non-UK domiciled individuals who are able to continue to add property to a settlement up to the time that they become deemed domiciled.

The tainting of a trust means that the protections afforded by PFSI will no longer apply to the settlement, and all of the income of the structure will be assessable under ITA07/S727 as it arises.

Example 1

Liam, who is not UK domiciled, has been UK resident since 2001. He settled a discretionary non-resident trust for the benefit of his son with capital of £100 in 2010. Liam was irrevocably excluded from being a beneficiary of the trust. To enable the trust to accumulate funds for his son’s benefit he made an interest free loan to the trust of £500,000 in 2010.

The trustees invested

  • £250,000 of the funds in offshore investments that generate income of £10,000 per year, and
  • £250,000 in UK investments that generate income of £15,000 per year.

For the purpose of this example, it is assumed that the transfer of assets abroad legislation applies, and other potential taxing provisions are ignored.

As Liam has been excluded from benefiting from the trust, he does not have the power to enjoy the income arising to the trustees. However, by virtue of the loan advance made to the trustees, he is entitled to a capital sum and as such ITA07/S727 will apply. Consequently, an amount equal to the income of the trustees will be treated as Liam’s in each year that it arises.

Liam is a remittance basis user and so will be assessed on an arising basis on the UK source income of £15,000 per year for each of the years from 2010 - 2011 to 2016 – 2017. Liam will not be assessable on the £10,000 of foreign income arising in each of these years unless the income is remitted to the UK.

On 6 April 2017 Liam becomes UK deemed domiciled because he is a long-term resident under ITA07/S835BA (see INTM603220). As Liam settled the trust before he became UK deemed domiciled, the charge under ITA07/S727 will be restricted to the income that is not PFSI (this is assuming that the terms of the loan are altered to prevent the tainting of the trust (see INTM603380). Liam will therefore be liable to income tax under ITA07/S727 on the £15,000 of UK source income arising in the trust for the years 2017 - 2018 onwards. The income of £10,000 arising in respect of the offshore investments will be PFSI and so will escape tax under ITA07/S727. However, this income may be subject to a charge under ITA07/S731 (see INTM601400 onwards) should Liam’s son receive a benefit from the trustees that is matched with this PFSI.

PFSI in an underlying company of a non-resident trust

For underlying companies (there can be a group structure or chain) owned by a non-resident settlement, income will be PFSI for the purposes of ITA07/S728(1A) if the following conditions are met:

  • if the income had arisen to the individual, then it would have been treated as relevant foreign income as defined in purposes of ITTOIA05/S830
  • for the purpose of the transfer of assets abroad legislation, the person abroad receiving the income is a company
  • the trustees of the settlement are participators in the person abroad (or participators in the first company in a chain of 2 or more companies, where the last company in the chain is the person abroad and where each company in the chain - other than the last one - is a participator in the next company in the chain); a participator for this purpose has the meaning given by CTA10/S454: a person having a share or interest in the capital or income of the company.
  • the income has become the income of the person abroad as a result of the particular relevant transaction
  • the trustees are not UK resident for the tax year in question
  • when the settlement was created the settlor was not UK domiciled and if the settlement was created on or after 6 April 2017 then the settlor was not UK deemed domiciled
  • no property or income is provided (directly or indirectly) for the purposes of the settlement by the settlor (or the trustees of any other settlement of which the settlor is a beneficiary or settlor) at any time in the period beginning with 6 April 2017 (or, if later, the date on which the settlement was created) and ending at the end of the tax year in question at a time when the individual is domiciled or deemed domiciled in the UK. This particular condition is referred to as tainting and further details of how a trust can be tainted can be found at INTM603360.

Example 2

Noel, who is not UK domiciled, has been UK resident since 2000. In 2012 Noel settled a non-resident discretionary trust for the benefit of his son with £1,000. Noel was irrevocably excluded from benefiting from the trust. Noel also advanced an interest free loan to the trustees of £1,000,000.

The trustees used the £1,000,000 to subscribe for shares in O Ltd: an offshore company. The company used £500,000 of the funds to invest offshore. Noel’s son Damian wanted to start up a UK business, and the directors of O Ltd used £500,000 to subscribe for shares in a UK company B Ltd through which Damian could operate the business.

For the purposes of this example, it is assumed that the transfer of assets abroad legislation applies, and other potential taxing provisions are ignored.

In the years before 6 April 2017 Noel will be assessable on the income arising in the offshore company under ITA07/S727, as he meets the capital sum conditions and O Ltd is a person abroad for the purposes of the legislation. On the basis that he is a remittance basis user, he will only be assessable on the income of O Ltd from its foreign investments if that income is remitted to the UK as this income will be deemed relevant foreign income. If B Ltd pays dividends to O Ltd, these will be UK source income and Noel will be assessable on these under ITA07/S727 on an arising basis.

On 6 April 2017 Noel will become UK deemed domiciled because he is a long-term resident under ITA07/S835BA (see INTM603220).

In 2017 – 2018

  • the trustees receive no income from O Ltd
  • O Ltd, however, receives income from its overseas investments of £20,000 and it also receives a dividend of £50,000 from B Ltd.

The £20,000 investment income from the overseas investments will be PFSI and so will not be treated as income for the purposes of ITA07/S727.

The £50,000 dividend from B Ltd would not have been relevant foreign income if it had been received by Noel and this will be assessable on him under ITA07/S727.

This outcome is on the basis that the terms of the loan made to the trustees by Noel have been changed prior to 6 April 2018 to ensure that it is on arm’s length terms (as specified under the legislation). If the terms of the loan are not amended, then the trust structure will have been tainted (see INTM603400) and Noel will be assessable to income tax for 2017 - 2018 under ITA07/S727 on the total income of £70,000 arising in O Ltd.

Note

Where the settlor of the non-resident trust is UK deemed domiciled for a particular tax year, offshore income gains (OIGs: see the Investment Funds Manual at IFM12100 onwards) that arise within the trust or one of its underlying companies are not treated as PFSI and will be assessable on the settlor under ITA07/S727 in the year that they arise. This is because they are not considered to come within the definition of relevant foreign income. If there is a dispute about the treatment of OIGs, refer the matter to the Personal Tax International technical team in Liverpool (see INTM604440).