INTM603400 - Transfer of assets abroad: Non-domiciled and deemed domiciled settlors from 6 April 2017: Exceptions to transactions ignored for tainting purposes

INTM603380 looked at situations where transactions which added property or income to settlements were ignored for the purposes of tainting the trust. This page looks at a number of exceptions to the rules on ignoring such transactions.

These exceptions concern scenarios where a loan has been made. In order for any exception to apply, it is important to note that the recipient of the loan must be the trustees of the settlement whose tainting position is being considered. Additional conditions exist for each exception and these are set out below.

The first exception

The first exception is where the following occurs:

  • a loan is made to the trustees of the settlement by the settlor, or the trustees of a settlement connected to the settlor, and
  • the loan is on arm’s length terms, but
  • a relevant event occurs.

A connected settlement for this purpose is one where the individual is either a settlor or a beneficiary.

ITA07/S721B(8) sets out when a loan is on arm’s length terms. This is when:

  • in the case of a loan made to the trustees of a settlement, interest at the official rate or more is payable at least annually; or
  • in the case of a loan made by the trustees of a settlement, interest is payable at no more than the official rate.

In such circumstances the principal of the loan cannot be ignored after the relevant event has occurred and it is to be regarded as having been provided for the purpose of the settlement at the time of the relevant event.

A relevant event occurs in the following situations:

  • capitalisation of interest payable under a loan
  • any other failure to pay interest in accordance with the terms of the loan
  • a variation in the terms of the loan such that they cease to be on arm’s length terms.

In relation to bullet point two above, HMRC will not seek to apply the tainting provisions for a minor failure to pay interest on time - as per Example 1 below where the payment was ten days late.

Example 1

In February 2020 Maria lends the trustees of the Maria 2019 Discretionary Settlement €250,000, repayable in quarterly instalments over 10 years. The loan carries interest at 3% per annum, payable quarterly in arrears. The official rate of interest in February 2020 is 3%. In 2023 the official rate of interest rises to 3.25%.

In May 2021 the trustees pay the quarterly interest due on the loan ten days late due to an administrative oversight. This would not be regarded as a failure to pay interest in accordance with the terms of the loan. The settlement would not be tainted, and the foreign-source income would remain protected.

Example 2

The facts are the same as in Example 1 above. From February 2022 the trustees do not pay the quarterly interest due on the loan on time. Payments are made between a week and several months late. This would be regarded as a failure to pay interest in accordance with the terms of the loan. The settlement would be tainted, and the foreign-source income would cease to be protected with effect from February 2022.

Example 3

The facts are the same as in Example 1. The trustees initially pay the interest in accordance with the terms of the loan but in June 2023 they request that the interest be payable annually with immediate effect. Maria agrees to the request and the terms of the loan are varied accordingly.

It is necessary to consider whether there has been a relevant event. There has been no capitalisation of the interest payable and no failure to pay it in accordance with the terms of the loan, but there has been a variation in the terms of the loan.

The interest rate of the loan has not changed at June 2023 and the interest is payable annually. The official rate of interest rose to 3.25% from April 2022. This did not cause the tainting of the trust at that time, but the loan as varied carries interest at below the official rate from June 2023. The principal of the loan is therefore treated as having been provided to the trustees at June 2023. The settlement is therefore tainted, and the foreign-source income ceases to be protected.

The second exception

The second exception can apply only where a settlor becomes UK deemed domiciled on or after 6 April 2017. Where a settlor does become so deemed domiciled, the time at which this happens is for these purposes called the “deemed domicile date”. The exception applies, subject to the matters set out below, where:

  • a loan has been made to the trustees of a settlement by the settlor (or the trustees of a settlement connected with the settlor)
  • that loan was made before the deemed domiciled date
  • the loan was not entered into on arm’s length terms, and
  • any amount outstanding under the loan on the deemed domiciled date (the outstanding amount) is payable or repayable on demand on or after that date.

In these circumstances the loan will be regarded as property directly provided by the lender on the deemed domiciled date for the purposes of the settlement.

However, if the deemed domiciled date is 6 April 2017, then there are transitional provisions, and the loan will not be considered to be property directly provided for the purpose of the settlement if:

  • the principal of the loan is repaid, and all interest under the loan is paid, before 6 April 2018, or
  • the loan becomes a loan on arm’s length terms before 6 April 2018 and
    • before that date interest is paid to the lender in respect of the period from 6 April 2017 to 5 April 2018 as if the arm’s length terms had applied for that period, and
    • interest continues to be payable thereafter in accordance with the terms.

Example 4

Tracy was born in Massachusetts, although her domicile of origin was in the UK. During her childhood her family emigrated to Western Australia, where she lived for many years. Tracy is married to an Australian citizen with whom she has three children. It is accepted that Tracy acquired a domicile of choice in Western Australia in early adulthood.

In March 2002 Tracy settled on the Hong Kong corporate trustee of the Tracy Children’s Settlement two investment properties located in Thailand, an investment portfolio of Australasian and Far Eastern listed shares and a substantial amount of cash held on deposit in Hong Kong. Tracy retained an interest in the settlement.

The trustees of the Grace 1983 Discretionary Settlement - of which Tracy is a beneficiary - lend A$1,000,000 to the trustees of the Tracy Children’s Settlement in October 2008. The loan is interest free and repayable on demand.

In early 2013 Tracy’s husband is offered a senior role at an investment bank based in London. The family move to the UK in March 2013, expecting to be there for five years. During 2017 Tracy’s husband leaves his job in order to start a business with two former colleagues. The business becomes successful, and the family remain in the UK beyond 2018.

Tracy does not become UK deemed domiciled for 2017 - 2018 as she was born outside the UK. However, she does become UK deemed domiciled in 2028 - 2029, having been UK resident from the tax year 2013 - 2014 onwards. Tracy’s deemed domiciled date is 6 April 2028, as she is UK resident for 2028 - 2029 and has been UK resident for 15 of the previous 20 tax years.

The trustees of the Tracy Children’s Settlement have repaid to the trustees of the Grace 1983 Discretionary Settlement A$50,000 of the loan outstanding, the balance being repayable on demand. The A$950,000 is an outstanding amount that is regarded as property directly provided for the purposes of the settlement on the deemed domiciled date. The Tracy Children’s Settlement is tainted for the year 2028 - 2029. The income that was previously protected foreign-source income ceases to be so with effect from 6 April 2028.

If the balance of the loan had been cleared before 6 April 2028 the Tracy Children’s Settlement would not have been tainted and, although Tracy would have been UK deemed domiciled, the income arising under the settlement would have remained protected foreign-source income. Alternatively, the terms of the loan could have been varied before Tracy’s UK deemed domicile date of 6 April 2028 so that it was on arm’s length terms.

Example 5

Charles was born in Belgium, where he grew up. His domicile of origin is Belgium, and he has never acquired a domicile of choice elsewhere, although he has lived in a number of countries.

In September 1987 Charles settled on the Guernsey corporate trustee of the Charles Property Trust a range of income-generating assets located outside the UK. Charles retains an interest in the settlement.

Charles loaned €1,000,000 to the trustees of the Charles Property Trust in November 2001. The loan is interest free and repayable on demand, but no repayments have been made.

In early 2002 Charles moved to the UK. Since then, he has lived in London but he does not intend to remain in the UK permanently or indefinitely. He is actively considering leaving in 2019 or 2020.

Charles becomes UK deemed domiciled in 2017 - 2018 because he is UK resident for the year and has been UK resident for 15 out of the previous 20 years. Charles’s UK deemed domiciled date is therefore 6 April 2017.

To prevent the trust becoming tainted, the terms of the loan are renegotiated: the trustees agree to pay interest on the loan at the official rate on an annual basis with effect from 6 April 2017. The trustees pay €25,000 interest to Charles on 31 March 2018 and continue to do so annually thereafter while Charles remains UK resident. The settlement is not tainted, and the foreign-source income will continue to be protected provided all the other PFSI conditions are met.