Regular readers will know that one of our favourite topics are the various offshore opportunities available to you. Because of the better global communications, easier transport, ability to work remotely, and the often cheaper overseas property prices many UK nationals are looking to flee the UK and set themselves up offshore in one way or another.

As well as the personal lifestyle benefits, one of the main driving forces is often the desire to avoid UK taxes, on future income.

If you become non UK resident by moving offshore avoiding UK taxes becomes much easier, however, another section of UK nationals are looking to use offshore opportunities to avoid UK taxes whilst continuing to live in the UK. This is something the UK taxman doesn’t like, as whilst there’s not much they can do about non UK residents, if you live in the UK they’ll do what they can to stop you reaping the offshore benefits.

What exactly are the offshore benefits?

Most of you will already know how the offshore angle can benefit you, however, just to recap you’re looking at the following;

So in other words an offshore company/trust could invest in Bulgarian property with no UK taxes on overseas rental income or any CGT on a future disposal. Given that UK taxes could knock out 40% of your returns this is a pretty big incentive. There are also other benefits such as increased privacy and ring fencing assets offshore away from potential creditors.

How do the anti avoidance rules work?

In terms of income tax, the key provisions are in S739-741 ICTA 1988, which provide for wide-ranging anti-avoidance powers designed to prevent the avoidance of Income Tax by individuals using offshore companies/trusts.

S739 would firstly need to be considered, and this applies to an individual who transfers assets, or who procures or is associated with a transfer by somebody else.

The conditions for application of Section 739 are:

If all of these conditions are fulfilled, the income which becomes payable to the offshore company/trust is deemed to be that of the individual who made the transfer, to the extent he has power to enjoy that income.

The first point to consider would be whether there would be a ‘transfer of assets’ by you. The UK tax authorities take a wide view of what constitutes a transfer of assets.

For example S739 may apply:

• where an individual transfers cash to establish a non- resident trust, or
• subscribes for the share capital of an offshore company, or
• where an individual transfers assets such as shares or property to a new or existing non-resident trust or other person or company abroad.

It can also apply where intangible assets are transferred; for example a UK individual may transfer his services to an offshore company.

The view of the Revenue is that a transfer may be made by way of sale or purchase of assets, or by way of gift.

However, one problem is that S739 doesn’t just apply where an individual transfer assets, rather it applies where an individual either transfers, or s associated with the transfer of assets. In particular, if the operations were contemplated as a single scheme they could be associated .

What constitutes an associated operation is complex, and is essentially a factual matter, however the legislation states that this includes

‘. an operation of any kind effected by any person in relation to any of the assets transferred or any assets representing, whether directly or indirectly, any of the assets transferred, or to the income arising from any such assets, or to any assets representing, whether directly or indirectly, the accumulations of income arising from any such assets. ‘

It’s therefore given an incredibly wide scope to essentially include any actions undertaken by you in relation to the trust assets in connection with the generation of income arising to the trust.

It’s also worthwhile noting that associated operations can also have a separate Inheritance tax consequences and in this case the Revenue define associated operations as two or more dispositions, of which:

Whilst the Inheritance tax definition is not directly relevant, it does give a good indication of the underlying purpose of the associated operation rule.

On the basis that the conditions above were satisfied, any income arising to the non resident trust can be taxed by S739, whether UK source income or foreign source income.

Note that one of the above conditions is that the UK resident must have power to enjoy the income arising to the non-resident (eg as a shareholder of an overseas company or as a beneficiary of a non-resident trust,). Even if you did not actually receive any income from the trust it is the potential to enjoy the income that is important. As such you would not have to actually receive any of the income at all.

The alternative provision is S740.

This applies where assets have been transferred abroad and a UK resident other than the settlor obtains a benefit. In order for this to apply the following conditions would need to be satisfied:

Section 739 is different from S740 in that it taxes non-transferors on benefits received.

Benefits chargeable by Section 740 include payments of any kind, for example cash (capital distributions), the use of property (e.g rent free occupation of a house), interest free loans, etc. Where the conditions are satisfied, the individual receiving the benefit is liable to tax on the amount or value of the benefit, (although the charge can be limited by the amount of past or future available ‘relevant income’ of the trust).

In practice S740 may not apply to a simple holding of shares in an offshore company receiving cash distributions from an offshore trust, as it only charged tax on the benefits received provided they are not otherwise charged to income tax. As such S740 would not apply to dividends from an offshore company or income distributions from an offshore trust, given they would be taxed in any case.

Even if there is a liability under S739 or S740 what impact this would have? It clearly applies so that income of the offshore trust is attributed to a UK resident person but S743 (2) appears to limit this in that it states:

(2) In computing the liability to income tax of an individual chargeable by virtue of section 739, the same deductions and reliefs shall be allowed as would have been allowed if the income deemed to be his by virtue of that section had actually been received by him.

This therefore allows the same deductions and reliefs as if the income was yours. The wording of this provision suggests that your actual deductions and reliefs can be offset against the deemed S739 income, and that if the trust satisfied the conditions for interest relief this relief should be allowed against either S739 income.

If this was the case, this could be a useful let out. Take the example of a UK individual raising finance to purchase overseas properties via an offshore trust/company structure. These financing costs could be significant, particularly if an interest only mortgage was used. Based on this any ‘net’ deemed income may in any case be minimal.

Another aspect that should be considered is that the legislation in S739 S740 applies unless you can show that the exemption in S741 applies.

In order for this to apply you would need to demonstrate either:

Actually persuading the Revenue that you can take advantage of this exemption can in practice be difficult.

S739 and S740 are essentially the main income tax avoidance rules and will catch many UK residents looking to use an offshore company or trust unless you can take advantage of the exemption or minimise the deemed income to an acceptable level.

The other main exception to these rules is that non UK domiciliaries would only be caught if the income was remitted to the UK. Therefore these anti avoidance rules do not cause a significant problem for most non UK doms.

There are some separate CGT provisions designed to catch UK residents who use offshore trusts and companies to dispose of assets free of UK taxes. We’ll look at these in another article.