Using an offshore trust & company combination tax efficiently
The benefit of using an offshore company to conduct a foreign trade is that if the company is non resident it will be exempt from UK corporation tax on the profits from that trade. UK resident (and domiciled) shareholders will still be taxed if they extract any cash from the company, but provided they kept it in the company, in principle they’d be able to avoid UK tax completely. There are however a number of obstacles to achieving this.
Problems with using an offshore company to carry out a foreign trade
Firstly there’s the problem in establishing the company as controlled from overseas. If it’s not it would be UK resident and subject to UK corporation tax on the profits of the foreign trade. It’s therefore essential that the company is controlled from overseas.
As discussed in ‘Central management and control – QC’s view’ and ‘Questions HMRC ask to assess company residence’ you’d need to ensure that the top level management decisions were carried out overseas. This is even more so where a company is owned by a couple of shareholders (rather than being a subsidiary for instance). For directly held offshore companies the risk is always that the UK resident shareholders will interfere in the decision making process which could lead to the company being UK resident. Secondly there’s the anti avoidance rules. In particular the transfer of asset rules apply to the straightforward situation where an individual incorporates a trading company based in a tax haven to avoid UK tax. This will then tax the income of the offshore company on the UK shareholder who actually set up the company (see ‘The income tax anti avoidance rules’ )
However, it doesn’t apply in all circumstances. There is firstly the motive defence where there is a genuine commercial reason for using the company and there is no tax avoidance motive. This defence could apply where for example a local party is to have a stake in the foreign business and it’s a term of his involvement that the company is based in a specific low tax jurisdiction
Thirdly there is the fact that the CGT anti avoidance rules can attribute capital gains of the offshore company to UK resident shareholders (see ‘CGT anti avoidance rules’)
Fourthly there are the problems in terms of actually extracting profits back to the UK. The key options are either:
- Selling the company
- Liquidate the company
- Pay a dividend
Each of these will be potentially subject to UK tax for a UK resident shareholder.
- A sale would be subject to capital gains tax
- Dividends will be subject to income tax
- A liquidation would be taxed under the transfer of asset provisions
So why use an offshore trust structure?
Using an offshore trust to hold the shares in the offshore company can help to eliminate some of these problems.
In order to avoid the transfer of asset provisions which tax income of the offshore company on the shareholder you’d need to use a trust with the settlor or shareholder and his spouse excluded from benefiting from the trust. There is also the ancillary benefit that using an offshore trust to own the shares makes it more difficult to argue that the company is controlled from the UK. This can make establishing non residence easier.
Therefore in many ways the preferred way to trade overseas would be to use an offshore company owned by an offshore trust with the settlor and spouse excluded from benefiting from the trust.
In terms of capital gains you’d need to exclude a wider class of people to avoid the capital gains being attributed to the person who settled the trust.
The key problem of course is that the settlor/spouse need to be excluded. There are ways around this. For instance this problem may be avoided if the initial trust is settled by another individual (eg parents for instance).
The settlor could also use even remoter relatives if they wanted capital gains to be excluded from the attribution to settlor rules.