We have already seen some of the tax advantages of trusts for non-domiciled individuals. Offshore trusts used to be established by domiciled individuals as well.

A trust or settlement is a legal relationship that is established when a person (settlor) transfers assets into the care of others (trustees) for the benefit of a third party (beneficiaries). In some circumstances, a settlor can be a beneficiary as well.

Offshore trusts became popular in the UK as a result of the high taxation regime of the 1970s and they proliferated during the 1980s. But successive changes to the UK tax regime in 1992 and legislation in 1998 greatly reduced the creation of offshore trusts by UK resident and domiciled individuals or the migration of onshore trusts overseas.

This was because the government imposed a capital gains tax charge on trustees who retired in favour of non-resident trustees. CGT was also imposed on UK resident and domiciled settlors on gains subsequently made by the offshore trust. Other changes included extending the period for which a beneficiary needed to go abroad to take untaxed capital gains from one to five years.

Further changes in 2006 are likely to see a continued reduction in the use of trusts generally by UK domiciled individuals for succession planning purposes. Assets being passed to interest in possession and accumulation and maintenance trusts above the nil rate band (£285,000 in 2006-07) will be subject to a 20% IHT charge. Every 10 years, there will be a 6% tax charge on assets within trusts above the nil rate band. This brings these trusts in line with discretionary trusts. These tax charges do not apply to non-domiciled settlors of offshore trusts.

The asset protection features of offshore trusts have been highlighted by high-profile divorce cases in the UK. Trust assets have to be disclosed on divorce, including an interest in a discretionary trust. The court can take into account a trust interest as a resource without making an order against the trust itself.

English matrimonial judges also have powers to vary many UK and offshore trusts, which can include settlements established before the marriage. Trusts located in the Channel Islands will generally be vulnerable to complying with an English court order. But other offshore jurisdictions, including Bermuda, the Bahamas and the Cayman Islands, have “exclusion of foreign law” legislation. Broadly speaking, this says a trust governed by the local law is not affected by any rights conferred on anyone under a foreign law and are therefore less likely to be varied by an English court order as part of a divorce settlement.

The choice of jurisdiction for locating trusts is becoming increasingly important if it means a UK matrimonial judge is less likely to be able to vary the terms of a trust in Bermuda, the Bahamas and the Cayman Islands than the Channel Islands.

Notwithstanding this, a court may choose to make an order for financial provision against a settlor/beneficiary and simply leave him to address the problem of accessing the funds with which to meet his obligations.

A growing number of UK resident but non-UK domiciled families have children and assets located around the world. For tax planning reasons and ease of management, it may be advisable to hold all of these in an offshore trust. The person establishing the trust can gain greater control over succession planning. The practical aspects are equally attractive to UK domiciled persons but the tax disadvantages generally make this an unattractive option.

It may be possible for trusts to protect assets against forced heirship rules. These rules exist in some jurisdictions, especially in continental Europe, and provide that on death a part of your estate passes automatically to all your children (and sometimes, but not always, partly to a spouse) even when there is a Will. Whether the trust protects assets from forced heirship will depend on the local trust and conflict of interests laws and where the assets are located. For example, if a child lives in France but assets are held in a Cayman Islands trust and are physically located outside France, it is questionable whether France could enforce the forced heirship rules in this case. But if assets include property in France, it is easier for the rules to be enforced.

Holding worldwide assets in an offshore trust may in some cases simplify the process of probate on your death. If you held assets in 20 countries in your own name then on your death a grant of probate would have to be sought in each of these 20 countries. This is not the case if they are owned by the offshore trust, which would continue to own the assets after your death. Care needs to be taken, however, since not all countries will recognise trusts and furthermore they may impose penalty taxes when assets are held through such a structure. Carefully integrated planning for each jurisdiction is essential.

Asset protection and succession will be discussed further in chapter 10.