Opportunities for Guernsey trust business in the US/UK market place 19 October 2016 www.forsters.co.uk www.forsters.co.uk
Disclaimer This presentation reflects our understanding of US tax issues based on our experience but, for the avoidance of doubt, neither of the presenters nor any member of Forsters LLP is qualified to give US tax advice and this presentation does not constitute US tax advice. www.forsters.co.uk
Agenda • Fundamentals of US taxation affecting trusts and individuals • Differences between US and UK trusts and their taxation • What are the "throwback rules" and why are foreign trusts so bad from a US perspective? • Foreign grantor trusts and why this can be a growth area for Guernsey trust business? • Retaining trust business in Guernsey after the death of the settlor of a foreign grantor trust through a PTC arrangement with a US CSP • Questions? www.forsters.co.uk
Fundamentals of US taxation affecting trusts and individuals • “Grantor” trust: transparent for US income tax purposes • “Non - grantor” trust: separate taxpayer for US income tax purposes • “Grantor” trust becomes “non - grantor” on the death of the settlor www.forsters.co.uk
Fundamentals of US taxation affecting trusts and individuals • US citizens and US residents subject to US income tax on worldwide income • Non-US citizens treated as US resident for income tax purposes if: • a “lawful permanent resident” of the US (i.e. a “green card” holder); • meet the “substantial presence test”; or • elect to be treated as US income tax resident. • Top Federal income tax rate in 2016 is 39.6% (up to 20% on long-term capital gains and qualifying dividend payments) • 3.8% “ medicare tax” • State and local income tax also need to be considered • Non-US citizens and non- US residents (“non - resident aliens” or “NRAs”) subject to US income tax on certain US source income and income effectively connected with a US trade or business www.forsters.co.uk
Fundamentals of US taxation affecting trusts and individuals • Individuals become US resident for income tax purposes under the "substantial presence test" where they are physically present in the US: • for at least 31 days in the relevant calendar year; and • for 183 days or more during that calendar year or during that year and the two calendar years immediately preceding it, counting: • all days of residence during the current year; and • 1/3 of the days of residence during the preceding year; and • 1/6 of the days of residence during the year before that preceding year. • “Closer connection statement” www.forsters.co.uk
Differences between US and UK trusts and their taxation • A trust is a foreign trust for US purposes unless it satisfies both the court and the control test: • the " court test " (i.e. that a court within the US is able to exercise primary supervision over the administration of the trust); and • the " control test " (i.e. that one or more US persons have the authority to control all substantial decisions of the trust). • Contrast with UK residency rules for trusts www.forsters.co.uk
Differences between US and UK trusts and their taxation • Grantor trust • US settlor: settlor subject to US tax on trust’s worldwide net income and gains • Non-US settlor: settlor only subject to US taxation on certain US source income • Distributions to beneficiaries not subject to US tax (though US reporting requirement if distribution over US$100,000 to a US person) www.forsters.co.uk
Differences between US and UK trusts and their taxation • Non-grantor trust • US trust: trust subject to US tax on trust’s worldwide net income and gains • Distributions to both US and non-resident alien beneficiaries are taxable on them (with trust entitled to a tax deduction) • Foreign trust: trust only subject to US taxation on certain US source income • “ Throwback rules” on distributions to US beneficiaries www.forsters.co.uk
What are the "throwback rules" and why are foreign trusts so bad from a US perspective ? • They penalise the distribution from foreign non-grantor trusts (including Guernsey resident trusts!) of accumulated income and gains realised in previous years to US persons • Under the “throwback rules”: • distributions taxable regardless of whether comprised of non-US or US source income or gains; • distributions taxable at ordinary income rates; and • subjected to an interest charge which makes the effective tax rate confiscatory after approximately 10 to 15 years of accumulation. • Very broadly, a US equivalent of the UK s91 TCGA additional CGT rate for accumulating stockpiled gains – except much worse! • Distributions to UK resident beneficiaries will be subject to double tax (difficulties in getting tax credit) www.forsters.co.uk
Foreign grantor trusts and why this can be a growth area for Guernsey trust business? • Conditions for a trust created by a non-US person to be a grantor trust for US purposes: • distributions of income or capital can only be made to the settlor or his spouse during his lifetime; or • the trust is revocable by the settlor (or revocable with the consent of a related or subordinate party who is subservient) to the extent that the trust is funded by him. www.forsters.co.uk
Foreign grantor trusts and why this can be a growth area for Guernsey trust business? • If properly drafted, foreign grantor trusts offer the following advantages during the settlor’s lifetime: • no US reporting while the trust has no US source income/directly held US assets; • no “throwback rules”; • trust assets receive free step- up in basis on the settlor’s death; • free step-up in basis of assets held in underlying companies can also be achieved on the settlor’s death; • distributions to US person beneficiaries not subject to US taxation (though US reporting requirement for the beneficiary if over US$100,000); and • other than above, if no US source income then no US reporting requirement. • Demonstrating an understanding of US trust issues will enable Guernsey corporate service providers to obtain business from clients looking to establish foreign grantor trusts www.forsters.co.uk
Retaining trust business in Guernsey after the death of the settlor of a foreign grantor trust through a PTC arrangement with a US CSP • Where the grantor of a FGT dies there is a US tax requirement to either: • Manage throwback rules by paying out income and capital gains to beneficiaries every US tax year – often not terribly desirable! OR • Set up a US domestic trust and pay the income and capital gains to it every year; OR • Domesticate the trust into the US i.e. convert the trust into a US domestic trust that satisfies the Court and the Control tests www.forsters.co.uk
Retaining trust business in Guernsey after the death of the settlor of a foreign grantor trust through a PTC arrangement with a US CSP • If the trusteeship is transferred to a suitably organised US incorporated PTC the Control test is satisfied • A Court Order is obtained to confirm that the Court test is satisfied • The day to day trust administration can be done from Guernsey • Business is retained that would otherwise be lost! www.forsters.co.uk
Decision Tree when confronted with an existing trust Is the trust a Grantor Trust? Yes No Is the settlor a US person? Is the trust a US Trust? No Yes Yes No • • only subject to US subject to US taxation taxation on US source on the trust (if income accumulated) or on All trust assets and Penal “throwback rules” • distributions to US the beneficiary (if income are deemed to be apply when distributions persons are not distributed) owned by and taxed to of UNI are made to US • subject to US taxation issues exist in getting the Settlor. beneficiaries (but are reportable if tax credits on in excess of distributions to UK US$100,000) resident beneficiaries www.forsters.co.uk
Points to take away … • US clients: embrace or avoid? • Not always possible to avoid US clients but embracing them combined with an understanding of the key issues yields new business • Understand the grantor vs non-grantor distinction • Foreign grantor trusts have minimal US issues during the grantor's lifetime • With planning, trust business can be retained after the grantor's death www.forsters.co.uk
Questions? www.forsters.co.uk
Contact Patrick Harney Partner, Head of Private Client, Forsters LLP T: (+44) 020 7863 8588 M: (+44) 07824 639 205 E: patrick.harney@forsters.co.uk Jeremy Robertson Solicitor, Forsters LLP T: (+44) 020 7863 8527 M: (+44) 07557 259 451 E: jeremy.robertson@forsters.co.uk www.forsters.co.uk
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