If It Looks Like A Duck, Swims Like A Duck And Quacks Like A Duck – The UK Taxman’s Approach To Civil Law Foundations

As a traditional – indeed, the original – common law jurisdiction, the UK has no history of explicitly recognising foundations within its legal framework nor has it made recent moves to change that.  However, in practice, the existence of overseas foundations involving UK residents cannot be simply ignored by the UK taxman since they involve their interests in assets – often generating income or capital gains.  As a result – and in the absence of a formal framework – the UK approach is to employ abductive reasoning to seek to determine how any given foundation should best be characterised within the UK’s own common law legal framework.  An exercise, in other words, in best approximation.  Given foundations are arrangements or vehicles to hold assets, the UK possibilities comprise different sorts of fiduciary relationships, or else maybe, characterisation as a company might be apt.

Perhaps the most significant difference between foundations and trusts is that foundations have a separate legal personality in their home jurisdiction – whereas trusts do not and are a set of defined relationships between human legal personalities.  At first instance, that would appear to suggest that foundations should always be treated in the UK as overseas companies.  However, in practice a substantive tax analysis of the sorts of foundations commonly established to hold private family wealth more often points to some sort of quasi offshore trust arrangement.

Civil law foundations are normally constituted to preserve family wealth and to ensure the smooth transfer of the entitlement to assets from one generation to the next.  As with a trust deed, the foundation By-Laws specify the parties for whom the foundation is holding the assets and as with many trusts they also specify for whom the foundation will hold the assets as the initial tiers of beneficial owners pass away.  Frequently, the initial primary beneficiaries are the people who established the foundation with their own wealth.  It is also common for the “founder” to have considerable control over the foundation – including the power to instruct the council to change the foundation terms.  Typically, therefore, foundations bear strong hallmarks for UK tax purposes of fiduciary relationships rather than companies and the question is then what sort of overseas trust they might best be characterised:

• In situations where the founder has retained de facto control over the assets and can procure them out of the foundation for their own use – that tends to point to a de facto bare nominee arrangement - where legal ownership might have been transferred to the foundation but absolute beneficial entitlement to the assets is retained;

• In situations where the founder intended to irrevocably give up any absolute future entitlement to the assets put into the foundation and for the assets to be held and managed by the council in accordance with their professional judgement for the benefit of the beneficiaries named in the By-Laws that would tend to point to some sort of “proper trust” – perhaps a discretionary trust or perhaps an interest in possession trust – depending upon the intention as to how the beneficiaries should benefit and whether the capital was to be preserved for the long-term or dissipated at the Council’s/de facto trustees’ unbridled discretion;

• Perhaps a hybrid characterisation where a founder retained absolute control and entitlement during their lifetime, but the foundation served as some sort of living Will whereby a “Will Trust” was created upon death with the secondary beneficiaries then having no such control over the assets and the actions of the Council/de facto trustees – an initial de facto bare trust then becoming a de facto discretionary trust or de facto interest in possession trust, perhaps.

These considerations can have a profound UK tax bearing on all concerned:

• Bare nominee arrangements are completely transparent for UK tax purposes – the same UK Income Tax and Capital Gains Tax consequences apply for UK residents who hold assets through nominees as would follow were the individuals to hold the assets in their own legal name – however, since nothing is settled on a proper trust there are no UK Inheritance Tax consequences for the individual concerned or for any trustees – beyond the assets remaining within the beneficial owner’s potential death estate;

• “Proper trusts”, on the other hand, can have hosts of UK Income Tax, Capital Gains Tax and Inheritance Tax consequences for the de facto settlor putting cash and assets in, for any UK resident beneficiaries receiving distributions out and for the de facto trustees holding and managing the assets;

• Treating foundations as companies might seem straightforward but that can be fraught with UK tax issues too and could be the worst of all worlds – it can potentially lead to anti-avoidance legislation attributing income or gains arising within a company to the beneficial owners/participators without that income or gains ever being distributed, whilst also leaving the corporate veil and corporate and shareholder tax considerations in place too.

One of the biggest problems to contend with is often the UK’s complex “transfer of assets abroad” anti-avoidance legislation whereby various longstanding pieces of statute can result in controlling beneficial owners in the UK of assets held in conventional or de facto overseas trusts or companies potentially having the income and gains arising within personally attributed to them and assessed upon them to UK Income Tax or Capital Gains Tax.  Often people are caught under this category of legislation upon moving to the UK after setting up an overseas structure which was not set up with UK tax advice in anticipation of the move.  Since foundations do not lend themselves to tax planning for UK residents it follows invariably that the transfer of assets abroad legislation was not considered at inception.

Notwithstanding all the issues surrounding the treatment of civil law foundations in the UK - they have been a regular feature of my work over the last 20 years.  Many people move to the UK after establishing foundations or are settled in the UK when they acquire a beneficial interest in the assets of a foundation established by an overseas relative.  Previously, even once settled in the UK some people who originated from civil law jurisdictions were familiar with the concept of foundations but had no such cultural familiarity with common law trusts and chose to establish foundations.  To the extent they thought about UK tax at all many such people tended to think the UK tax authorities would never know about them.  Of course, the expectation of secrecy has disappeared over the last 15 years in light of offshore data leaks and transparency initiatives such as the Common Reporting Standard and that has of itself resulted in a huge amount of regularisation work in the UK.

In practice, the only way to get certainty on the UK taxation treatment of a civil foundation and the parties involved in it is to seek professional advice and through those advisors to disclose its existence to HMRC and initiate a dialogue with HMRC to agree how the foundation should be treated.

Prior to 2009, what little official HMRC guidance existed suggested that the default UK tax treatment of civil law foundations was to treat them as companies.  However, that was not the case in practice.  Indeed, I was never involved in one real world investigation or disclosure involving foundations holding family wealth where HMRC ever even sought to argue a corporate characterisation was appropriate.  Indeed, when on 11 August 2009 the UK government announced a Liechtenstein Disclosure Facility amnesty and signed a Joint Declaration – Memorandum of Understanding with the Liechtenstein government for cooperation on tax matters, the memorandum made explicit that since Liechtenstein foundations were set up to preserve and maintain assets for beneficiaries they were trusts for the purposes of the agreement.  The memorandum was wisely silent on what type of trusts Liechtenstein foundations were and left that open for case-by-case interpretation based on the particular facts of each situation.  Nothing has changed since then with Liechtenstein foundations or foundations vis-a-vis the UK more widely.

Depending on the circumstances and the professional guidance received, there are three main mechanisms for disclosure and agreement:

• A voluntary disclosure made to HMRC under the Worldwide Disclosure Facility (WDF) through HMRC’s electronic Digital Disclosure Service platform;

• A voluntary disclosure made to one of HMRC’s specialist anti-avoidance investigation teams under HMRC’s Code of Practice 8 – reserved for complex technical matters;

• A request to make a voluntary disclosure of deliberate wrongdoing to HMRC under HMRC’s Code of Practice 9/Contractual Disclosure Facility (COP 9/CDF) protocol - asking for HMRC to investigate what must be admitted at the outset as tax fraud as a civil matter with full co-operation.

Where only comparatively small amounts of tax are concerned the WDF method might sometimes make sense.  However, the electronic disclosure form provides no means to make full disclosure of such a matter without an accompanying report being submitted in conjunction with it.  The grade and type of inspector allocated to such a WDF disclosure is variable and they are not always well equipped or possessing of sufficient authority to engage with it pragmatically.

COP 9/CDF disclosures require obvious deliberate intent to evade tax such that it would be at point for individuals to make an admission of it in an initial Outline Disclosure in return for an HMRC guarantee of criminal prosecution.  Situations involving foundations are often more nuanced than that or come to light after the death of the party who might have conducted any such deliberate behaviour.

Not just by default, but also because HMRC’s COP 8 Inspectors tend to be some of HMRC’s most experienced, well-trained and pragmatic personnel, COP 8 is often the optimum process for broaching the existence of civil law foundations with HMRC and conducting a constructive dialogue with HMRC to agree the historic UK tax position of the parties involved and to settle any outstanding liabilities.  It then provides an agreed basis for the future taxation treatment too or else to agree to dissolve the foundation as one of the bases of the settlement.

Sometimes, a connection with a foundation will come to light after it has been formed but upon the first relevant preparation of a UK Self-Assessment tax return for the individual concerned.  It should then be disclosed with professional advice as a “white space” disclosure to HMRC on the tax return itself.  Such a disclosure must fully explain all relevant information to HMRC, the taxation treatment applied and the basis for coming to that conclusion.  HMRC then have an opportunity to enquire and disagree if they see fit.

It is a measure of how pragmatic HMRC are prepared to be in agreeing on a case-by-case basis any reasonable assumptions on the treatment of foundations that there has been a notable absence of litigation on the UK status of foundations through the UK tax courts.  For the taxpayer too, rather than risk a potentially unpredictable or legally dogmatic and unhelpful outcome in the courts it is generally best to agree that if a foundation looks like a trust and, on balance, bears all the hallmarks of a particular sort of trust, ideally one with not the worst tax consequences, that indeed is what it is.  There is a lot to be said for “the duck test” and its inherent fairness.

Andrew Park
Andrew Park is a Partner at Price Bailey in the UK. He specialises in regularising back tax issues with the UK tax authorities for all types of clients and all taxes – including cryptocurrency investors now coming under investigation or receiving “nudge letter” invitations from HMRC to make voluntary disclosures. Andrew can be contacted at email: andrew.park@pricebailey.co.uk / tel. +44 07717 892 537