The taxation of non-domiciled individuals and offshore trusts is a deeply complex area that is traditionally the preserve of private client advisers. Of equal complexity is the topic of private equity tax, which incorporates the Disguised Investment Management Fund (DIMF) rules and is the preserve of an equally specialist (but usually separate) set of private equity tax experts. Where the two areas interact, such as in the case of offshore trusts which hold carried interest rights, misunderstandings pervade. 

This article attempts to examine this interaction and debunk a popular myth: that offshore trusts are now almost always inappropriate for holding carried interest – usually resting on the logic that a trust is effectively ‘transparent’ when payments of carried interest are made to trustees. This oversimplifies a complex debate.


Prior to the introduction of the DIMF rules, on 8 July 2015, it was common to see UK resident, non-domiciled private equity executives use offshore trusts to hold carried interest. Payments of carry tended to arise from non-UK limited partnerships and give rise to non-UK capital gains, making the interests appropriate for remittance basis taxpayers (more commonly known as res non-doms) to settle into offshore trusts.

However, the DIMF legislation dealt a serious blow to the tax efficiency of such structures by deeming that carried interest ‘arises’ to - and is taxable on - a UK resident fund manager regardless of who owns the carried interest right. This means that £100 paid to an offshore trustee holding the right to carried interest will typically produce a personal tax bill for the fund manager, at a special Capital Gains Tax (CGT) rate of 28%, and so probably of £28 (but subject to some ability to use the remittance basis, which topic is an article to itself). This is generally known as a ‘dry’ tax charge because the fund manager is liable to tax despite not having received funds personally with which to pay the tax. The same £28 tax bill would typically have arisen if the carried interest had been held by the fund manager personally.

As a consequence an assumption has taken hold in some quarters: that there is no longer any benefit to holding carried interest in offshore trusts, and further, that doing so will make the tax position worse.

In some cases, on an objective analysis of the client’s circumstances, that assumption may be correct - it may indeed be the case that the carried interest should be held other than in an offshore trust, with straightforward personal ownership often being the best alternative. However, the decision is rarely straightforward and there can be several good reasons for continuing to use trusts for carry, some of which are set out below.

  1. The ‘asset like any other’ myth

One of the biggest misconceptions is that carried interest is an asset like any other – a house or a car – that can be passed on like any other. This is dangerous. Carried interest is almost always an interest in a partnership, which may be based in the Channel Islands, Delaware, Cayman or many others. The consequences of a death of a partner on that person’s partnership interest will depend entirely on what the fund documents say about what happens on the death of a partner, which will vary from fund to fund. Common practice will vary even more between jurisdictions. It can be extremely dangerous to assume that the carried interest right is akin to any other ‘asset’, and that the value of the interest will be ring-fenced and protected in full upon death. Holding the interest in trust sidesteps this problem.

  1. UK inheritance tax and post-death payments of carry

Whilst the imposition of a trust might on one level seem tax neutral from a UK tax perspective (because of the ‘arises’ rule described above), the reality is that this perceived tax neutrality is in fact based on one relatively narrow scenario: when sums of carry are paid out and either (i) taxed on the fund manager (if held personally), or (ii) deemed to ‘arise’ to the fund manager and taxed on them in any event (if held by the trust).

For many other tax purposes the trust is far from neutral. Take for example the very frequent case of resident non-domiciled individuals who have become deemed domiciled by virtue of being UK resident for 15 years or more. Upon their death (assuming they were still UK resident and deemed domiciled at death) their worldwide estate (including the remaining value of the carried interest plus any carry proceeds that have been paid to them) will be subject to UK inheritance tax at 40%. In contrast, carried interest rights and sums representing carry proceeds will, if held in an appropriately structured offshore trust, fall outside their estate for inheritance tax purposes notwithstanding the fund manager’s personal UK tax position. 

This benefit alone presents a huge potential upside of holding carry in trust. However, a further advantage may arise on carried interest payments made to offshore trustees after the life of the fund manager. Such payments cannot ‘arise’ to the fund manager after their lifetime and so will simply be a normal capital gain in the hands of the trustees, which will often not be subject to UK tax. In contrast, carried interest payments made to the fund manager’s executors or heirs after death will be subject to UK capital gains tax if those persons are UK tax resident. All of this is fact specific and so requires a proper analysis.

  1. Tax on income/gains made from investing proceeds

Allied to the above is the position on carry proceeds which are subsequently invested – perhaps in an overseas investment portfolio or real estate – and which produce income and gains of their own. The tax profile of these income and gains may look very different depending on whether the carry has been paid to the UK resident fund manager personally (in which case they will be fully taxable to UK income tax/capital gains tax if that fund manager is deemed domiciled) or paid to an appropriately structured trust, known as a ‘protected settlement’, which potentially gives rise to no UK tax liability at all. Over time, the trust may roll up income/gains on a gross basis which could have a significant positive impact on the long-term returns.

  1. Double tax relief and ‘washing out’ trust income or gains

Furthermore, the trust may provide an opportunity for planning in relation to other, unrelated income and gains. The key legislative provision here is 103KE TCGA 1992 which is subtitled ‘Carried interest: avoidance of double taxation.’ In a paper released by STEP early in 2017, an ‘HMRC Policy & Technical Adviser, Financial Products & Services’ was quoted as follows:

“We consider that s103KE TCGA 1992 can provide relief where: 

- a distribution is made from an offshore trust which holds the right to receive the carried interest arising from performance of investment management services by the investment manager, with the express intention of defraying the tax liabilities charged upon the investment manager under S103KA 1992 for those services; and 

- that distribution is made by way of a payment made directly from the trust to the investment manager after the trust has received the payment of carried interest. 

Clause 37 of the Finance Bill currently progressing, excludes carried interest gains from the rules within s86 and s87 TCGA 1992. If there is a tax charge resulting from a capital payment made by the trustees to the investment manager to defray the latter’s tax charge under s103KA, such that the capital payment is matched against other income, offshore income gains or non-carried interest gains, then tax in respect of the capital payment should be relievable under s103KE.”

The effect of the above appears to be that distributions made from trusts to fund managers, if done for the express purpose of defraying the fund manager’s tax liability on the payment of carry (further to the ‘arises’ rule described above), can be matched with income and gains, removing those income and gains from future tax calculations whilst allowing tax relief against the double charge. This is an effective washing out of those ‘other’ income and gains: a potentially huge advantage where the carry is held in trust.

  1. US and other overseas considerations

Points two to four above focus exclusively on the UK tax position, which as described is fact specific and far from one-sided. However, non-domiciled executives will often have exposure to a second high tax jurisdiction, most frequently the US through US citizenship or green cards. A trust may often be recommended from the perspective of that second jurisdiction and so should certainly not be ruled out for UK tax reasons alone.

  1. Good old fashioned succession planning

Finally, individuals often hold assets in trusts for a variety of non-tax reasons, including the management of family disputes, avoidance of probate, catering for incapacity, asset protection and many others. No advice should be given purely in a tax ‘void’, and doing so can often create problems which greatly outweigh any perceived tax advantage or disadvantage. The personal versus trust debate is much more nuanced than might immediately seem the case.