In the recent case of Louwman v HMRC [2025] UKFTT 295 (TC), HMRC could be said to have had a bit of a windfall based on what exactly is foreign.
The matter relates back to the 2017 changes to the domicile rules and the introduction of deemed UK domicile for income and capital gains purposes. The changes meant that people who were about to become deemed UK domiciled were encouraged to fund non-UK trusts before the new rules came into force and, provided they did not have the benefit of the income and gains generated by the assets, they would not be taxed on them, i.e. if the relevant amounts were left untouched in a discretionary trust.
As it is a bit hard to argue that such funding so close to the new rules coming in to force was not driven by a desire to reduce UK tax, a special rule was added to the Transfer of Assets Abroad (ToAA) regime to create a category of income called ‘Protected Foreign Source Income’ (PFSI) that is taxed under the benefit rule instead of as it accrues. Without PFSI, the ToAA rules would have looked to tax the income in the trust upon the newly deemed domiciled individual, undoing the protection that the legislation had just introduced.
The taxpayer in this case had made non-resident settlements in March 2017 and the assets within the settlements had generated Offshore Income Gains (OIGs) in 2019, 2020 and 2021, plus accrued income profits (AIP), or losses, in the same years. OIGs are the gains made by a UK taxpayer when they sell an interest in a ‘non-reporting’ offshore fund. A reporting fund is one that reports (odd that) its undistributed income and gains to investors on an annual basis so they can be taxed on the income and gains on a similar basis. A non-reporting fund doesn’t do this, so its investors are taxed on undistributed income and gains when they sell up. Therefore, they get a deferral of the UK tax due on such amounts until sale, but at the cost of both income and gains being taxed at the income tax rates. AIPs are the profits in respect of accrued, but unpaid, amounts that an investor is compensated for when they sell their security to a new holder.
HMRC assessed both the OIG and AIP to tax as they were the wrong sort of foreign and didn’t qualify as PFSI. This is because for the OIGs (more on the AIP later), they would not be relevant foreign (there’s that word again) income of the UK taxpayer if received direct.
This does sound a little bizarre as, despite the use of the word relevant, surely ‘offshore’ in OIGs makes them foreign? However, to be relevant, the foreign income has to have a non-UK source and be chargeable under one of the listed provisions or, if not within this ‘main’ list, come within a secondary list of items.
The First-tier Tribunal (FTT) found that OIGs have no source, as they are capital payments that are deemed to be income, and so they fall at the first hurdle for being relevant, as do AIPs as the FTT also found that their taxing legislation applied without reference to a source. Further, neither comes within the secondary list, although some OIGs do. These are OIGs that are treated as arising to an individual who is not domiciled in the UK, but here the income would belong to a person who is deemed domiciled in the UK.
Therefore, although offshore, they are not foreign, or at least not foreign enough.
The taxpayer had a fallback position in that OIGs (and AIPs) were clearly meant to be within PFSI and so the FTT were allowed to read its definition that way. The bar for the FTT to do this is very high, and although it felt that not including OIGs and AIPs in PFSI was probably an oversight, that bar was not crossed.
When discussing this aspect, the elephant in the room, which the FTT and HMRC would not be able to address, and the taxpayer would not as it doesn’t help them, is that if this really was an oversight, the legislation would have been amended with retrospective effect.
Or perhaps being a little more realistic, if this really was an oversight that the government wanted to acknowledge, then the legislation would have been amended with retrospective effect. But, let’s face it, from 2022 when the enquiry was clearly getting ready for litigation, no politician was going to put their heads above the parapet and say that they were going to hand money back to those dreaded ‘non-doms’, even if they are now ‘doms’.
This case provides a salient reminder. HMRC will follow the legislation and try to apply it in the way they think is correct, but what the legislation actually says and does is down to the politicians. The Treasury and Ministers would have been kept informed of this case (if not the name of the taxpayer involved) given its nature and the arguments being advanced by the taxpayer and it would have been a political decision to let this one play out, which has led to a windfall to the Exchequer.
Home >Articles > Protected foreign source income: limits exposed
Protected foreign source income: limits exposed
Not foreign enough.
In the recent case of Louwman v HMRC [2025] UKFTT 295 (TC), HMRC could be said to have had a bit of a windfall based on what exactly is foreign.
The matter relates back to the 2017 changes to the domicile rules and the introduction of deemed UK domicile for income and capital gains purposes. The changes meant that people who were about to become deemed UK domiciled were encouraged to fund non-UK trusts before the new rules came into force and, provided they did not have the benefit of the income and gains generated by the assets, they would not be taxed on them, i.e. if the relevant amounts were left untouched in a discretionary trust.
As it is a bit hard to argue that such funding so close to the new rules coming in to force was not driven by a desire to reduce UK tax, a special rule was added to the Transfer of Assets Abroad (ToAA) regime to create a category of income called ‘Protected Foreign Source Income’ (PFSI) that is taxed under the benefit rule instead of as it accrues. Without PFSI, the ToAA rules would have looked to tax the income in the trust upon the newly deemed domiciled individual, undoing the protection that the legislation had just introduced.
The taxpayer in this case had made non-resident settlements in March 2017 and the assets within the settlements had generated Offshore Income Gains (OIGs) in 2019, 2020 and 2021, plus accrued income profits (AIP), or losses, in the same years. OIGs are the gains made by a UK taxpayer when they sell an interest in a ‘non-reporting’ offshore fund. A reporting fund is one that reports (odd that) its undistributed income and gains to investors on an annual basis so they can be taxed on the income and gains on a similar basis. A non-reporting fund doesn’t do this, so its investors are taxed on undistributed income and gains when they sell up. Therefore, they get a deferral of the UK tax due on such amounts until sale, but at the cost of both income and gains being taxed at the income tax rates. AIPs are the profits in respect of accrued, but unpaid, amounts that an investor is compensated for when they sell their security to a new holder.
HMRC assessed both the OIG and AIP to tax as they were the wrong sort of foreign and didn’t qualify as PFSI. This is because for the OIGs (more on the AIP later), they would not be relevant foreign (there’s that word again) income of the UK taxpayer if received direct.
This does sound a little bizarre as, despite the use of the word relevant, surely ‘offshore’ in OIGs makes them foreign? However, to be relevant, the foreign income has to have a non-UK source and be chargeable under one of the listed provisions or, if not within this ‘main’ list, come within a secondary list of items.
The First-tier Tribunal (FTT) found that OIGs have no source, as they are capital payments that are deemed to be income, and so they fall at the first hurdle for being relevant, as do AIPs as the FTT also found that their taxing legislation applied without reference to a source. Further, neither comes within the secondary list, although some OIGs do. These are OIGs that are treated as arising to an individual who is not domiciled in the UK, but here the income would belong to a person who is deemed domiciled in the UK.
Therefore, although offshore, they are not foreign, or at least not foreign enough.
The taxpayer had a fallback position in that OIGs (and AIPs) were clearly meant to be within PFSI and so the FTT were allowed to read its definition that way. The bar for the FTT to do this is very high, and although it felt that not including OIGs and AIPs in PFSI was probably an oversight, that bar was not crossed.
When discussing this aspect, the elephant in the room, which the FTT and HMRC would not be able to address, and the taxpayer would not as it doesn’t help them, is that if this really was an oversight, the legislation would have been amended with retrospective effect.
Or perhaps being a little more realistic, if this really was an oversight that the government wanted to acknowledge, then the legislation would have been amended with retrospective effect. But, let’s face it, from 2022 when the enquiry was clearly getting ready for litigation, no politician was going to put their heads above the parapet and say that they were going to hand money back to those dreaded ‘non-doms’, even if they are now ‘doms’.
This case provides a salient reminder. HMRC will follow the legislation and try to apply it in the way they think is correct, but what the legislation actually says and does is down to the politicians. The Treasury and Ministers would have been kept informed of this case (if not the name of the taxpayer involved) given its nature and the arguments being advanced by the taxpayer and it would have been a political decision to let this one play out, which has led to a windfall to the Exchequer.
.tmb-editorspic.jpeg?sfvrsn=7981419_1)
