TRUSTS AND TAX PLANNING

1. Introduction

A trust is an arrangement where by one person (called a trustee) is the legal owner of property but holds it for the benefit of another (called a beneficiary). Property capable of forming the subject matter of a trust (the trust property) includes anything, which is capable of being transferred although typically this will comprise shares, money or land. Trusts may be implied by law or may be expressly created either orally or by a written instrument depending upon the nature of the trust property. For tax planning purposes the trust will invariably be evidenced by a written document called a Trust Deed, Declaration of Trust or Trust Instrument.

The trust is a concept originally developed by the English common law with origins going back to medieval times. Many legal systems are based upon English law and have similar legislation relating to trust. International trust (where the arrangement spans more than one legal jurisdiction) can therefore be administered effectively in the many offshore low tax areas which have an English based legal system.

With the trust being an invention of the English common law, in a number of Roman based civil law counties, the trust was either not recognized by or little used as a legal arrangement. Consequently there tends to be a lack of anti-tax avoidance provision in relation to trusts and this gap can provide scope for legitimate tax planning for residents of these countries.

Establishment of and maintenance of a trust can be a relatively simple and inexpensive operation providing significant tax saving in a secure and confidential environment. Typically someone resident in area of high taxation (the settlor) will transfer ownership of the trust property to a resident of an area of low taxation (the trustee) for the benefit of the beneficiary or beneficiaries. Because the legal ownership of the trust property becomes vested in the trustee it ceases to be taxed as part of the settlor and properly managed it will be able to earn and accumulate income and make distributions free (or at a reduced rate) of tax for the trust period. Perpetual trusts are not generally permitted and the maximum life of a trust and periods for which interest may be accumulated vary between jurisdictions. A exception is the Turks and Caicos Islands where under the trust law applicable in that jurisdiction there are no limitations on the duration of a trust or upon the accumulation period. The trustees will be one or more individuals, a bank or a trust corporation and the trust instrument will set out how the trustee

Establishment of and maintenance of a trust can be a relatively simple and inexpensive operation providing significant tax saving in a secure and confidential environment. Typically someone resident in area of high taxation (the settlor) will transfer ownership of the trust property to a resident of an area of low taxation (the trustee) for the benefit of the beneficiary or beneficiaries. Because the legal ownership of the trust property becomes vested in the trustee it ceases to be taxed as part of the estate of the settlor and properly managed it will be able to earn and accumulate income and make distributions free (or at a reduced rate) of tax for the trust period. Perpetual trusts are not generally permitted and the maximum life of a trust and periods for which interest may be accumulated vary between jurisdictions. An exception is the Turks and Caicos Islands where under the trust law applicable in that jurisdiction there are no limitations on the duration of a trust or upon the accumulation period. The trustees will be one or more individuals, a bank or a trust corporation and the trust instrument will set out how the trustee should invest and deal with the trust property, when and to whom distributions should be made, and it will list the other powers to be exercised by the trustees.

Discretionary Trusts

In the lower tax jurisdictions, the general principle is that where the trust property is settled by a non-resident solely and for the benefit of non-residents and the trust income is derived from outside the jurisdiction, the trust will be free of all taxes and duties. Usually the trust instrument will specifically exclude from the potential class of beneficiaries residents of the jurisdiction in which the trust is administered. However under modern tax law mainland tax authorities in jurisdictions which recognize a trust as a legal entity tend to look through the trust arrangement if a beneficiary is entitled to the income of a trust (or is entitled to have it applied for his benefit) and tax him accordingly even if none of the money is actually paid to him. For this reason modern practice is for the trust property to be settled on the trustees to be held by them on trust to apply the income or the capital (or both) for the benefit of a class of beneficiaries in such proportions as the trustees shall in their absolute discretion think fit.

It cannot then be said that any one beneficiary has any legal entitlement to any share in the income or capital of the trust property because the trustees may see fit to exclude him in favour of the other members of the class. The beneficiary will only therefore be assessed to tax by the mainland authorities on such amounts as are remitted to him whilst he remains resident within the jurisdiction. Because the settlor has divested himself of legal ownership of the trust property this will not comprise part of his estate for inheritance tax purposes.

Other Advantages of the Offshore Discretionary Trust

Apart from the favorable tax treatment of trusts there are many other advantages, which include:

• The ease and speed with which a trust may be established.

• A trust may form and own companies and a company wholly owned by the trust may be used to hold the trust property. This arrangement may have advantages in the context of administration, as such a company may be exempt from income tax. Because there is no requirement to file the trust instrument the true beneficial ownership of the company can remain totally confidential.

• There is generally no requirement to file trust accounts.

• The identity of the settlor need not be disclosed.

• In some jurisdictions it is possible to create a trust where no beneficiaries are named at the outset.

• It is possible to appoint a protector without whose consent the trustees may not exercise certain powers, but it should be emphasized that this must not be left open to interpretation by mainland tax authorities as an attempt by the settlor to retain a measure of control over the settled property.

• It is common for the trust instrument to be accompanied by a memorandum of wishes of the settlor, which although having no legally binding effect may be used as a guide by the trustees when deciding upon distributions to the beneficiaries. Such a memorandum may of course be altered and updated from time to time to meet changing circumstances.

• Because of the long term nature of the trust it is common to include a provision in the trust instrument for the translocation of the trust to another jurisdiction in the event of certain specified unforeseen circumstances which may include, for example, political upheaval or the reimposition of exchange controls or of higher levels of taxation.

• Used in conjunction with an offshore company for trading purposes the trust may provide the necessary break in the chain of ownership between the settlor and the company without which the income of the company may be regarded in mainland jurisdictions as that of the resident beneficial owner and taxed accordingly, even though such income is not actually received by the settlor.

It can be seen therefore that the discretionary trust may be used not only as a means by which a wealthy individual may divest himself of certain of his assets but also typically by expatriates working overseas who wish to accumulate savings offshore in the knowledge that they will not form part of their taxable estate when they return to the mainland and in conjunction with an offshore company by those involved in international trade who wish to accumulate profits offshore for the benefit of others.

4.   Asset Protection Trust

      Asset protection trusts are popular vehicles for doctors, dentists and other US professionals who practice without the benefit of limited liability; damages awarded by juries in US courts are often in excess of such insurance cover as professionals are able to arrange in a highly litigious society. Now with the growth of stricter liability laws in other countries they are becoming increasingly popular outside the US. Again use of divorce laws of certain countries can bring about the break-up of assets, which may have been built up over a long period of time.

      Whereas generally the law will not allow trusts to defeat or defraud current or known pending creditors, they should prove effective against unknown future claimants. Thus the asset protection trust may remove or lessen the anxiety of the dentist, the physician, or the businessman who otherwise would live in fear of a potential malpractice claim. Similarly for the wealthy individual generally, an asset protection structure allows disposition of assets on the basis of the owner’s choice rather than according to statutory obligation.

      A number of offshore jurisdictions such as Gibraltar and the Turks and Caisos Islands have introduced legislation which gives a specific statutory basis for the setting up of asset protection trusts so that these trusts can be set up without some of the legal uncertainties which do in fact attend trusts which rely only upon a common law base.

5.   Trusts – Some Further Considerations

      It should be remembered that essential to a trust and to its efficacy as a tax planning instrument is the very intention of the settlor to transfer the trust property to the trustees. There are settlors who might prefer to believe that when the property is transferred to the trustees they will follow their instructions in respect of the trust property. However the settlor must be advised that he must properly divest himself of the legal and beneficial ownership of the assets and that the trust documentation must reflect this as otherwise it can be held that he has not properly established his intention to create a trust in the first instance and there is the possibility that the property could be held to be on an automatic resulting trust for the settlor.

Over the years we have both advised on and set up trusts for members who have had this requirement in consultation with our legal team. If you are considering such an entity contact us at www.therioclub.com.
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