Trusts

The term trust can loosely be applied to any situation where one person holds property but is not entitled to the benefit of that property.  This section deals with discretionary trusts and the more common arrangement of nominee shareholding (sometimes called bare trust or mandatory trust) is dealt with separately. A trust comes into existence when a transfer of property is made from one person (the settlor) to another (the trustee) under an agreement that this property will be held for the benefit of a person or group of people (the beneficiaries). Trust is therefore a term describing any situation where the legal ownership of an asset lies with one person (the trustee) but the benefit (or beneficial interest) lies with another person or group of people (the beneficiaries).

History/Common Law Tradition
Trusts are the product of a body of law called equity which historically was a secondary and parallel legal system administered by British monarchs outside the jurisdiction of normal courts and based on principles of good conscience.  Most of the law surrounding trusts remains unwritten, uncodified and all of it is based on moral principles. Trusts trace their ancestry back to the 11th century and  whilst they are well understood in The United Kingdom and The United States their nature is very alien to civil law systems (such as European countries). Attempts to implement them by means of international conventions and domestic legislation have generally not met with much success leading to an unresolvable conceptual incompatibility between the inherently British legal tradition of unwritten law based on previous decided cases with its judicial flexibility and a codified civil law system.

No Legal Personality
Since a trust is merely a legal arrangement as explained above it does not have a legal personality (by comparison with a company for example) and therefore any assets under trust are owned by the trustee. Though in some cases these assets will be intermingled with the trustees’ own assets, professional trustees will keep them in a separate bank account specific to each trust they administer. Where assets under trust are intermingled with the trustees’ own assets in theory they are held separately if, for example, the trustee was declared bankrupt or sued however this relies on trust law being correctly applied which may not be certain especially in countries where there is a conflict between local civil law and the common law notion of trusts.

Administration

Role of the Settlor
In a properly administered trust the role of the settlor is usually limited to transferring the initial trust property to the trustee. Ongoing involvement in the trust fund is generally prohibited by professional trustees since it is likely to cause an inference that control of the trust property has not effectively passed to the trustee and that the trust is a sham. If the trust is a sham then it will not be effective and this will defeat any advantage for which it was set up. Notwithstanding the above some settlors may wish to continue having an involvement and may therefore seek to appoint themselves as trustee, protector and/or beneficiary but this always imposes some limitation on the discretion of the trustee and thereby weakens the trust. For a client who wishes to keep ongoing control of their assets a discretionary trust is not appropriate and they should consider the alternatives: either a bare trust (or nominee) arrangement or a foundation in which the founder may continue to be involved.

Role of the Trustee
The role of the trustee, their level of responsibility and accountability varies from country to country and from trust to trust and most legal systems afford persons drafting a trust a wide discretion when it comes to the powers of the officers of a trust. The most basic duty of the trustee is to protect and nurture the assets under trust for the benefit of the beneficiaries and to consult the protector (if any) when required. Generally speaking the standard of behaviour to which a trustee is held is higher than that of the director of a company and accordingly many professional trustees will insist on limiting the trusts’ role to passive investment but this is not necessarily the case. Trustees also have to give consideration to requests from beneficiaries either for advancement of funds or for information and may have to balance competing interests between beneficiaries impartially. The role of the trustees may also include appointing or removing beneficiaries and may include acting on instruction left by the settlor to be actioned on their death.

Role of the Beneficiaries
The role of beneficiaries is likely to be limited to receiving payments from the trust during its life and the transfer of the trust property when the trust is wound up. The level of information a beneficiary is entitled to request depends on the country where the trustee is located, the proper law of the trust and the nature of the beneficiaries’ interest under the trust. From recent cases it appears that even beneficiaries under a discretionary trust have a right to information from the trustees. One special power of the beneficiaries is that they may be able, if acting together, to end the trust and take receipt of the trust property themselves. Any such action is likely to be made by application to court and generally requires an element of good-faith on behalf of the beneficiaries to prevent the threat of such an action being used to interfere with the trustees’ discretion. 

Role of the Protector
The role of protector is a recent addition to trust law. The protector is a nominated person having the right to be consulted in certain instances. What powers of veto or consent are required and in what circumstances the trustee must consult the protector is specific to each trust.  Protectors are generally appointed at the start of the trust by the settlor and may be a family friend or lawyer. Some professional trustees are reluctant to accept the appointment of protectors since they necessarily interfere with the discretion of the trustee and thereby weaken the trust. Also they may risk bringing the trust property into the remit of a high tax country if they live in the same country as the settlor which may defeat the purposes of the trust if it was set up for the tax benefits of the foreign country.

Tax Advantages

Income/Receipt of Capital Gains
Since income and capital gains are taxed on the trustee (as legal owner of the trust assets) the level of tax will depend on the location of the trustee. For this reason most professional trustees are located in low or no tax countries. For a settlor living in a high tax country transfer to a trustee in a low or not tax country means that further income or capital increases will be taxable at a lower rate.

Inheritance Planning
Trusts are also used to avoid inheritance tax and death duties by transferring assets away from the settlor prior to death.

Employment Benefit Trusts (EBTs)
In a close company (one having few employees who are also directors and shareholders) EBTs may be set up to gain tax advantage by a reduction in corporate tax and/or a reduction in the personal taxation of the directors. Although the use of EBTs for this purpose has been curtailed in some countries such trusts may still be beneficial in some cases.

Association with Tax Avoidance
Although trusts have many non-tax related uses and long predate income tax their extensive use in the 1970s and 1980s means that they are strongly associated with tax avoidance and this may mean that they attract unwanted attention and even harsher tax treatment from tax authorities who have many established lines of attack given a large number of high profile cases by onshore tax authorities against trusts. For clients wishing to avoid this possible stigma a foundation may be appropriate in terms of both succession planning and asset holding.

Avoidance of Controlled Foreign Corporation (CFC) Rules
Most countries attempt to some degree to tax and regulate foreign entities which they feel are being used to avoid tax due to them or which they feel falls within their remit due to being operated within their borders. The principle basis for these rules is, in the case of trusts, the location of the trustee; specifically where the trustees spend the majority of their time. Therefore a trust administered in country A may also be taxable in country B if the trustees spend most of their time there. Where trusts are taxable in more than one country there may be dual taxation arrangements in place however if one of the countries is a low or no tax area this is likely to defeat the tax planning reasons for which the trust was established. Various methods have been used to attempt to avoid this situation with different degrees of success. The method of simply holding meetings in a low tax country is, for example, likely to be ineffective in almost all cases. The method of appointing local trustees may, if operated properly, be effective in avoiding CFC rules based on management alone. More sophisticated anti-avoidance rules may seek to attack a foreign entity on the basis of a lack of substance or that it is wholly or mainly artificial and therefore should be ignored for tax purposes. More sophisticated systems may also base taxation of companies not simply on their management but also on their ownership and voting rights on the basis that the shareholders having the right to appoint and remove the board of directors are effectively in control of the company. Since trusts do not have owners they may be extremely effective in avoiding anti-avoidance rules of this nature provided they are properly administered.

Non-Tax Related Uses

Escrow
An escrow arrangement is used in any circumstances where money or assets are due to be delivered from one party to another only upon completion of some task or the occurrence of some contingency. There are many situations where this might happen such as the raising of share capital for a company, the holding of a security deposit under a lease or the transfer of property when work has been completed. An escrow arrangement works like a nominee (or bare trust) arrangement: the escrow agent (trustee) takes receipt of property from party A on the instruction that he will only transfer it to party B (or return it to party A) on the instruction of both parties.

Spendthrift Trusts
Trusts have been used to prevent reckless heirs from squandering family wealth on the death of the parents by limiting their interest to income or to capital (at least until they reach a certain age). As a general principle a beneficiary is alienated from interest under a trust if they are declared bankrupt in order to protect the trust assets from attack from creditors of the beneficiary.

Care for Persons with Special Needs and Minors
Trusts are often used to make provision for beneficiaries who will be unable to care for themselves on the death of the settlor and in situations where it may be appropriate that one heir should benefit more from the death of the settlor since they require a greater amount of care with its associated costs.

Partners/Lifestyle Trust
Partners who are not married, gay or whose familial arrangements are not straight-forward may find that some countries’ legal systems do not provide adequate solutions on their death or separation. In such cases a specifically drafted trust can be used to ensure that partners and/or children are treated as the settlor intends.

Charitable/Philanthropic Uses
Trusts are also a popular choice for charitable purposes as a common law alternative to the foundation. Trusts are limited to some extent by the rule against perpetuities (explained later).

Employment Benefit Trusts (EBTs)
Aside from being used in close companies for tax benefits EBTs are also used in larger companies to provide incentives for staff as well as scholastic or other philanthropic advantage for employees or their families.

Limitation on Uses

Moral Purposes
Because trusts stem from a legal system based on fairness and good conscience they cannot be used for illegal or immoral purposes.  The effect of this principle is that a trust established to avoid creditors or to unlawfully disinherit a spouse or child is likely to  be ineffective.

Conflict with Civil Law
Trusts are not compatible with Civil Law legal traditions and this conflict should be considered at the outset of establishing a trust. For example we can take the UK (common law tradition) citizen with an ex-wife and child in the UK who moves to Spain (a Civil Law country), remarries and has another child in Spain. On their death a Spanish court may not recognise the validity of a trust or may feel that Spanish succession law overrides a trust arrangement. In this case Spanish property under trust may not be protected as the settlor had wished. In this case a foundation or limited company may be more appropriate since they would both be more likely to be recognised by Spanish law.

Not Suitable for Trading
Although there is no prohibition on the use of trusts as trading vehicles it is generally discouraged. Trustees generally restrict the use of discretionary trusts to passive holding since their liability is often considerably higher than that of a company director and they may mitigate this by limiting the scope of the trust’s operation. Similarly third-party companies and trade creditors may be reluctant to engage with a trustee who they do not know or with a trust which they do not understand. Where trading is required it is commonplace for the trustees to incorporate a company through which to operate.

Perpetuity Period
Trusts generally have a statutory limit on the time for which they are allowed to operate. This varies from country to country but is usually around one hundred years. This limit, though high, may not be suitable for someone looking to establish an indefinite philanthropic organisation or make provision for two or more future generations. In this case a foundation may be a suitable alternative.

Purpose Trusts
As a general principle (excluding certain historical exceptions) trusts without beneficiaries cannot be enforced and for this reason causes without defined beneficiaries should be done by foundation (the advancement of a religious group, a disaster relief fund etc). However a number of countries have now enacted legislation to provide for trusts without beneficiaries and a purpose trust may be a suitable vehicle as a common law alternative to the foundation.

Alternatives