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- Change the Trustee
- Change the location of the trust by initiating the transfer clause
- Appoint the investment adviser to manage assets
- Obtain tax planning advice
- Monitor and approve the disposition of trust property to the beneficiaries, and
- Petition the Court for relative action.
Trusts were used as early as 1066 during the Norman Conquest of England to protect assets. This idea is not unique to English law, however. Many jurisdictions have similar arrangements. It is estimated that approximately half of the independent wealth in the world is held through some form of trust structure. Many jurisdictions have various trusts arrangements but this article will deal with the English body of legal principles known as Equity. The English system of common law was based on what was known as writs. These writs followed previously determined cases or rulings. If a current case could not fit into one of the existing forms, there was no restitution or equitable relief provided. Persons who were unable to gain restitution would petition the King directly. Restitution was the restoring of anything to its rightful owner or the act of putting someone back in as good a position as he would have been if no complaint had been committed. Often when a petition went to the King it was referred to the Lord Chancellor who was known as the King’s conscience. Since the judgment passed down was not from a predetermined formula but was from “good conscience and fair dealings” it became known at Equity. The use of Equity gave rise to the act of Use. Use arose where a person conveyed property to another person with the understanding that it was to be held on behalf of the conveyor/settlor or on behalf of a third party designated by the conveyor or settlor. The essential characteristic of trusts is that a person known as the settlor transfers property to or control to another for the benefit of someone else. The settlor transfers the control of the property to another known as the trustee for the benefit of someone else known as the beneficiary.
Trusts are recognized as one of the most flexible and versatile vehicles for holding and managing assets. The nature of a trust s frequently misunderstood. Some see it as only a means to hide assets. Some even consider the placing of assets in the hands of a trustee as an act of deceit. In truth, when a settlor places assets in a trust, he or she ceases to have any control over them. The benefit passes to the beneficiaries or is held on their behalf. The trustee is the person required by law to execute the trust agreement. They actually hold title to the property “in trust” for the benefit of others, the beneficiaries. The trustee must carry out specific duties with regard to the property. The trustee has what is known as a fiduciary duty to the beneficiary. Put in it’s simplest form, a trust is established when assets are transferred to a trustee with the instructions that they are to be applied for the benefit of the settlor’s beneficiaries.
Lets go back to early English law for a moment. The Lord Chancellor was a powerful person. He had jurisdiction over spiritual matters as well as matters of conscience. He could not deny the authority of the law in the common law courts, and the rights they conferred on others in respect to the property transferred. However, the Lord Chancellor could say to the trustee that if he did not honor his obligation this would damage his conscience. The Lord Chancellor would therefore feel he should take action to prevent this. He would enforce the beneficial rights of the person who the transfer was intended to benefit. These beneficial rights become part of the title to the property. English law adopted a split concept of ownership. There was the legal ownership by the trustee and there was the equitable ownership held for the person known as the beneficiary. Upon this distinction between legal and equitable ownership, the modern law of trusts has developed. The legal definition of a modern trust has become: “An equitable obligation binding a person (the trustee) to deal with property over which he has control (the trust property) for the benefit of persons (the beneficiaries) of whom he may himself be one and any one whom may enforce the obligation”. A trust becomes a device to separate the legal ownership from the equitable ownership of an asset.
A modern feature of a trust is the development of the English international trust or what has been more commonly referred to as an offshore trust. By this we mean a trust established by a settlor where the settlor or the person holding the property, the trustee, for the benefit of others, the beneficiaries, is located in different jurisdictions. Different rules may apply to each aspect of the trust formation and administration as well as to the transfer of the assets to the trustee.
Unfortunately, over the past several hundred years court decisions and legislation in many countries have limited some of the protective aspects of traditional trusts. This is especially true of those subject to U.S. law and especially if the settlor of a trust is also a beneficiary of the trust as well. To obtain the maximum asset protection, it would be wise to establish the trust in a non-U.S. jurisdiction. You would want to look for a jurisdiction that had favorable trust and banking privacy protection laws. This is where an offshore trust comes into play.
The offshore asset protection trust is usually more protective than a domestic trust. There are many reasons for this, but the most important is the difficulty for a creditor to reach assets held in a trust. When an offshore trust is properly established it becomes very difficult for a court to exercise it’s jurisdiction over the trustee or affect the trust assets. For instance, a U.S. Court could not provide action against an offshore trust. Therefore it would not be able to exert its powers over the offshore trustee. To attack the offshore trust, the judgment creditor would have to depend on the foreign jurisdiction’s principle of comity. Comity is a form of “legal courtesy,” where one jurisdiction allows within its territory the judicial act of another jurisdiction. It is very important to select a jurisdiction that does not grant comity to a judgment of a court of another country. This would render the judgment of the country worthless. In such a case, the judgment creditor would have to begin the lawsuit again within the trust’s foreign jurisdiction. Unlike the U.S. which can accept a case on a contingency fee basis, the foreign jurisdiction will require prepayment of many legal fees and by the time the case reaches the foreign jurisdiction’s court systems, the statute of limitations may have expired. Because of these hurdles and the geographic and financial concerns, the offshore asset protection trust is not as likely a target for litigation as its domestic counterpart would be.
The domestic trust and its trustees are subject to local jurisdiction and both, along with the settlor, are easily included in litigation. Having an offshore trust with foreign jurisdiction will provide a significant deterrent to the creditor as he decides on pursuing a case.
Offshore trusts in creditor unfriendly locales such as the Bahamas can keep your assets out of the grasp of potential creditors while still allowing you control of your assets. Offshore trusts can create a mass of legal obstacles that can keep potential creditors at bay. Under most U.S. jurisdictions, a settlor is prevented from keeping a trust’s beneficial interests away from creditors. This is accomplished by either rendering such a trust invalid or by rendering protective provisions ineffective by granting the creditors access to the trust assets to the extent of the settlor’s maximum interest in the trust. Therefore a U.S. judgment creditor can eventually gain access to assets held in a trust established in an U.S. jurisdiction. Therefore if the settlor-debtor has beneficial ties to a domestic trust, the trust assets will be reachable by the creditor. This can be accomplished by a court order on the U.S. trustee or by declaring the trust invalid.
Certain offshore jurisdictions, the Bahamas for example, do not adopt this philosophy. They have gone as far as enacting certain statutes to disclaim this type of action. An action brought to recover assets from a trust established in such an offshore jurisdiction can be brought only on grounds of fraudulent transfer. A fraudulent transfer is the transfer of property in order to defraud a creditor. For a transfer to be fraudulent, it must have been done to actually hinder, delay or defraud creditors. When a legitimate offshore trust is used, the only way a creditor can reach the trust assets would be to bring judgment action in the offshore jurisdiction using the lawyers of that jurisdiction. Once again, these lawyers are not allowed to accept cases on a contingency fee basis. Therefore, if the creditor pursues the judgment in the offshore jurisdiction, he must be prepared to pay the offshore lawyer from his own pocket. Often this has to be done in advance. In addition, many offshore jurisdictions require the creditor to post a bond or other surety to guarantee the payment of costs for the court if he is unsuccessful.
Often you will see the laws of the foreign jurisdiction allowing for the use of the “trust protector” concept. Properly implemented, this allows the protector, who may be the settlor, to have significant powers over the trustee. For example, the protector could have the right to veto discretionary trustee actions and to even remove the trustee with or without cause. The offshore trust will also have a provision of duress. The duress provision will make it ineffective to attempt to force the removal of the trust protector by the U.S. settlor through a U.S. court order. If this were allowed, the U.S. court could allow the judgment creditor to reach the trust assets. However, a properly structured offshore duress provision will require the foreign trustee to ignore the protection removal order if issued under duress thus safeguarding the integrity of the trust.
In most cases where the U.S. court could hold the settlor-debtor in contempt for failing to comply with its order, the settlor-debtor will comply with the court’s order and issue the required directives. Such compliance will be ineffective because the foreign trustee will ignore the duress directives. He must do this because he is subject to the laws of the offshore jurisdiction which require faithful adherence to the legitimate terms of the trust. The U.S. Supreme Court has held that a person cannot be held in contempt for failing to do that which is not within his power to do unless he created the impossibility. According to the Journal Of Asset Protection, “The settlor-debtor should not be deemed to have created the impossibility where the trust containing the properly constructed duress provision has been established far in advance of the origination of the creditor’s claim”.
Another very effective advantage of an offshore trust is most offshore trusts are drafted to take advantage of the changes of situs or flight provisions of the offshore trust. Here properly drafted trust provisions can enable the trust to move from one country to another in the face of a creditors attack. Just imagine the complete and absolute frustration of a creditor having to “chase” the case to another jurisdiction and having to start all over with new lawyers. This is not to mentions new fees and related cost. Once again, this almost assures the statute of limitations will expire long before restitution can be reached. In summary, a “flee clause” allows a trustee to remove a trust from a jurisdiction where problems of a political or economic nature arise. This clause may be automatic and effective upon the occurrence of any of a number of events. Also, an independent committee can be set up outside the settlor’s/trustee’s domicile to determine when a “flee” might be needed in order to transfer the trust to another more advantageous jurisdiction.
There are several other trust expressions we need to explain further to gain a better perspective on trusts. The Trust Protector is a person, or persons, that is appointed by the individual establishing the trust, the Settlor, to act as an intermediary between the Settlor and the Trustee. Due to the fact that the Settlor has irrevocably renounced control of the trust’s assets, the Protector can provide a certain level of control over the actions of the Trustee. The Protector will often inform the Settlor and the ultimate beneficiaries of the trust in regard to the Trustee’s proposed actions. The Protector normally has the power to:
A flee clause allows a Trustee to move a trust from one jurisdiction to another. We have discussed this previously in this paper.
Often the topic of investment risk and risk diversification come up in the discussion of offshore trusts. The fact is, virtually all investments carry risk. Some investments carry more risk than others. Often the use of risk diversification spreads this risk over several sectors and risk levels. The purpose of diversification is to manage risk. This is the reason a trustee will diversify investments across different risk levels. The appropriateness of one investment can only be judged in comparison to the investment portfolio and investment objectives as a whole. A trustee who is not an investment expert and who fails to obtain professional advice may be in violation of his fiduciary responsibilities. A reputable advisor will consider the settlor and beneficiaries’ risk tolerance and will understand how various investments can be used to obtain different objectives.
Under most circumstances, the trust document or deed is a secret document. It is not normally recorded and is not available for viewing. The trust structure can be utilized in any circumstance where the settlor wishes to ensure confidentiality and anonymity. With respect to an offshore trust, the trust can provide the anonymity while allowing the trustee to be removed or even relocating the trust in a more favorable jurisdiction. This flexibility is one of the most attractive features of an offshore or foreign trust because it allows the settlor to customize his or her trust to meet specific needs and objectives without being subject to undue publicity. Today it is very common to find an offshore trust combined with other corporate structures to provide an even higher level of confidentiality and protection. With the use of a Protector, unforeseen problems can be delt with confidentially.
An offshore trust can be established in a jurisdiction which provides income tax considerations that either eliminate or reduce the current income tax burden on the trust. Furthermore, such jurisdictions usually provide that no local taxes are charged to the trust.
International taxation is the taxes imposed on such items as personal income and profits or gains that could possibly arise in more than one jurisdiction. Often there are foreign tax jurisdictions that levy tax rates which are much lower than the taxpayer’s local jurisdiction. There are considerable differences between various offshore or foreign financial centers. Different jurisdictions may have specific tax treaties with other countries. A tax treaty specifies how certain income is to be taxed in the event both parties have jurisdiction over the income in question. Depending on where the taxpayer is situated, he may wish to take advantage of a particular offshore jurisdiction.
As we have discussed, a trust is a structure where an individual, the settlor, places assets with another, the trustee, for the benefit of another person or groups of people, the beneficiary. In addition to the confidentiality and asset protection of an offshore trust, the trust should also be drafted in such a way to minimize the client’s overall exposure and liability to taxation. The U.S. Internal Revenue Code is a very complex instrument. As a general rule, when the settlor transfers assets to a trust, that asset is now the property of the trust and the settlor is not responsible for future taxes. There are exceptions such as living trusts which are revocable instruments and the settlor continues to bear the tax burden. Normally trusts established by U.S. settlers or having U.S. beneficiaries are subject to U.S. tax. This was not necessarily the case prior to 1996, but in that year Congress changed the laws and eliminated most of the tax benefits in using foreign or offshore trusts. Before 1996, offshore trusts were used to shelter income and avoid estate taxes. Congress passed what is known as the Small Business Protection Act, which effectively reduced or eliminated the tax benefits for offshore trusts. By transferring assets, the settlor may cease to be taxable. This is the feature of trusts that has led to most claims of abuse. The classic example is where the settlor resides in a high tax jurisdiction and transfers assets to a trustee in a low tax jurisdiction. It is then the purpose of the trust/trustee to accumulate tax-free income for the settlor or trust beneficiaries. This procedure is currently being challenged by anti-tax avoidance legislations. This type of abuse is more noticeable when the settlor and beneficiary are in the same tax jurisdiction. Where the settlor and beneficiary may be in different jurisdictions with different tax rates, some substantial tax advantages may be possible. The settlor is no longer the legal owner and therefore no longer liable for taxation on the income and capital appreciation. Where the trust and beneficiary is located in a tax advantaged jurisdiction, the benefits may well be felt. When the settlor is also a beneficiary under the trust, the tax authorities have instigated substantial anti-tax avoidance measures to combat what they call their abusive tax schemes. Nevertheless, properly structured trusts, perhaps involving multiple corporate entities, can provide very useful asset protection and tax planning measures. Just remember, the difference in tax avoidance and tax evasion, may well be “ten years.”
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Asset Management, Inc. is not affiliated with Mutual Service Corporation.
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