Many people prefer not to think about what will happen on their death but none of us are immortal and failure to make proper plans can mean that we leave behind a mess which has to be sorted out by our nearest and dearest at great expense and inconvenience at a time when they are emotionally vulnerable. Many individuals seek to put order to their affairs by making a comprehensive will. Under this arrangement the Executors named in the will would apply for a grant of probate, take possession of the assets of the deceased and then distribute those assets according to the terms of the will. These arrangements are perfectly in order but result in high administration costs (often around 4% of the total value of the estate), long time delays (even a simple estate would normally take at least one year to be wound up) and will often mean that considerable sums become payable in inheritance tax or estate duty. The only real alternative to a will arrangement is to set up a trust structure during lifetime which, with careful planning, can operate to eradicate these delays, administration costs and taxes as well as giving a large number of additional benefits. For these reasons the use of trusts is increasing dramatically.
The purpose of this document is to provide an explanation of how trusts work and how they can be used to advantage. We shall also attempt to dispel some of the most common misconceptions about trust structures.
The concept of a trust was first used in Anglo Saxon times and is an arrangement whereby property is transferred from one person (The Settlor) to another person or corporate body (The Trustee) to hold the property for the benefit of a specified list or class of persons (The Beneficiaries). Although a trust can be created solely by verbal agreement it is normal for a written document to be prepared which evidences the creation of the trust (the Trust Deed), sets out the terms and conditions upon which the trust assets are held by the Trustees and outlines the rights of the Beneficiaries. In essence, a trust is not dissimilar to a will except that assets are transferred to trustees during lifetime rather than those assets being transferred to executors on death. The trust deed is analogous to the deed of will.
Those unfamiliar with the trust concept usually express concern at the idea of transferring ownership of their property to a trustee. However, this concern can be alleviated if the trust concept and the distinction between legal ownership as contrasted with beneficial ownership is properly understood and the trust is governed by a sound trust law which can be enforced in a reputable jurisdiction.
The distinction between legal and beneficial ownership in English law evolved over centuries and has been transferred to many jurisdictions around the world, either through the adoption of English common law and equitable principles or as part of the express legislation of local law. International recognition of trusts has also been achieved by The Hague Trusts Convention which has been signed, ratified and implemented by a number of countries.
The practical advantages of a trust are derived from the fact that a distinction is drawn between the formal or "legal" owner of property and the person who in reality has the use or benefit of the property - the "beneficial" owner. Thus for formal legal purposes the trustee is recognised as the owner whereas the person who has the use or benefit of the property (the beneficiaries) are protected by a body of legal rules which impose very strict duties on trustees and the way in which they administer the trust property. It is possible for the settlor to retain an interest in the trust and, for example, to be an actual or potential beneficiary. However, in many jurisdictions this can have estate duty and tax disadvantages. Where the settlor retains an interest directly or indirectly in trust property it is important that the trustees remain independent and exercise proper control over the trust property. If the person who sets up the trust continues to exercise control over the trust assets this may render the trust void.
The law imposes strict obligations and rules on trustees including a duty to account for any benefits the trustee may have gained directly or indirectly from a trust. This goes beyond fraudulent abuse of position by a trustee. There is a basic rule that a trustee may not derive any advantage directly or indirectly from a trust unless expressly permitted by the trust, for example , where he is a professional trustee and the trust provides specifically for a right to make reasonable charges for services. However, full disclosure of the basis and amount of charges is required. Accordingly a professional trustee who derives some other indirect commercial advantage which is not fully disclosed and approved will be acting in breach of trust. This appears to be something which some institutional trustees forming part of larger commercial groups sometimes overlook where, for example, a trustee company arranges for trust investments to be handled by a fund management company within the same group and fees are charged for this service without authority in the trust document. Independent trust companies who do not give investment advice, on the other hand, are able to place money for investment without favour and switch from one investment adviser to another as performance or circumstances dictate whereas it is rare for the larger institution to use anybody other than their own associated companies for investment irrespective of performance
The most important rule relating to the duties of a trustee is that requiring them to obey the directions in the trust deed both with regard to the interests of the beneficiaries (i.e. who is entitled to what) and with regard to the administration of the trust (managing the trust property). Trustees are also subject to very strict standards as to the way in which their powers and discretions may be exercised.
The courts regard a trust as creating a special relationship which places serious and onerous obligations on the trustees. Thus the law regards the special "Fiduciary" relationship of a trust as imposing stringent duties and liabilities on the person in whom confidence is placed - the trustees - in order to prevent possible abuse of that confidence. A trustee is therefore subject to the following rules:
(1) No private advantage
A trustee is not permitted to use or deal with trust property for private direct or indirect advantage. If necessary the court will hold him personally liable to account for any profits made in breach of this obligation.
(2) Best interests of beneficiaries
Trustees must exercise all their powers in the best interests of the beneficiaries of the trust.
(3) Act prudently
Whether or not a trustee is remunerated he must act prudently in the management of trust property and will be liable for breach of trust if, by failing to exercise proper care, the trust fund suffers loss. In the case of a professional the standard of care which the law imposes is higher. Such trustees hold themselves out as having special expertise in trust work and therefore the courts will expect them not simply to act prudently but to exercise skill of a very high standard. Failure to exercise the requisite level of care will constitute a breach of trust for which the trustee will be liable to compensate the beneficiaries. This duty can extend to supervising the activities of a company in which the trustees hold a controlling shareholding.
Trusts are a powerful tax planning tool but they also have many other uses which are of equal if not greater importance. It may be particularly important for those who have set up confidential offshore accounts or companies to consider using a trust to transfer those assets after death. A fact which is not well publicised is that Swiss banks hold vast assets in suspense accounts because those assets cannot be claimed by their legal heirs. Accounts were set up and maintained in strict confidence in order to avoid taxation. On death it can be highly inconvenient, if not impossible, to claim those assets under the probate procedure of a will because to do so would reveal the existence of the assets and may trigger a charge to inheritance tax, many years of avoided income tax interest and other penalties. These amounts due to the taxman may come to more than the value held within the account! The same considerations can apply to the shares of an offshore company. A trust can be used to hold a bank account or the shares of an offshore company and these problems can then be avoided. A properly drafted and managed trust can confer advantages under any or all of the following heads:-
(1) Asset protection
Trusts can be used very effectively to protect assets. In simple terms, assets transferred to a trust no longer form part of the property owned by the settlor and therefore if the settlor experiences financial problems the trust assets cannot be grabbed by the creditors of the settlor. Those assets would therefore be protected if the settlor experienced financial difficulties due to bankruptcy, dissolution of marriage or a court award made as a result of, for example, a professional negligence claim. Thus, although the settlor may be declared insolvent a portion of his assets might be safeguarded by the trust structure and could therefore be used to maintain the family of the settlor otherwise. This premise is legally correct but is an over-simplification of the law. Under certain circumstances it is possible for an aggrieved creditor to have the transfer of the assets into trust set aside by showing that the settlor set up the trust with the intention of avoiding a current or future liability or because the relevant debt arose within a specified time after the transfer into trust. In effect, it has hitherto been difficult to know that the assets transferred into trust are completely safe from creditor attack. It was for this reason that many of the more astute offshore jurisdictions created what is generally referred to as the concept of the "asset protection trust" by initiating legislation which provides that as long as the transfer into trust is made at a time when the settlor does not have notice of any impending claim against those assets then as soon as the assets are correctly placed into trust they are absolutely safe from future attack. By choosing an offshore jurisdiction which has initiated "asset protection legislation" it is possible to gain a degree of additional protection over and above the already considerable asset protection inherent in a normal trust structure. It is therefore important to set up the trust in an offshore jurisdiction which has initiated such legislation in order to guarantee the maximum security for the trust assets.
(2) Tax planning
Assets transferred into a suitably drafted offshore trust structure are, in simple terms, no longer considered as belonging to the settlor and therefore the income and capital gains generated by those assets are taxed according to the rules in the country of residence of the legal owners - the trustees. Inheritance tax would normally be eliminated because the trustees would not die upon the death of the settlor. Anti-avoidance legislation in the home country of the settlor or in the situs of the trust assets may operate to reduce the effectiveness of a trust for tax planning purposes but, generally speaking, trusts can be extremely effective for tax planning purposes and a correctly structured and administered trust will produce substantial savings in income tax, capital gains tax and inheritance tax/estate duty.
(3) Avoiding the expense and delays of probate
The death of the head of the family will usually result in major disruption of the family estate whether or not there is a will. In most common law jurisdictions the estate must go through the probate procedure with much consequential delay, expense, publicity and upheaval. By establishing a trust probate can be avoided because the fact of death will have no effect on the trust property which will continue to be held and managed in confidence by the trustees in accordance with the terms of the trust.
The probate procedure mentioned above is, essentially, a public procedure. The relevant home country tax authorities will need to receive a complete list of all the property owned by the deceased in order that that property can be assessed for estate duty and in order that the property can be legally transferred to the executors who may then distribute to the legal heirs of the deceased according to the will. This procedure is therefore entirely unsuitable for those who wish to keep details of their assets confidential. If a confidential offshore structure has been set up during lifetime then revealing the existence of that offshore structure during the probate procedure may have considerable negative tax consequences. It may therefore be wholly inappropriate to include those offshore assets within the will. If a will is not to be used to transfer assets then the only other legal form of transfer is via a trust which would generally serve to save estate duty and to keep the trust assets confidential.
(5) Avoiding forced heirship
In non-common law jurisdictions there will often be questions of forced heirship to consider i.e. the deceased will not be permitted to leave his property to anyone he wishes on his death. This is a particular problem in continental European countries and other civil law jurisdictions as well as in countries of Islamic tradition. A trust can be used to overcome the problem of forced heirship but care is needed in selecting a jurisdiction for the trust which has an appropriate trust law.
(6) Estate planning
Many people do not want their assets to pass outright to their heirs, whether chosen by them or as prescribed by law, and prefer to make more complicated arrangements. These might involve providing a source of income for a widow for life, making provision for the education of children or providing a fund to protect members of the family in the event of sudden illness or other disasters. A trust is probably the most satisfactory and flexible way of making arrangements of this kind.
(7) Protecting the weak
A trust provides a vehicle by which a person can provide for those who may be unable to manage their own affairs such as infant children, the aged, the disabled and persons suffering from certain illnesses.
(8) Preserving family assets
Preserving the family assets or increasing them is often a motive for setting up a trust. Thus, an individual may wish to ensure that wealth accumulated over a lifetime is not divided up amongst the heirs but retained as one fund to accumulate further, with provision for payments to members of the family as the need arises while preserving some assets for later generations.
(9) Continuing a family business
A person who has built up a business during a lifetime will often be concerned to ensure that it continues after death. If the shares in the company are transferred to trustees prior to death a trust can be used to prevent the unnecessary liquidation of a family company. The terms of the trust will ensure that the individual's wishes are observed. These might include provision for payments to be made to members of the family from dividend income received by the trustees but that the trustees retain the shares and keep the company running save in special circumstances justifying sale of control or liquidation. This may be particularly advantageous where the family members have little business experience of their own or where they are unlikely to agree on the correct way to manage the business.
(10) Gaining flexibility
The best laid plans can, in a changing world, rapidly become obsolete. A discretionary trust can, however, be structured to provide for a system of management of property that is capable of rapid change as circumstances demand.
There are many jurisdictions, both onshore and offshore, in which it is possible to set up a trust. When choosing the correct jurisdiction it is important to select one which has a strong tradition of enforcing trusts, has an English Common Law system, has an established reputation for trust business, has enacted modern legislation which embraces the newer concepts of trusts - particularly asset protection - and imposes low or no tax on the trust. In the light of these requirements, the onshore jurisdictions such as the UK, USA and Australia are unsuitable because of the high tax that they would visit upon the trust structure. Other jurisdictions are not recommended because of political uncertainties e.g. Hong Kong. Others because they have only recently started to attract trust business and therefore their courts and professionals have only limited trust experience e.g. Mauritius, Cyprus, Nevis etc. Other jurisdictions, whilst being noted for their trust expertise, have not kept pace with the modern trends in legislation which give additional benefits and additional protection to trust assets - surprisingly many of the more traditional trust jurisdictions fall into this category such as Jersey and Guernsey.
There is a very wide choice of jurisdiction and only a small number of those jurisdictions are able to offer all the important elements and can therefore be said to be the best available. Although there are other jurisdictions which offer similar advantages we believe that Gibraltar, the Turks & Caicos Islands and Isle of Man are amongst the best available.
Gibraltar and the Turks & Caicos Islands, in particular, have initiated strong asset protection legislation and have a requirement that a professional trustee is licenced. Trust companies must therefore prove to the relevant licencing authority that they have the necessary probity, experience, financial resources, management methods and professional indemnity insurance to ensure that they can set up and administer trusts in a totally proper and professional manner. Our Group companies, ICSL Trust Corporation (Gibraltar) Ltd and ICSL Trust Corporation (TCI) Ltd were amongst the first companies in their respective jurisdictions to gain licences to act as a professional trustee. The Isle of Man is expected to introduce similar licencing requirements in the near future.
It is not correct that trusts once set up cannot be revoked. Trusts can be made revocable but this usually has tax, estate duty, asset protection and stamp duty disadvantages. Revocability is a matter to be discussed when the terms of the trust are considered.
(2) Loss of control of property
Many potential settlors are reluctant to transfer property to trustees because they fear loss of control over that property. In other words there are many who like the idea of a trust but wish to continue to exercise effective control over the trust assets despite the transfer to the trustees. However, careful planning together with an understanding of the fundamental legal requirements of a trust is required if the trust is to remain valid. If too much control is retained over the assets there is a risk that the trust will not be effective and the person who set up the trust will continue to be regarded by the law as the owner and all the advantages of having the assets held in trust may be lost. In particular, a court may force a settlor to exercise any control he retains in a particular manner thereby negating any asset protection advantage which would otherwise have existed. Despite this there are devices which may be used to give comfort to a settlor:
(a) Letter of Wishes
When setting up a discretionary trust it is common for the settlor to indicate to the trustees by letter or otherwise how the settlor would have dealt with those assets if he had retained the necessary control. Such a letter will not be binding on the trustees, and therefore has no adverse consequences, but in practice most reputable trustees would be reluctant to deal with the trust property in any way other than that suggested by the settlor except, for example, where a change in circumstance or other matters suggests it is clearly disadvantageous to the beneficiaries to act in that manner.
It is possible for a protector to be appointed who exercises some degree of control over the trust property. In our opinion, it is unwise for the protector to be given anything other than negative powers as this may mean that the protector is considered to be a quasi-trustee and negative consequences may result especially when the protector is resident in a high tax country. Thus, for example, the protector's powers should be limited to vetoing the decisions or actions of the trustees rather than having power to force the trustees to act in any particular way. For example, the trust deed may stipulate that no distribution from the trust can be made by the trustees without the consent of the protector but the trust deed should not give the protector power to instruct or force the trustees to make a distribution. The need for the protector to be consulted are structured without a protector being appointed. It is usual for a trusted friend, family relative or professional adviser of the settlor to be appointed as the protector but it is becoming increasingly common to use the services of a professional trust company to act as protector. For this reason our own organisation offers to act as a professional protector where we are not retained to act as trustees.
(c) Two Tier Company and Trust Structure
Greater flexibility can sometimes be achieved by having the underlying assets owned by a company whose shares are owned by a suitable trust -rather than having the underlying assets owned directly by the trust. The settlor, or an appointee of the settlor, may act as the director of the company and may therefore exercise day to day control over the underlying assets with minimal interference or need to refer to the trustees. This two tier structure may have tax and other disadvantages where the director of the company is resident in a high tax country but can be used to good effect in certain circumstances.
(d) Joint Trustees
There is no reason why a trust could not be structured so that there are joint trustees with the agreement of both trustees being required in order to take any action. The second trustee may be the settlor himself, or a corporation controlled by the settlor. Again, there may be negative tax or other consequences resulting from such a structure or if the settlor is resident in other than a low tax jurisdiction but this is a solution worth considering. Alternatively, a check and balance may be obtained by having two different professional trust corporations acting as joint trustees. This can be cumbersome and expensive but may be suitable for certain trusts.
(e) Self Administered Trust Companies
It may be possible for a settlor to establish his own trust company which acts as trustee of his trust. If tax savings are a primary motive for establishing the trust this will rarely be a suitable solution except in cases where the settlor and his family are resident in an offshore or low tax jurisdiction but may be a possibility where the tax considerations are irrelevant. Correctly structuring the ownership of the trust company can often be problematical so this structure has yet to gain widespread popularity but may be worthy of consideration.
(f) Hybrid Companies
A hybrid company is a company which is limited by shares and guarantee and therefore has both shareholders and members. The directors and shareholders control the company but have no rights to receive benefits. The members have no control but hold the rights to benefit from the company assets. Thus the shareholders are analogous to the trustees and the members are analogous to the beneficiaries. The "settlor" transfers assets to the company but retains the shares and makes his family the members. In this way he can pass on benefits without losing control. With this solution problems can arise upon the death of the shareholders as, unless great care is taken, there ceases to be an effective way of administering the company. The ideal solution is to place the shares under the control of a suitable trust company but, of course, this will result in no more controls for the "Settlor" than he would have using a traditional trust structure.
Many believe that the costs of running a trust are prohibitive. Whilst it is true that many of the major banks and other financial institutions will make hefty charges for setting up a trust and will then expect to receive a percentage of the trust assets in annual administration fees, the level of fees charged by the smaller independent trust companies are generally much more reasonable and make the advantages of setting up a trust available to those with even relatively modest estates. Independent trust companies are also able to offer a more personalised service and also benefit from the fact that they are truly independent and can therefore select the best investments for the trust without being under pressure to place trust money with their own in-house investment advisers - see the section entitled "Accountability of trustee" for further explanation on this important point.