Tax Planning and Trusts
As the legal owner of the trust property is the Trustee not the beneficiaries, it is normally the Trustee who would be liable to be taxed on the trust property. If the Trustee is resident in a country where trusts are not taxed, it will often be possible for the trust fund to avoid being taxed directly. Whether the beneficiaries will be taxed in relation to the trust fund will depend on specific legislation in their countries of residence. This feature has given rise to a number of interesting tax planning opportunities. A few of these are described below.
The United Kingdom
The UK has been described as the “world’s best tax haven for people who were not born there”. The UK has attracted high net worth individuals from all over the world partly because of its favourable tax system. Persons who are not “domiciled” in the UK but who are resident there for tax purposes are not subject to UK income and capital gains taxes on non-UK source income and gains unless remittances are made to the UK. Capital assets situated outside the UK are outside the scope of UK inheritance tax for so long as the owner remains non-UK domiciled (and not “deemed domiciled” in the UK). Using an offshore or non-UK trust can enhance these tax benefits further by for example enabling the complete avoidance of inheritance tax to be achieved. Individuals may reside in the UK and providing that they only remit to the UK (for living expenses, for example) capital they will have no liability to UK income or capital gains tax in respect of their offshore assets.
In order to achieve these considerable tax benefits it is usual to take detailed tax advice prior to establishing a trust. Attention needs to be given to claiming non-UK domiciled status with the UK tax authorities and consideration given to the form of trust structure depending upon how the trust assets are to be invested. Appropriate record keeping and segregation of income will be required in the administration of the trust and a holding company may be required in many cases.
The United States
American citizens are subject to US taxation by reason of their nationality. Residents and deemed residents of the US are also subject to US taxation on their income (which includes capital gains). US taxes are not low by international standards, but despite this the US attracts many immigrants and international families often have branches in the US. It is possible for a person who is not a ‘US Person’ to create a trust for the benefit of persons who are US taxpayers or US residents free of US taxes, although since 1996 income from such trusts must be reported to the Internal Revenue Service of the USA.
It is also possible to provide income from an offshore trust fund to US taxpayers or US residents which is taxable in the US, while maintaining the capital of the trust fund outside the scope of US gift and estate taxes.
As a result of the Reserve Bank’s policy of relaxed exchange controls, residents of South Africa can now transfer significant sums each year to non-South African trusts in a straightforward manner thereby enabling significant diversification of their asset base and the added benefit of sheltering capital. Although South African residents are subject to estate duty and income taxes from worldwide sources, appropriately-structured and funded offshore trusts can enable residents of South Africa to build up long-term investments, allowing the growth to fall outside the dutiable estate and with the possibility of minimizing income tax and capital gains tax.
Canada has also attracted many immigrants and offers citizenship after three years of residence if relatively modest investments are made in the country. Where family members have moved to Canada from other countries, a family trust that was established and funded by a non-resident of Canada tax can be used to provide benefits to the Canadian-resident beneficiaries with only the amounts distributed to such residents that represent income and capital gains being subject to Canadian income tax. A family trust may thus provide an element of tax deferral. Such trusts generally now have to be reported to the Canadian tax authorities even if not taxable, but the ability to defer tax can be of considerable benefit to family members who may wish to acquire Canadian citizenship.
If a person moves his tax residency from one country to another there may be opportunities to mitigate taxation in both the old and the new countries of residence. It is difficult to generalise since the specific tax treatment will depend upon the precise situation and the countries in question. “Going cross border” can often enable capital gains taxes to be avoided completely and for income tax to be deferred in the new country of residence if assets are transferred to an offshore trust structure before the new tax residence has been established. It may be possible to use offshore trusts to defer liability to income tax in the case of persons moving from abroad to countries such as New Zealand, Sweden and Switzerland. Tax planning using trusts in Continental Europe is not generally straightforward, but with appropriate professional advice it may be possible to achieve considerable tax savings. It is possible to use trusts to mitigate estate or inheritance taxes in a number of countries, which is often of considerable interest to entrepreneurs.
Other uses of Trusts
Charitable trusts can be established to further worthy or desirable purposes. Such charitable trusts are exempted from rules against perpetual duration and can last indefinitely. Charitable trusts can be established “on-shore” (such as in the United Kingdom) as well as offshore. “On-shore” charitable trusts may be able to benefit from double taxation treaties so that withholding taxes can be reclaimed or dis-applied in relation to the trust assets, but will need to meet governmental requirements in order to obtain charitable status for tax purposes. Offshore charitable trusts may be set up generally without intrusive scrutiny by the local tax or regulatory authorities.
As many trusts will be established by a transfer of assets during the lifetime of a person, such assets will not fall into the estate of that person on death, but will remain held by the Trustee for the benefit of the beneficiaries. Although inheritance rights under civil law legal systems will be relevant, the fact that assets do not fall into the estate may prevent the direct triggering of estate or inheritance tax liabilities. Even if no tax saving is intended, the use of a trust in these circumstances can provide a greater degree of confidentiality since probate formalities which may apply (such as the publication of wills and the advertising for creditors) would be avoided.
Non-charitable trusts set up to further particular purposes are generally invalid under English law. The trust laws of a number of offshore jurisdictions such as the Cayman Islands and Bermuda do permit trusts to be established by which funds are applied to further pure purposes. Purpose trusts can be used to support research or ideological interests or be used by companies to avoid holding assets on balance sheet in structured financial transactions.