Trusts have been used in Common Law countries for many hundreds of years. With the development of international business, international tax and estate planners were quick to realise the benefits of using trusts in low tax jurisdictions to help mitigate tax liabilities and to assist with the flow of family wealth across the generations.
Historically, clients from Civil Law countries have been more familiar with the concept of the foundation. They are now, however, becoming increasingly aware of the benefits of trusts.
Dixcart can provide expertise in relation to the formation and management of both trusts and foundations.
Uses of Trusts and Foundations
Trusts and foundations are used for a wide variety of reasons. These typically include one or more of the following:-
- Asset protection.
- Circumvention of forced heirship laws.
- Continuity on death.
- Favourable tax treatment.
- Preservation of wealth and selective distribution of assets.
Similarities and Differences between Trusts and Foundations
There are many similarities between trusts and foundations:
- One has a Settlor, who may have reserved powers, the other has a Founder, who may have rights reserved to him over the management of the foundation.
- One has a Trustee and the other a Council and Officers.
- One is governed by the provisions of a trust deed and the other by a charter and articles or regulations.
- Both have Beneficiaries.
The differences between trusts and foundations lie in the nature of the solutions:
- A trust is not a legal entity, while a foundation is a registered legal entity.
- The ownership of the assets in a trust is vested in the Trustee, whilst a foundation owns the assets directly.
Acceptance of Trusts and Foundations
Almost all low and nil tax jurisdictions have laws recognising trusts including a number in civil law countries. Foundations, however, are only available in a small number of jurisdictions, although this number is increasing.
Common law (Anglo-Saxon) countries have recognised the trust concept for many years and acceptance of trusts is now spreading rapidly into civil law countries as people become aware of their benefits. The Hague Convention of 1985 formally recognised trusts and has now been adopted by thirty-four countries.
Trusts in More Detail
At a very basic level, the concept of a trust is relatively simple: a person (Settlor) places assets in the legal custody of another (Trustee) held for the benefit of a third party (Beneficiary). The trust is not a separate legal entity, but more of a legal "obligation" agreed between two parties: the Settlor and the Trustee. This is the basic concept of a trust.
Three certainties must exist for a trust to be valid:
- Intention: the Settlor must have clearly intended to settle the trust and to confer legal control of the assets.
- Assets: the trust is not operational until the assets have been transferred.
- Objects: it must be clear for whom the trust was created and therefore for whom subsequent assets transferred to the trust are being held.
These are the bare minimums for the trust to be valid. Common validity issues that can result in the trust being dismissed are:
- The Settlor wishes to maintain full control of the trust assets and gives orders to the Trustee.
- Assets are never transferred. The trust was only created as a safety net in case something adverse happens to the Settlor.
- The Settlor wants to be the sole Beneficiary of the trust.
Failing any of the three points detailed above can lead to potential legal issues for the Settlor. A court could determine that the trust is a "Sham Trust" and order any assets transferred (assuming they ever really existed) to be repatriated and included as part of a settlement.
Trustees owe a fiduciary duty to both the Settlor and the Beneficiaries as well as to the trust itself. Depending on the jurisdiction under whose laws the trust is constituted, the trust can either have a pre-determined life span or be indefinite. Trusts are intrinsically very flexible.
Foundations in More Detail
A foundation may be defined as “.... an independent self-governing legal entity, set up and registered or recorded by an official body within the jurisdiction where it is set up, in order to hold an endowment provided by the Founder and/or others for a particular purpose for the benefit of Beneficiaries and which usually excludes the ability to engage directly in commercial operations, and which exists without shares or other participation”.
A foundation is more structured than a trust as it is governed by its charter and articles or regulations. The roles of the Council, Officers, Supervisory Person and Secretary are well defined and provisions have to be made for meetings. Potentially a foundation provides more certainty than a trust and is less likely to be treated as a sham particularly in civil law jurisdictions.
Foundations can be perpetual and have stated objects and purposes. Those who administer a foundation are personally liable to the Founder and to the Beneficiaries if they act outside the governing rules of the foundation. The liability of a foundation is limited to the value of its net assets. The Founder may have a liability to transfer any assets he has agreed to endow to the foundation. The will and intentions of the Founder can be imposed on the foundation and the rights of the Founder are assignable by him.
A few of the defining characteristics of a foundation are detailed below:
- It is a legal entity in its own right and can therefore own assets directly.
- It is controlled by a Council of which the Founder can be a dominant member.
- Unlike most trusts, the Beneficiaries may be denied access to information and they generally do not have equitable or any other form of ownership over foundation assets.
Although the foundation has similar characteristics to a regular company, it has no shareholders and is thus ‘self-owned’ and ‘self-governed’.
Completely unlike a trust, the Councillors or Directors of a foundation owe their duty to the foundation itself and not to the Beneficiaries. Their main consideration will therefore be in terms of what the Founder wants and not what might be in the best interest of Beneficiaries.
Title to the assets stands in the name of the foundation itself as it has full legal capacity. The trust-related concept of ‘dual ownership’ by the legal owners and the equitable owners is not relevant to a foundation.
The concept of ‘sham’ and ‘lack of (Settlor’s) intention’ does not arise, as the foundation is an incorporated entity and speaks for itself.
Tax Treatment: Important Considerations
When considering whether to use a trust or a foundation one needs to consider the effect of the tax treatment on all parties concerned. In Common Law jurisdictions there should be certainty as to the tax treatment of the Settlor and Beneficiaries of any trust and in Civil Law jurisdictions there should be certainty of tax treatment in respect of foundations. Careful consideration and advice needs to be taken when using a trust in a Civil Law jurisdiction and a foundation in a Common Law jurisdiction. If there is no agreed position on the tax effects then the tax authorities are likely to treat the trust or foundation in a way that most suits the tax authority.
SIMILARITIES AND DIFFERENCES BETWEEN A TRUST AND A FOUNDATION
An important distinction between a trust and a foundation is that a trust is a legal relationship between the Settlor, the Trustee and the Beneficiaries. The trust itself is not a legal entity. The Trustees are the legal, but not beneficial, owners of the assets. A foundation constitutes a legal entity in its own right. Another key difference is that a trust can be used for commercial purposes, but a foundation, except under limited circumstances, cannot.
The practical day to day administration of the assets placed in the trust or foundation will be carried out by the Trustee of the trust, or the Board of the foundation.
Although the Settlor or Founder does not control the assets, he does retain an advisory role to provide the Trustee or Board with an indication as to how he would like the assets to be managed. For a trust this will normally take the form of an unenforceable and informal letter of wishes. With a foundation the intentions are normally incorporated in the foundation’s by-laws and therefore tend to be less flexible in meeting changing needs. It must be emphasised, however, that the Settlor or Founder can normally only make recommendations or suggestions and not issue instructions, unless the power to do so is specifically written into the trust or foundation documentation.
Capital and Filing Requirements
There is no minimum capital requirement for the establishment of a trust. Generally there is a minimum initial capital requirement for a foundation, dependent on where it is formed.
In the majority of jurisdictions there is no requirement for a trust to file any documentation. Foundations, depending on the particular type, are normally registered and the Registrar must make available certain information, although not necessarily the name of the Founder.
One advantage of a trust is the ability for the management of a trust to move from one country to another, with a change of Trustee. This provides additional fiscal and tax protection. There is no obligation to register a trust, and therefore there is no residual or ongoing obligation for the trust to meet any newly imposed regulations in the jurisdiction of the previous Trustee.
Summary and Additional Information
The specific choice between a trust and a foundation is often more dependent on how familiar and comfortable an individual is with the particular entity rather than its precise characteristics. An important issue to consider is the probable tax treatment of all parties involved.
Dixcart is able to offer solutions to meet specific situations incorporating either of the structures discussed in this document.
If you require any additional information regarding trusts and foundations please speak to your usual Dixcart contact or to John Nelson in our Guernsey office: firstname.lastname@example.org or to Christine Breitler at our office in Switzerland: email@example.com