Thousands of trusts have been settled by clients of private banks in Asia during the past 10 years. There is nothing like market uncertainty, a low interest rate environment, political instability, and even, war, to focus the minds of investors on protecting their assets.
But thousands of new trusts have also brought significant change. Trust-related litigation is growing fast. New decisions continue to flow from international courts. And governments and tax authorities continue to restrict benefits previously enjoyed by trusts. International bodies chasing laundered money, and governments seeking to prevent tax evasion, have become increasingly suspicious of the use of trusts.
So what are the pitfalls for new users; what questions should we ask ourselves?
As most trusts are intended to outlive the settlor, and to protect assets until they are eventually distributed, the big concern for most investors will be that of certainty. How certain am I that the trust will work, and that my wishes will be followed? How certain am I that the trust will not be attacked and dismantled?
Interestingly enough, the trustee will be asking a different question of the future settlor, but towards the same end. Do you genuinely intend to make a gift of your assets, and pass control over those assets to the trustee, or do you want the trustee to own the assets, but to make the decisions yourself?
To be valid, a trust must have three so-called "certainties" . And one of these is "certainty of intention" . The trustee will need to ensure that the settlor does genuinely intend to make a gift of assets, and that he intends to surrender control, for the trust to be valid.
If we do not fully intend to make a gift of our assets, and if we do not genuinely intend to allow the trustee to control the assets in accordance with the powers written in the trust, we may not achieve the solution we seek. The trust will be weak, and will be open to attack by dissatisfied heirs and others.
"Will the trust be recognized in my home country, and, if not, how will this affect me, the trustees, and the beneficiaries?"
The trust is a creature of common law, the system of law in most countries that were once British or American colonies. There are far fewer common law jurisdictions today than civil law countries, and trusts are not generally known under, or recognized by, civil law. In an attempt to resolve the many conflicts that arise, Hague Convention number 30 on the law applicable to trusts and their recognition was promulgated in 1985. Few countries have, unfortunately, ratified the Convention.
One implication of non-recognition is that a trust may be disregarded. A trust settled by a resident of a civil law jurisdiction - PRC, Taiwan, or Indonesia, for example - for the benefit of heirs living in the same country, will, if challenged, probably be disregarded by the local courts when determining any distribution of assets on death. If a trust is simply disregarded, it is likely that the assets will be considered as assets owned by the settlor at his death, as if there were no trust at all.
3. Conflicts of law
"How will the assets be distributed upon my death, and will the trustees distribute the assets as I have asked, even if this is in conflict with the laws of my home country?"
The laws of many countries include what are commonly referred to as "forced heirship" rules; provisions that require us to leave certain portions of our wealth to specific family members on death. Some popular trust locations also have such laws, such as Jersey in the Channel Islands. In an attempt to attract business, however, many offshore trust locations have passed special laws to apply specifically to trusts established by foreigners, to try to override any home-country forced heirship rules.
Where a family is harmonious, and members agree with the manner in which the assets of the trust will be distributed, there should, in practice, be very few problems. Where there is disharmony, however, an aggrieved heir making claims through local courts can create significant problems for all concerned, and the laws of the distant offshore centre will provide very limited protection.
"Will the transfer of assets to the trustees be taxable, and if so, is it me or the trustees who will be liable? Will income and gains of the trust be taxable, and who is liable? Will distributions to beneficiaries on my death be taxable, and, if so, who will be liable?"
Most professional trustees are based in offshore "low-tax" or "no-tax" jurisdictions. And as income of a trust will be income of the trustee, income and capital gains will generally be free of tax in that jurisdiction. The residence and citizenship of the settlor and beneficiaries will be important, however, and can give rise to tax liabilities. As can the location of the assets. Even if assets located in Hong Kong, US, or UK, for example, are held by a trustee, estate taxes may still be due on the death of the settlor of the trust.
Governments are constantly seeking new means of raising taxes and are increasingly focusing efforts on the taxation of trusts. Trustees themselves are increasingly targeted. You could perhaps consider using a contract of privatbancassurance, or other more widely recognized and accepted means of planning, where trusts are not known in the countries concerned, and where the taxation of trusts is unclear.
"How secure are the assets if there are claims against the trustees from my ex-spouse, creditors, illegitimate children, legal heirs, or others?"
The laws of different trust jurisdictions offer various degrees of protection against claims by creditors and others. In general, a trust will not protect assets against claims that existed at the time that the trust was established, or claims that arise within a set period thereafter. Divorce courts and family courts are also increasingly sympathetic to disenfranchised family members.
"What if trustees die, or if a corporate trustee should collapse?"
Where trustees are individuals, the surviving trustees will often have the power to appoint a new individual in the event of the death of any one. Provisions for this should be included in the trust documentation. As one learned judge commented, "to act as trustee once is an act of kindness, to act as trustee more than once is an act of madness" . Trustees' duties are onerous, and potential liabilities extremely high. Professional corporate trustees should be used wherever possible.
"What if the offshore trust location is invaded or in danger?"
Political stability of the chosen trust jurisdiction is paramount. Imagine the position of a trustee in a location at war with the US, for example, and the consequent "freeze" of all trust assets. Considerable inconvenience and financial loss would likely follow. For this reason, many professional trustees have established trustee branches in various jurisdictions to provide the ability to "export" a trust in the event of any such risk.
Assuming that the world continues to change at its current pace, trusts will continue to be as popular in the next decade as in the last. We must ask questions, however, and we must have our concerns addressed, if future problems are to be avoided. As settlors are increasingly finding, there is no substitute for independent legal advice, and the costs involved in establishing an effective plan are never wasted.
By Paul Rust, Managing Director, LI Far East