UK case law would seem to make Private Interest Foundations far more desirable for UK domiciled individuals than the better known and more traditional trusts - However, this may not be the case for those based on the Continent

The function of both trusts*1 and of private interest foundations*2 was and is to legally separate an individual or individuals from their assets for the current and/or future benefit of disclosed and/or discretionary beneficiaries. Legally both a trust and a private interest foundation are self-owning entities with no ultimate controller or owner which is exactly what makes them so attractive to tax planners and those seeking to protect assets from either 3rd parties, fiscal authorities and/or the injudicious actions of those who might otherwise be expected to become direct beneficiaries if assets were to be distributed directly. 

*1 Primarily used in common law jurisdictions such as the UK, the USA and most ‘known’ tax havens
*2 A creation of the ‘continental’ civil law system

Private Interest Foundations (PIFs) - An Overview

Protecting Your Assets

A correctly established private interest foundation (PIF) can be drafted in such a way that it can offer virtually all the benefits of a traditional APT. In fact, in many ways a foundation is often both the better and safer method of protecting assets from 3rd party litigation especially if the private interest foundation is located in a highly monitored jurisdiction such as Switzerland or Liechtenstein or has been set-up by SCF using a Panamanian PIF structure where SCF has drafted the Regulations and the Foundation Council is independent with banking outside of Panama

Reducing Tax Obligations

Private interest foundations, whilst not necessarily desirable for those located in civil law jurisdictions such as France or Germany, have very positive benefits for those located in common law countries, particularly the United Kingdom where there is case law which established the veracity of private interest foundations (see below under Foundations – General Principles)

Trusts - An Overview

Protecting Your Assets

Trusts can be established in such a way that they can be used to protect assets from potential 3rd party litigation. These types of trusts are known as “Asset Protection Trusts” or APTs and are primarily used in the United States by professionals such as medical doctors, dentists and lawyers where high indemnity insurance and an extremely litigious environment mean that few successful professionals can afford not to consider establishing an APT. However, it should be noted that such APTs don’t have fiscal benefits and further should always be declared to the Internal Revenue Service (IRS).

Reducing Tax Obligations

Many ‘Tax Haven’ jurisdictions such as Jersey, Guernsey, the Isle of Man and of course most of the former British colonies in the West Indies offer trust structures (normally discretionary in nature) that are subject to little or no annual tax or annual duty. However, it would be a mistake to assume that simply because the ‘tax havens’ offer such fiscal benefits that non-tax haven jurisdictions accept their fiscal veracity. In fact, as a general rule ‘trusts’ set up by those resident and domiciled in common law jurisdictions such as the United Kingdom, Australia, Ireland, Canada etc. generally do not benefit from many tax breaks due to the advanced anti-avoidance provisions in situe. However, for those not domiciled in such countries or for those resident in a civil law jurisdiction trusts can often offer significant benefits.

The Principality of Liechtenstein can trace its origins back to 1719 when the regions autonomy was conceded by Emperor Charles VI. Historically closely connected to Austria although this century it has established substantial links with Switzerland including the adoption of the Swiss currency. Since the Second World War the jurisdiction has become a major financial service provider in central Europe with numerous trust companies located in its capital Vaduz. Numerous legal undertakings have been established to allow tax planning flexibility the most well know being private interest foundations (stiftungs) and private law establishments (anstalts) both of which offering unique advantages. The main benefit of private interest foundations and establishments is that they are self owning entities like trusts but can be controlled, if required, by the founder during his or her lifetime. Banking & Confidentiality: For those seeking confidentiality over their business and financial affairs Liechtenstein probably offers the best 'haven' in Europe. It is not a member, or associated member, of the European Union and only has one double taxation treaty with Austria. Under their most recent banking legislation, passed on the 21st of October 1992, both present and former bank staff together with government officials cannot disclose any banking information to third parties. If one of the numerous local legal entities, including anstalts, aktiengesellschafts and foundations, are needed it is highly recommended that local lawyers are employed since any non-authorized disclosures would result in penal consequences. For the same reasons, their employment is also recommended even when personal or foreign company accounts are being opened. Obviously, Liechtenstein like all other respectable jurisdictions do not wish, notwithstanding the aforementioned, to be seen as a center for illicit/criminal activities and, provided sufficient evidence is adduced, will release information. Further, any cash deposits over 500,000.00 Swiss Francs will be subject to strict source verification. Nevertheless, it should be noted that the Liechtenstein authorities will not assist third party inquiries relating to foreign tax obligations. If a foreign company is opening an account full banking confidentiality will still apply, however, it is then necessary to consider that jurisdictions disclosure rules.

Our Ratings for Liechtenstein

Corporate registration efficiency: 5 / 5 Cost: 3 / 5 Confidentiality: 4 / 5 Local banking facilities: 5 / 5 Legal system: 5 / 5 Political stability: 5 / 5 Reputation: 5 / 5 Location: Liechtenstein is located between Austria and Switzerland. Population 30,000. Private Interest Foundations: A separate legal entity like a limited liability company but unlike a company it is self owning and not owned by shareholders. Like trusts foundations generally do not have direct commercial interests but can own companies that are commercially driven. In countries such as the UK and USA foundations can offer unique advantages as anti-avoidance provisions have primarily been drafted for trusts but not for foundations. In addition, case law suggests that courts in English speaking countries accept that foundations are separate legal entities like companies but that they are also self-owning. Further, unlike trusts a founder, akin to a settlor in a trust, can reserve special rights during his or her lifetime including the right to determine his or her foundation. The principal governing body is the Foundation Council, which generally has, consists of Liechtenstein lawyers and/or trust companies. If required it is possible to employ an independent 'protector' to ensure that local Foundation Council members carry out their duties as required. Private Interest Establishments: Very similar in format to a foundation save that they can directly own and operate commercial enterprises. If an establishment does directly own and control a business enterprise it will be subject to the same auditing requirements that pertain to Liechtenstein companies. Advantages: - Highly developed infrastructure and pro-business government. - Sophisticated and varied legal entities. - Very stable economy. - Banks have AAA status. - The currency is the Swiss franc. - Little corruption. - Beneficial or even share ownership need rarely be publicity recorded. - There are no nationality requirements in respect of most officerial positions. - Non-commercial entities do not require audited accounts. - Efficient local processionals. - Excellent communications. - English is widely spoken. - Courts will only disclose beneficial ownership details in criminal cases and then only when such activities are deemed criminal under Liechtenstein law

The concept of a trust is unique to ‘common law’ or English speaking jurisdictions. Historically, it developed from the English laws of equity and was widely used in the United Kingdom as both an effective and legal tax avoidance method. In synopsis, a trust is merely a way in which a person (known as the ‘settlor’) may transfer his or her assets to independent third parties (known as ‘trustees’) to manage and control the disposed assets in favour of either known or unknown beneficiaries. It is important to note that to be affective a trust must give full autonomy to the trustees. If this is not the case, it could be claimed that the trust was not ‘settled’ and therefore was not a properly constituted trust instrument. It this occurred, the settlor would still be legally deemed to be the owner of the trust assets and therefore taxable upon them as an individual — defeating the raison d’être behind the trust. Obviously, given the requirement to totally deny the settlor control over what were formerly his or her assets, such a structure demands a high degree of trust in the trustees. Fortunately, trustees are not totally free of control often being regulated, whilst by convention, they will very closely adhere to a document known as the ‘letter of wishes’. This is a brief of the desired disposition and/or method of investment of the trust assets by the settlor to the trustees at the time of the creation of the trust. In addition, the settlor will often appoint a ‘protector’, normally a trusted family lawyer or accountant, to oversee the trustees and normally to act as a cosignatory on the trust bank account.

Unlike other trust mechanisms, an asset protection trust (APT) does not necessarily seek to reduce the settlor’s tax responsibility. In fact, for US nationals this could have significant negative consequences. Rather, ‘its purpose is to act as a form of insurance for high-risk individuals, primarily those in the medical and legal professions, in litigious jurisdictions like the USA. Before establishing such a trust for an American, it is essential to confirm that the basic mechanism would be accepted as bona tide by the I.R.S. (Internal Revenue Service). Jurisdictions, which have special APT legislation, include Cyprus and the Cook Islands.

Trusts – In Detail

The concept of a 'trust' is unique to common law or English speaking jurisdictions. Historically, it developed from the English laws of equity and sought to separate the creator of the trust, known as the Settlor, from specified real or personal property usually for the benefit of future heirs and/or to ensure that any future dispositions Would be made in a manner generally in keeping with the original intentions of the Settlor. Once a Settlor has decided what property he wishes to transfer to the hypothetical trust (normally a complex written document) he must decide upon its administrators, the 'Trustees'.  It is vital to understand that these must have full autonomy to independently manage and control the transferred property in favour of either known or unknown beneficiaries. If full autonomy is not granted then it could be claimed that the trust was not settled and therefore, was not properly constituted.

If this happened then the Settlor would still be legally deemed the owner of the trust assets - defeating the-raison d' étre behind the trust in the first place. Obviously, given this requirement to totally deny the Settlor direct control over what were formally his assets demands great trust' in the Trustees.  Fortunately, Trustees are not totally free of control since they must normally strictly adhere to the trust instrument unless such instrument involves an illegal act or is in breach of some current public policy. Certainly, it is normally open to interested, or potentially interested parties, to seek the assistance and interpretation of the applicable courts.

In almost all common law jurisdictions, they have reserved the right to vary, abrogate or otherwise change the terms and conditions in a deed of trust including the originally designated 'Trustees' and/or beneficiaries.  Notwithstanding the above, it must be understood that the courts in, most common law jurisdictions will do everything in their ability to carry out the wishes of the Settlor and, bar some malfeasance, are unlikely to interfere with a deed of trust.

It is clear that all Trustees implied through circumstances or clearly designated, have a fiduciary duty to act honestly and in good faith for the benefit of the trust even if such responsibility denies them personal opportunities. The best analogy is probably afforded by the fiduciary duty owed to a shareholder by a company director.

However, unlike a director a Trustee must not be directly answerable to any third party since this would infer that the Trustee was in reality a mere 'nominee' acting as a catalyst for someone else. If the Settlor was the instructing party then the trust would not have legally settled ' Further, unlike most dispositions a Trustee is not the direct legal recipient of the transferred assets. In fact, whilst the Trustee has the right to deal with the aforementioned as if he was the owner - subject to the deed of trust conditions and perhaps other Trustees - he cannot use them for his own personal use and, as a corollary, no third party creditor can sequestrate trust assets simply because of a dispute with a Trustee.

In other words, proprietary title is in limbo despite the existence of trustees who are responsible for the same as if they were directors and/or shareholders in a company. At the time of the creation of the trust instrument, the deed of trust, it is common that the Settlor provides the trustees with a 'Letter of Wishes' which, as its name implies, express's the wishes and desires of the Settlor at the time of the original disposition.

This' Letter' is not meant to be slavishly followed by the trustees since to do so would threaten the independence of the trust but rather it is ‘deciphering’ documents meant to assist the trustees carry out their independent functions. Of course, it does carry weight and should be read in conjunction with the deed - these often being standardized documents - but it should never result in the Settlor having de facto control. In recent years there has also been a growing propensity to use 'Protectors' as an additional safeguard against any wrongdoing by trustees.  In most cases, the protector will be a lawyer or accountant known by the Settlor who will be granted co-signatory rights, together with the trustees, over the trusts bank account facilities. Of course, a protector also should never be the Settlor or anyone else too closely connected with the trust since this could, once again, compromise the independence of the trustees.  Certainly, various obiter statements in English cases appear to be ascribing 'Protectors' with fiduciary duties akin to those of trustees (See I. R. C v. Schroeder 1 983 STG 480) Therefore, for safety reasons any modern trust should, if employing protectors, ensure that they are independent from the Settlor or other relevant parties.

What type of Trust?

Whilst there are many different types of trust employed in the world’s common law jurisdictions, it is the discretionary trust, which finds most favour in the offshore trust areas. This type of trust not only ensures that the settlor has divested himself or herself from the requisite assets, but it can also provide significant benefits to the intended heirs/beneficiaries. The reason for this is that whilst it is known that there will be, of course, beneficiaries, a discretionary trust leaves the amount of capital and/or interest to be paid to the normally unnamed beneficiaries totally at the discretion of the trustees. In effect, this allows the trustees the ability to control when and what type of payment should be made and hence, will ensure the most favourable tax consequences for the beneficiaries. In précis, trusts can be broken down into 3 constituent types with the 4th type, an asset protection trust (APT), simply being a variation of an An 'Accumulation and Maintenance Trust'

1. An 'Interest in Possession' Trust: As its name implies this provides for a beneficiary to have a distinct right to the income from a particular part of the trusts capital assets. The capital asset may or may not be passed on to the beneficiary.

2. A 'Discretionary' Trust: This gives the trustees total discretion to decide, subject to their fiduciary duty, how, when and to whom the income, and perhaps capital, of a trust is transferred.

3. An 'Accumulation and Maintenance Trust': This is basically a combination of the other two trust types. Generally, it will start as a discretionary instrument but will have provisions to change into an interest in possession trust normally when the beneficiaries have reached a particular age.

4. An ‘Asset Protection Trust’: Unlike other trust mechanisms, an asset protection trust (APT) does not necessarily seek to reduce the settlor’s tax responsibility. In fact, for US nationals this could have significant negative consequences. Rather, ‘its purpose is to act as a form of insurance for high-risk individuals, primarily those in the medical and legal professions, in litigious jurisdictions like the USA. Before establishing such a trust for an American, it is essential to confirm that the basic mechanism would be accepted as bona tide by the I.R.S. (Internal Revenue Service). Jurisdictions, which have special APT legislation, include Cyprus and the Cook Islands.

Who can use a Trust?

Until recently, there were virtually no restrictions on who could make effective use of a trust. However, both common law and statute have severely restricted the legal employment of trusts for those tax domiciled in countries such as the United Kingdom and the United States. In the case of the US, the one notable exception is the asset protection trust (see below). Notwithstanding these restrictions, trusts are still very valuable weapons in the tax planners’ arsenal since virtually no civil law country has any effective anti-trust legislation. In particular, they can often be used to avoid Continental ‘forced heirship’ provisions.

Examples - Traditional Uses for Trusts

'A' has a wife 'B' and 2 children 'C' (Age 10) and 'D' (Age 18). 'A' wishes to keep the family assets for the benefit of future generations, however, 'D' has shown himself to be frivolous and incapable of acting in the best interests of the family. In addition, 'A' wants to ensure that should he die his wife 'B' will have the right to remain in the family house.

ANSWER: A trust should be prepared outlining the long-term objectives of 'A' either during his life, an inter vivos trust, or upon his death by means of a will. The instrument could provide for 'B' to have a life interest in the family home with this interest reverting back to the trust or to 'C' and/or 'D' depending on circumstances. In fact, in such a situation it might be decided to give the trustees adequate 'Discretion' to take account of all possibilities. During the interim period such a trust would generally empower the trustees to pay a certain amount to 'B', 'C' or 'D' to cover all day-to-day expenses. Other possibilities would include provisions that 'C' or 'D' should directly inherit a given proportion of the trusts assets on the attainment of a given age or circumstance i.e. upon marriage. Obviously, the possibilities are endless but the great advantage is that once an appropriate trust has been created, 'A' will have some control over the disposition of family assets even from the grave! Obviously, the first example only takes into account the most simple of trust objectives.

However, the trust soon developed as a very effective 'tool' for circumventing, in particular, capital gains and inheritance taxes. The concept being that if for example, 'C' and 'D' above did not directly receive any pecuniary benefit, then ho could a government seek to tax them. Of course, once a trust did make a direct disposition 'C' and 'D' would have to pay taxes but remember that the trustees would, if we accept the discretionary model, be able to control the amount and time of the payment to ensure the most tax efficient result.

It goes without saying that a trust is a taxable entity, however, traditionally and logically it needs only to pay income and not capital gains or inheritance orientated taxes. Remember, in common law whilst assets may have been transferred to a trust the said assets are not owned by anyone until future dispositions have been made. In other words, it was the ideal 'holding' vehicle and could considerably postpone any tax liability.

Unfortunately, as will be shown later on, many of the advantages of trusts have been lost as a result of aggressive legislation in common law jurisdictions. However, possibilities still exist for those in some civil law countries and also for non-tax objectives such as asset protection.

The Rule Against Perpetuities

In the above examples it can be seen that significant powers of control over the future use of assets were granted -to the original Settlor, however, from a logical point of view this could have a disastrous effect on the availability of capital for future generations. To prevent this, most common law jurisdictions have developed specific limitations on the perpetual control of trust assets.  In the United Kingdom, a trust cannot remain active for more than 80 years after it has been settled or 21 years after the demise of an identifiable person who was alive at the time of the creation of the said trust.

Onshore Application

I n common law countries the use of onshore trusts for those locally domiciled and resident, at least for tax mitigation purposes, has greatly diminished. In the United Kingdom, for example, there has been a rash of legislation in recent years (such as S.739-740 of The Taxes Act, 1988, S. 110 of The Parliament (Finance) Act, 1989 and S. 87-97 of The Taxation of Chargeable Gains Act, 1992)- which has prevented the use of tax avoidance mechanisms unless there existed a genuine commercial reason, ascribed British residence to foreign trustees and made Settlor's personally liable for their trusts capital gains. However, as will be discussed later, there can still be considerable advantages available for those not domiciled, even if resident, in countries such as the United Kingdom.

Offshore Application

Today, the majority of tax mitigation trusts are established outside of high taxation common law countries like the United Kingdom. The principle reason is that 'tax friendly' jurisdictions such as Jersey and the Isle of Man provide respectability, greater confidentiality and hence protection against the ubiquitous reverse burden of proof principle employed in most high tax countries. If one on the other hand is domiciled, or perhaps resident, in a civil law jurisdiction one must be careful that trusts are recognized.

The International Recognition of Trusts

The main problem with the international recognition of trusts is that civil law countries have difficulty coming to terms with the concepts involved. Certainly, the idea of property ownership being in limbo for a given duration is alien as is that of beneficial, or true, ownership not necessarily resting with the shareholders. In addition, most civil codes (at least in Europe) adopt the Legitima Portia Principle; a 'Principle' which seeks to prevent a free disposal of ones assets in favour of guaranteeing specific proportions to ones next of kin. These facts, together with a reluctance to tie up capital and/or property for future generations, can result in civil law countries refusing to recognize trusts. Nevertheless, as a general rule Western European civil law jurisdictions will often accept a validly constituted foreign trust so long as its enforcement does not cause a breach of indigenous law.

The Hague Convention 1984 Effective 1st of January 1992

In an attempt to introduce greater harmony between the laws of common and civil law jurisdictions an international meeting was held in the Netherlands. This set out to establish the acceptance of certain principles, which should be applied by the courts of the signatory nations. To date, it has been ratified by the United Kingdom, Canada, Australia and, more surprisingly, Italy. In respect to the latter this should provide greater certainty for those with trust assets in this jurisdiction.
The attributes to be ascribed to a trust are elucidated in Article 2, however, it will be noted that they may still differ from those of an established trust jurisdiction. For example, it is quite common for English and Irish courts to imply a trust even if there are no written documents.

Article 2 'Trust Characteristics' as laid own under The Hague Convention 1984  

(i) It is accepted that a trustee has no direct proprietary interest in a trust and that it is not part of his own estate
(ii) Notwithstanding the above, title to the trust assets can be in the name of the trustee or held on his behalf by another
(iii) A trustee has a fiduciary duty to manage, dispose or employ trust assets in the manner prescribed by both the trust instrument and applicable law .

Advantages

Can transfer legal ownership from a Settlor to trustees without giving the aforementioned direct beneficial interest in the trust property. Can provide an effective mechanism of distributing trust capital and/or income to minimize tax consequences for beneficiaries. Prevents immature or frivolous beneficiaries from dissipating family assets and, therefore, 'protecting' future generations.
May be able to prevent the application of the Legitima Portia Principle in respect of assets in civil law jurisdictions. May still be very useful for tax mitigation purposes especially for those not domiciled in a common law area where anti-trust legislation may exist. The use of 'Protectors' can significantly reduce problems caused by dishonest or incompetent trustees.

Disadvantages

Many of the traditional tax benefits no longer exist for those resident and domiciled in common law countries because of antitrust legislation. In the United States such benefits are not normally available even for those merely resident. There may be difficulty in getting a civil law jurisdiction, particularly in Eastern Europe, to accept the validity of a trust instrument even if this does not cause any conflict with indigenous laws.  By definition the employment of a trust must result in the former 'owner(s)' of the trust property losing direct control over their former assets. Whilst the settlement of a standard format trust may not be prohibitively expensive the maintenance may be if the trustees have to play an active role and/or have specialist skills.
All trusts tend to tie up capital and are generally less productive and flexible than directly controlled mechanisms. The rule against perpetuities is almost universally employed and will result in the trust having a finite duration.A ‘foundation’ or ‘establishment’are separate legal entities without traditional share or equity holders, In effect, the lack of direct ownership provides for a unique stand alone structure with, once assets have been correctly transferred, no reference back to the creator of the applicable undertaking. An advantage of such structures is that their governing legislation often allow for a much greater degree of control than can be afforded to the settlor of a trust. The main difference between most foundations and establishments is that the former generally does not engage directly in commercial activities (acting as a de facto holding of investment vehicle), whilst the latter can make direct investments. In addition, an establishment can transfer ‘control’ (but not ownership, which always rests with the undertaking itself) to another transferable unit. Foundations and establishments are generally only available in civil law jurisdictions.