The SCF Group
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.
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» Trusts & Foundations - An Understanding