A trust is an instrument of tax planning, asset protection, and inheritance planning. A common misconception is that a trust is a special legal entity while it is not. Rather, it is a form of a fiduciary agreement.
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Trust structure
Our new phrase is: Incorporating a trust in a country such as the Cayman Islands is not difficult if you contact a business consultant who can act on behalf of you.
Three parties take part in forming a trust:
- Settlor or Grantor is the person who transfers some property of his/ hers to the trust. After the property is transferred to the trust, the Settlor loses control over it. If the Settlor reserves the right to take the property back from the trust, the trust can be deemed void.
- Trustee is the person (or company) that manages the property in trust in the interest of the Beneficiary. Alternatively, the Trustee may have the task of achieving a certain goal. The Trustee is not entitled to benefit directly from the property in trust.
- Beneficiary is the person who benefits from the property kept in trust. The beneficiary can also come into possession of the property under certain conditions. A trust can have several beneficiaries. The beneficiaries are entitled to demand efficient property management from the Trustee. If necessary, a beneficiary can sue the Trustee. Courts of law in Great Britain and other countries that use similar judicial systems have vast experience in protecting the rights of trust beneficiaries. For this reason, Trustees seldom violate the Trust Deeds (see below).
A trust can also have a fourth party, namely, a Protector.
- Protector is the person who oversees the activities of the Trustee.
For practical purposes, it is important what scope of authority the Protector has.
Possible powers of the Protector:
- To fire and hire the Trustee;
- To sanction or veto the Trustee’s decisions;
- To introduce amendments to the Trust Deed;
- To alter the list of beneficiaries;
- To change the trust’s domicile (the jurisdiction where disputes could be held);
- To request financial reports from the Trustee.
The list shows that the scope of the Protector’s authority can be rather wide. However, the wider it is, the higher is the chance that the property in trust may be deemed to belong to the Protector. This fact may bring negative legal and fiscal consequences. This is why it is important to study the trust-related legislation of the country where the trust is about to be created.
In offshore jurisdictions in particular, almost anybody can be appointed Protector. It can be
- The Settlor;
- One of the beneficiaries;
- A trusted agent of the Settlor (an attorney, a close friend, or a family member);
- A legal firm.
Even though the choice is wide, a trusted agent is usually appointed Protector.
Trust subject
There is one more obligatory element that a trust must have, namely, assets or property. A trust cannot exist without assets.
When a trust is created, the property rights are split into two parts:
- Legal property rights (the rights to own and manage the property) belong to the Trustee;
- Beneficiary property rights (the rights to benefit from the property) belong to the Beneficiary.
Because the property rights are divided in this way, the Beneficiary cannot be taxed on the property in trust, as it does not belong to him / her. Fiscal obligations arise only when the beneficiary receives benefits from the trust.
Trust documents
The main trust documents include the following ones:
- Trust Deed is the central document of a trust. It specifies the property put in trust as well as the property management methods. Trust Deeds are normally made in writing.
- Letter of Wishes is an auxiliary document that the Settlor or the Protector can send to the Trustee. The Letter of Wishes should contain recommendations rather than instructions. In the latter case, the trust may be deemed void.
In addition to that, the Trustee has to keep financial records. In most offshore jurisdictions, these records do not have to be submitted to the authorities. Instead, they have to be submitted to the Beneficiaries or the Protector.
Main types of trusts
Revocable Trust/ Irrevocable Trust. If the trust is revocable, the Settlor is entitled to revoke the property in trust. Such a trust is useless for asset protection because it can be easily deemed void by a court of law. If the trust is irrevocable, the Settlor gives up his/ her property rights for a certain period. You can find more information about the differences between a revocable and irrevocable trust at this page.
Fixed Trust/ Discretionary Trust. In a fixed trust, the profits are distributed in accordance with the instructions of the Settlor and the beneficiaries are listed by name. In a discretionary trust, the beneficiaries are indicated as a group of people (for instance, “my first wife’s children born to me”). The Trustee is entitled to distribute the profits to the Beneficiaries at his/ her discretion. Discretionary trust suit the purpose of asset protection especially well. As the names of the Beneficiaries are not specified, it is very hard to lay fiscal claims against them.
Beneficiary Trust / Purpose Trust. If the trust has a Beneficiary, it is a beneficiary trust. Most trusts are beneficiary trusts. A purpose trust does not have beneficiaries. Instead, it is created for a certain purpose. The purpose can be specified narrowly (hold the securities of company ABC) or widely (preserve historical heritage). As there are not Beneficiaries in a purpose trust, there is nobody to tax. For this reason, a purpose trust offers wide opportunities for tax planning and asset protection. A Purpose trust can also have a Protector whose function would be to sue the Trustee in case he/ she violates the conditions specified in the trust deed. (If the trust is a beneficiary one, the Beneficiaries are entitled to sue the Trustee.)
Asset Protection Trust. The term is rather blurred because all types of trust serve asset protection purposes. It is used in some offshore jurisdictions such as the Cook Islands, for example, that specialize in asset protection services.
International Trust. Any trust can be an international one if it has the following properties:
- The Settlor is a resident of country A but he/ she creates a trust in country B;
- The beneficiaries are located in country A but the property in trust is located in country C.
What is a sham trust?
A sham trust is a trust that does not bring about any legal consequences for its parties. A trust can be deemed sham only in a court of law.
Main characteristics of a sham trust:
- The Settlor did not have the rights for the property when the trust was created;
- The trust has been created with the sole purpose of deceiving the Settlor’s creditors;
- The Settlor has reserved the right to revoke the property in trust;
- The Settlor has reserved the right to control the activities of the Trustee;
- The trust documents do not reflect the true intentions of the Settlor.
There have been many precedents when trusts have been deemed void (sham). This is why you should seek professional assistance if you would like to set up a trust.
