The Recognition of Offshore Trusts

Foreword:
The reader should know that although trusts are not recognised in most civil law countries they are a familiar and popular concept with common law jurisdictions. However, not all common law countries have the same basic trust concepts which led to some debate as to whether a trust established in one country would be recognised and accepted in another.

The Hague Convention on the Law Applicable to Trusts (1984)
This Convention attempted to simplify matters with the main intention being to facilitate the recognition by one country of trusts created by the law of another. The Convention also attempted to provide a common set of criteria for determining which law should govern a trust.

The implications of the Convention will in the short-term be of none dramatic. However, its main effect has been to provide a reason for a number of onshore and especially offshore jurisdictions to re-examine their trust laws and introduce reforms to facilitate the recognition of foreign trusts. Using the UK as an example, it introduced the Recognition of Trust Act 1987 and the Recognition of Trust Act 1987 (Overseas Territories_ Order 1989 extending the Convention and Act to any colony, the Channel Islands and the Isle of Man.

The majority of offshore centres which provide trust services have enacted their own legislation that is similar in nature to the UK statute, which in turn was similar to the terms of the Hague Conviction

The Administration of Discretionary Trusts
The reader should be made aware that, although a wide variety of trusts can be created in offshore centres there is no doubt that the most widely used type is the discretionary trust.

The appeal of Discretionary Trusts
The popularity of this type of trust is centred around its flexibility, not only of the settlor but also for the trustees. Settlors generally prefer this type of vehicle as it enables them to make provisions for a wide variety of beneficiaries, including those who may not even be born. In addition, the trustees will usually be given the ability to add beneficiaries (and also to exclude them if the need arises) which further makes it possible for the changing circumstances of beneficiaries to be taken into account when distributions are contemplated.

Likely Beneficiaries
Clearly, each case will be different although it would be usual to find that the beneficiaries of an offshore discretionary trust will be the settlor, his family and dependants. That is not to say, of course, that others would not also be included in the list of possible recipients of the trust funds.

As mentioned before, in most trust deeds the trustees will be given the power to add to or delete from, the list of discretionary beneficiaries. This can create additional confidentiality benefits as the trust deed need only contain a single named beneficiary (perhaps a charity) and the names of the "intended" beneficiaries can be added by a supplementary deed at a later date, this is a widely used device offshore although it does create further considerations.
Many settlors are happy to be included as a discretionary beneficiary on the basis that, if approached by the tax authorities in their home country, they might be able to argue that they can only receive benefit at the discretion of the trustees, This argument might be sufficient to avoid tax on the income or capital gains of the trust property on the basis that they have no absolute right to receive a benefit. However, this argument should not be relied upon in all cases as in some onshore locations, the settlor, who is also a beneficiary of his discretionary trust, will be assessed to tax on the trust property.

Types of Power Given to the Trustees
Most discretionary trust deeds will give the trustees very wide powers over the trust property This will not only include who is to make distributions to, when to make them and the amount to pay, but also who to appoint as an agent or adviser and when to terminate the trust. The trustee will therefore have, in most cases, almost absolute discretion over the trust property.

Concerns of the Settlor
It should come as no surprise that some settlers are reluctant to allow their trustees such wide powers. After all, (or who) could stop them from exercising their discretions in a manner which the settlor never intended or generally disapproves of?

To provide, or offer, some comfort, there are two main ways in which a settlor may be able to have some way in the way in which his discretionary trust is being administered.

Letters of Wishes
Purpose of a letter of wishes
Trustees of discretionary trusts will usually have very little information concerning the circumstances and requirements of the discretionary beneficiaries. Without this type of information it can be difficult for the trustees to each a decision when considering the exercise of many of their discretions, particularly when it comes to distributions. The settlor can, however, offer the trustees some assistance by preparing a letter setting out his wishes in respect of how he would like the trust administered and in particular, who he would like to benefit.

Effect of a Letter of Wishes
Settlors should be advised that a letter of wishes is not a legally binding document and that the terms need not be followed by the trustees. In turn, the trustees and the settlor's advisers should remember that the main purpose of the letter is to provide the trustees with additional information (which may or may not help them in their decision making process) and that they can choose to take an action or reach a

Usual contents of a letter of wishes
The actual contents will vary from case to case but generally such a letter would start by stating that it is not intended to bind the trustees in any way and that it is not intended to create a separate trust. A reference to the letter not creating a separate trust might be included, as some practitioners have argued that certain trusts have been administered in accordance with the provisions of a letter of wishes and not in accordance with the terms of the trust deed. If this is the case the letter would take on the nature of a trust itself. Such a phrase is intended to prevent this claim being made.

After confirming the lack of effect which the letter will have, the settlor would then usually go on to mention who he would like the trustees to benefit and in what proportions. He might also mention that he may decide to change the terms of his letter in the future and also include reference to who he would like the trustees to communicate with after his death. Usually, this would be settlor's spouse or one of his children.

Letters are generally signed by the settlor, although not usually in the presence of a witness as to do so might create the impression that the letter was intended to have legal effect (and perhaps be likened to a will).

Disclosure of the terms of a letter of wishes
At the time of writing the only case which specifically dealt with the rights of a beneficiary to receive a copy of the letter of wishes was heard in Australia (Hartigan Nominees Pty Ltd v. Ridge (1912) ). In this case it was decided that the letter of wishes need not be disclosed to the beneficiaries on the basis that it was a confidential letter between the settlor and the trustees and confidentiality should normally be respected.

However, if there was hostile litigation against the trustees and the beneficiaries were trying to prove that the trustees had exercised their discretions improperly (perhaps by following or refusing to follow, the terms of a letter of wishes), a letter might have to be produced to the beneficiaries.

In view of the issued raised by the Hartigen Case many practitioners now request settlers to include in their letters of wishes a note to the effect that the letter is confidential.

Memorandum of Wishes
Some offshore service providers suggest that instead of a settlor signing a letter setting out his wishes in relation to the administration of the trust, the trustees should record the
Settlor's wishes in a file note which is then placed with the trust records. A copy of the note is then sent to the settlor for his review but he is not asked to sign it.

( Break ) The Trust Protector

The role of the protector is to oversee the actions of the trustees and also to provide them with an insight and understanding into the wishes of the settlor, and in some cases, the wishes of the beneficiaries.

The protector may also be appointed to act as a central point of liaison between the beneficiaries and the trustees and to resolve any disputes which may arise from time to time.

The protector does not have the same powers as the trustee, for example, the legal ownership of the trust property is held by the trustee who is responsible for the management and control of the trust and its property. The protector, however, is not the registered or legal owner of the trust property and would not be involved with the day to day administration of the Trust. He will have to fulfil certain duties and responsibilities and will also be given certain powers under the terms of the trust deed.

Reasons why a protector may be required
The settlor may be concerned that the trustee will fail to exercise his powers and duties in a satisfactory manner and would like a third party to keep watch over the trustee's actions.

He may be concerned that the trustee may not pay attention to his wishes.

He would like certain powers to be withheld from the trustees;

He would like a third party to act as moderator, and the main point of contact, between the beneficiaries and the trustees.

Usual powers of the trust protector
The trust deed must specify what powers the protector will have as there are generally no statutory powers which will be available in default.

i) To remove and appoint the trustees;

ii) To approve a change of proper law;

iii) To approve to the addition or removal of beneficiaries;

iv) To approve proposed trust distributions;

v) To approve the appointment of an agent or adviser;

vi) To approve investment recommendations;

vii) To appoint replacement protectors;

viii) To approve a proposal to terminate the trust;

Fiduciary Powers
Firstly, a 'fiduciary power' is generally accepted to be one which has been conferred on a person for the benefit of others. Clearly, if the protector has powers which enable him to affect the interests of the beneficiaries (i.e. the power to approve trust distributions) then he will have fiduciary powers and will, as a result, be expected to fulfil the duties which are expected of those with such powers.

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The Usual Structure (Contents) Of an Offshore Discretionary Trust Deed

The Parties to the Deed
The first part of the deed would usually cover who the settlor and the trustees are. In some cases another party may be mentioned although this is not particularly common in trust deeds (but is very common in deeds of retirement and appointment).

The Recitals
This section will include wording to the effect that the settlor intends to create a trust and will often specify the overall purpose of the trust (which might be to benefit the settlor's family).

Definitions
Most deeds will contain a section which defines the meaning of terms which are included in the deed. For example, the term 'Beneficiaries' will be defined and an explanation given as to who (or what) will or can benefit. Other terms which are usually defined, and which the trustees should pay particular attention to include the 'Perpetuity' (Trust Duration) Period', and the 'Trust Fund'.

Provisions and Powers
The next section would usually contain details of how the trust property is to be held and distributed. In addition, the powers of the trustees would be included in this section. In this section it should clearly state that the trustees have discretionary powers and that the interests of the beneficiaries will also be of a discretionary nature.

Schedules
In an attempt to simplify trust deeds it is usual for a deed to contain schedules which are referred to in the deed. They are commonly used to list the beneficiaries or perhaps the trustee's powers.

Execution Page
Usually, although not always, the deed will be executed by the parties at the end of the document. All parties to the deed should sign or seal and their execution of the deed should be witnessed.

Trust Accounting Principles for Offshore Trusts

Purpose of Trust Accounts
In general terms, trust accounts serve the following purposes:

a) They provide trustees with the ability to check that the terms of the trust have been complied with;

b) They help to explain to beneficiaries how their entitlements have been calculated and also how the trust property has been accounted for;

c) They assist the trustees with the general management and control of the trust assets by recording the present state of affairs (which is particularly useful with regard to trust investments);

d) They enable the trustees to fulfil their statutory duty to keep adequate accounting records which most offshore centres impose;

e) They provide information which is required for taxation purposes. Although most offshore trusts are not taxed locally, beneficiaries who receive distributions from a trust may need to submit accounting information to their tax authorities.

( Break )The Role of the Settlor

A number of settlors, particularly of offshore discretionary trusts, will want to retain some level of involvement in the administration and management of the trust and may suggest that they be given some say in the decision making process.

As mentioned previously, the residence of the trust for tax purposes will usually be determined by where the management and control lies. To avoid possible problems, the management and control of an offshore trust should be exercised by trustees who are resident in an offshore centre, preferably in the centre chosen as providing the proper law. However, if someone other than the trustees are making the decisions and managing the assets, the residence of the trust will, in all probability, be deemed to be where the management and control is actually being exercised. If the settlor, through his wish to have say in the decision making process, effectively has these powers then serious and damaging consequences could result.

Appointed As Co-Trustee
Generally, it would not be advisable for the settlor of an offshore trust to be appointed a co-trustee alongside an offshore trustee. This is because all the trustees will have equal powers and responsibilities in relation to the management and control of the trust and its property, and as a result the trust might be deemed to be resident where the settlor is located. If he is resident onshore, serious tax consequences could result.

Completing a Letter of Wishes
The Settlor of a discretionary trust should be encouraged to complete a letter of wishes if he feels it will provide him with comfort in the knowledge that he has been able to provide the trustees with guidance and advice in relation to how they may wish to exercise their discretion.

Appointed Investment Adviser or Other Agent
There is generally no restriction on who can be appointed as investment adviser or as any other designated agent, provided that the person who the trustee appoints is suitably qualified or experienced in the area concerned. As a result the settlor could be appointed to such a position. However, the trustees should look at the extent of the powers such an agent has been given and in particular whether they can be perceived as being able to exercise management and control over the trust property.

Appointed as a Beneficiary
The settlor could, of course benefit under the terms of the trust which he has created but he should consider whether there would be any possible taxation consequences of having an interest (either absolutely or at discretion) in property which he has placed into trust.

Control
The settlor could be appointed to the board of the Company (as too could members of his family and his advisers) which would enable him to have control over the trustee functions. However, if challenged it is doubtful whether this type of arrangement would create any tax savings, in view of the fact that the settlor would have retained the management and control of the trust property through his role as director of the trustee company.

Cost Savings
A fee for acting as trustee would not be charged and the only expenses which would have to be met would be the cost of incorporating the company and keeping it in good standing. There may be a requirement that the company has to be licensed to act as trustee (and possibly have a locally licensed trust company to act as its agent) and if this is the case additional cost would be involved.

Limited Liability
In theory, a limited liability company with no assets of its own would be better able to take on the trusteeship of assets which might be viewed as being of a speculative nature. In addition, if the trust is designed to provide creditor protection, a private trustee company might be a better option to act as trustee in view of its limited liability features.

Confidentiality
Private limited companies, especially those in offshore centres, can be structured to maintain confidentiality. They also prevent the possible worry over secrecy which some settlors have when appointing outside trustees.

It has been common practice in Bermuda for a purpose trust to own the shares in a private trustee company which would further increase the confidentiality possibilities.

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Offshore Trusts Owning Underlying Companies - The Benefits and Risks

A great many offshore trusts own shares in underlying (usually offshore) private limited companies. Before we look at some of the administration issues which company ownership can create for trustees, we should perhaps mention why the trust/company structure is so popular.

Possible Benefits
The following summarises the main benefits commonly associated with a trust/company structure.

Limited Liability
The limited liability feature of a company reduces risk and also enables property to be held in the structure which might not be considered a suitable 'directly held' trust asset (e.g. high risk investments or assets of a wasting nature).

Separate Legal entity
A company is a separate legal entity and any legal actions which may be brought against it or the assets which it holds could, in theory, be restricted to the company and not extend to the trust or other companies in the structure. The risk of attack on the rest of the assets in an offshore structure can therefore be 'ring fenced' by using a company, or a number of different companies, depending on the nature and number of assets to be placed under the ultimate control of the trustees.

Asset holding
Certain types of assets cannot be registered in the names of the trustees and a company provides a useful and practical asset holding alternative.

Confidentiality
The ownership by the trustees would be confidential and would only usually be recorded by a nominee declaration.

Tax reasons
There may be tax savings available in holding property in an offshore company, with the shares of that company in turn being owned by the trustees of an offshore trust. For example, the shares of an offshore company are excluded property for UK inheritance tax (IHT) purposes; UK real estate which is owned by an offshore company can take that property out of the IHT tax net. Ultimate ownership by an offshore trust adds further weight to the possible tax savings available in some onshore centres.

In addition, under US estate tax legislation, on the death of the grantor, tax is payable on US situs assets which are held in trust. If an underlying company is used to hold the US situs assets there would be no tax to pay on the death of the settlor.

Possible Risks
The risks centre on the duties expected of trustees particularly where the trustee owns a controlling interest in an underlying company. A controlling interest would arise, for example, where the trust owns at least 51% of the issued shares in the underlying company. Most offshore trusts which own shares in an underlying company tend to own 100% of the issued shares of that company.

A Possible Solution
Many offshore trust deeds will contain a clause which is designed to reduce the duties and responsibilities of the trustees in relation to their control over underlying companies. There has been considerable debate on this issue. However, many practitioners believe that a provision which allows the trustees not to interfere in the running of an underlying company, unless they have actual knowledge of the mismanagement of that company, might provide some protection.