The advantages of using trusts
The use of trusts has for many centuries be regarded as an effective and legal tax planning method. It enables people to avoid the consequences of legal ownership of property and money while enjoying the benefits of ownership. A trust is a legal entity of almost unlimited flexibility, for holding and disposing of property.
The concept of a trust is a unique feature to ‘common law’ or English speaking jurisdictions. A trust is created when one person (known as the Settlor) transfers his or her assets to independent third parties (known as Trustees) who manage and control the disposed assets in favour of either known or unknown beneficiaries. By doing so, property rights are divided, the Trustee is recognized as the sole owner of the trust property at law and that the beneficiary’s interest is only recognized in equity. The ultimate effect of this division allocates to the trustee the burdens of property ownership and to transfers to the beneficiary the benefits arising therefrom.
It is essential that full autonomy be given to the Trustees to ensure that the trust is effective. Otherwise, the trust could be challenged as not settled and therefore was not a properly constituted trust instrument. If this happens then the Settlor would still be legally deemed to be the owner of the trust’s assets and therefore still liable to pay tax as an individual. Serious consideration must be given since the Settlor will not have any direct control over what were formally his assets after the formation of the trust. A tailor made trust agreement or deed is therefore required to specify how the trust’s capital and income are to be held, managed and distributed as well as the investment powers of the Trustees. The Settlor may also appoint a protector (normally a trusted member of their family or business associate) who will oversee the Trustees and normally be a co-signatory to the Trust account. Besides, a trust establishes a fiduciary relationship with respect to property, subjecting the Trustee who holds title to the property to equitable duties to hold and administer the property for the benefit of beneficiaries. Thus, the Trustee must have fiduciary duties to perform and the beneficiaries must be named or ascertainable. Additionally, the beneficiaries are the only persons with the right to enforce the trust agreement or deeds.
Types of Trust
Fixed trust agreements set out precisely who will benefit and when under the trust arrangement.
Discretionary Trust are normally used in the ‘offshore’ world to ensure that the Settlor has divested himself of his assets. It also provides sufficient benefits to the intended heirs by leaving the amount of capital and/or interest to be paid to the unnamed beneficiaries at the sole discretion of the Trustees. The Trustees not only have the ability to control when and what type of payment should be made but also ensure that the beneficiaries are not immediately tax accountable.
Irrevocable and Revocable Trust
Trusts may be either irrevocable or revocable. In the latter case the trust is called a “grantor trust”. In the case of an irrevocable trust, the trust assets are not usually considered to be part of a deceased Settlor’s estate, and passes to the beneficiaries without probate or estate taxes.
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 reduced the legal employment of trusts for those tax domiciled in countries such as the United Kingdom and the United States. Notwithstanding these restrictions, Trusts are still very valuable weapons in the tax planners since virtually no civil law country has any effective anti-trust legislation, meaning that they have become increasingly popular with those located in Europe and the Asia.