US Congress criticized for new foreign trust and expatriate laws
In an effort to offset credits given to the poor, underprivileged and so-called middle-class worker, US Congressmen, worried that they may lose taxpayers votes, inserted at the last moment the long expected restriction on foreign trusts and expatriates into the Small Business, Health and Welfare Acts of 1996. It is more than two years since the Clinton Administration drafted a law designed to step up the Internal Revenue Service's authority to tax income from funds transferred abroad by US taxpayers to offshore jurisdictions. However, Congress' enigma was how to adopt a law with as little fanfare as possible in order not to disturb special interest groups. Congress was well aware that these foreign trust and expatriate curbs would raise an infinitesimal amount against the $50 billion of tax cuts granted the low and middle class taxpayers. Widespread criticism has been levelled at Congress of using domestic politics as a ploy to support the rising tide against foreign investment.
By far the most significant of the new foreign trust laws as amended by the 1996 Small Business Job Protection Act, the Heath Insurance Portability and Accountability Act, and the Personal Responsibility and Work Opportunity Reconciliation Act are the enhanced information reporting requirements for transfer of property and distributions from foreign trusts. Virtually all offshore trusts are now required to file annual reports and to appoint a US agent with authority to act in connection with tax examinations. The Revenue Service is empowered to determine taxes when no agent is appointed, and severe penalties are established to ensure compliance. Under the Act, a 'responsible party' (grantor of an inter vivos trust, a transferor of a foreign trust and the executor of a decedent's estate) must file within 90 days of creation of the trusts the amount or property transferred, the identity of the trust, and each trustee and beneficiary. The designated US person must be authorized to act as the trust's limited agent. Preliminary surveys of Government authorities in offshore jurisdictions reveal that they will co-operate with the US in encouraging trustees in their respective regimes to comply with the reporting requirements. Other new information requirements force US persons to report to the Internal Revenue Service gifts or bequests from foreign sources totalling more than $10,000.
In another major change, the outbound foreign grantor trust laws were amended so that the exception for transfers at fair market value are narrowed to exclude obligations issued to a trust, grantor, beneficiary or any related person. Also, a non-resident alien individual who transfers property to a foreign trust, and then becomes a resident of the US within five years after the transfer, is treated as making a transfer to a foreign trust. In addition, the inbound foreign trust rules have been altered so that generally they apply only to the extent that they result in amounts being currently taken into account in computing the income of the US citizen , resident or domestic corporation.
Finally, the interest rate applicable to accumulation distributions from foreign trusts is increased from six per cent simple interest to compound interest at the underpayment rate. In essence, grantor trust distributions that previously were tax-free now may be subject to as much as 100 per cent tax when interest charges on accumulated income are taken into account. Already tax experts in the US are advising clients to restructure their foreign trusts to maintain tax savings for US heirs. One method being recommended is to structure the trust so that distributions are paid to the grantor or other non-US family members and subsequently to redistribute them as tax-free gifts to the US beneficiaries. Another approach is to structure the trust so that it pays out capital distributions from foreign trusts. However, in this case the income must first be distributed to qualifying non-US family members before capital is released.
Under the amendment to s877 of the Internal Revenue Code inserted into the Health Reform Act the ten year expatriation rule has been expanded to tax more income and gains from certain wealthy and high-income individuals who terminate residence. Congress long had hoped to stop the tax evasion route whereby US persons relinquished their US citizenship with a principal purpose of avoiding US income taxes and were subject to alternative methods of minimum taxation for ten years after expiration. Now all citizens leaving the US will be considered to be having as their principal purpose the avoidance of taxes if for a period of five taxable years ending before loss of citizenship their average annual net income exceeded œ100,000 or the net worth is more than $500,000. An expatriate estate tax is imposed on the transfer of a taxable estate of a decedent non-resident not a US citizen if the decedent lost citizenship within ten years of the date of death unless it can be proved that the loss of citizenship did not represent a principal purpose of avoiding estate or other taxes. Expatriates must also provide information statements to Federal authorities that include identification number, foreign address, foreign country of citizenship, whether net worth exceeds $500,000 and any other information requested. Minimum penalty for failure to file a statement with the Revenue Service is $1,000. The US State Department estimates there are 'three million US citizens living abroad but thousands of these individuals may not even know they are US citizens'.
On the positive side of the new tax law, American companies are pleased that the foreign earned income exclusion to US expatriates of $70,000 plus a limited allowance to cover housing costs remains since finding qualifying expatriates to locate abroad is becoming more difficult. However, major companies are protesting at the phase out of the tax credit granted to corporations. Closing the s936 tax credit will be particularly devastating to Puerto Rico where the $10 billion of accumulated tax-free profits plays a key role in the economy. Mainland US companies operating in Puerto Rico contribute 40 per cent of the Commonwealth's output. Puerto Rico has lent more than $1.2 billion of the $10 billion reinvested profits available for mortgages, infrastructure projects and loans to other Caribbean markets at below-market rates. The Treasury expects to raise $7 billion in new revenues over a decade by wiping out the break. However, it is an ill omen for the Puerto Rican economy which has a 14 per cent unemployment rate and a per capita income of only $7,500, which is about half the level of Mississippi, the poorest US State.
(Information from Walter Diamond, Overseas Press and Consultants, Hartsdale, N.Y., U.S.A. Tel: 914-946-4089 Fax: 914-946-5864 )
Tax Havens of the World
A recent release (Release 88) updating Walter and Dorothy Diamond's Tax Havens of the World, issued in August 1996, draws attention to the fact that some important changes have occurred in tax havens or, more likely, offshore business centres. The revised introduction draws attention to some interesting jurisdictions and their rise and fall.
Venezuela is quoted as a good example of a tax haven that relinquishes much of its status because the government chose to pursue a nationalist policy. Norfolk Island, growing in importance for the Australian government, amended its tax laws to make it part of Australia and the growth of Andorra was somewhat restrained when the government prevented, in 1973, any non-resident forming a company. The ban ended in 1983 and in 1993 Andorra gained more self rule with the adoption of its first constitution. Nauru, with its rich phosphate deposits and with one of the highest per capita incomes in the world, is being promoted by the government, and attention is drawn to Austria with its treaties with Eastern Europe which makes it an attractive country to establish parent holding companies. Malta, after six years as a fully fledged tax haven, in 1994 amended the Malta International Business Activities Act and the Malta Financial Services Act. Hungary is, perhaps, the nearest Eastern Europe comes to having any genuine tax havens. The government encourages westerners to open special savings accounts with deposits of western currencies: they guarantee secrecy of accounts and the freedom of tax on any interest, with interest being paid at the rate of seven per cent per annum on deposits exceeding £10,000.
One interesting newcomer, the Dominion of Melchizedek which is said to be now located on Karitane some 1,000 miles south of Tahiti, is attempting to make a dent in the financial world with its highly publicised offer of brass plate entities. This country consists of three spheres of influence, a Jerusalem dominion, a Polynesian dominion and a Ruthenian dominion and the services of Melchizedek registered banks have been promoted through trust companies established in Belize, Nauru and Indonesia. The official languages of the country are Ruthenian, English and Hebrew.
Another oddity are the thatched roof cottages and barns in Norderfriedrichskoog, a hamlet with only 50 residents, on Germany's North Sea coastline. This has been a zero tax status for 300 years since a German duke relieved inhabitants from paying taxes as a reward for building a sea wall. And so on; several other oddities are described. The Republic of Kiribati, offering Chinese businessmen options to buy 'foreign investor' passports for $15,000. Albania, in Eastern Europe, has curtailed its rush status as a site for offshore investment.
The introduction is not only concerned with some of the oddities, some of the more established and progressive offshore centres are referred to. The current growth area appears to be the Indian Ocean with Mauritius and, particularly, Seychelles with its progressive legislation, looking like worthy competitors to some of the established offshore centres.
Looking at the amendments we note the following amongst references to trusts.
This note is not meant to be a world-wide survey but highlights some of the features which appear in the supplement.
There are some substantial entries in respect of Belize trusts and in respect of the Isle of Man, and the entries on Trust Enterprise in Liechtenstein are revised with reference being made to the trust settlement, a unique creation in Liechtenstein legislation.
A revision of the Malaysian company refers to the formation of the Association of Labuan Trust Companies in July 1994 and includes in its membership the trust companies established by the big six accounting firms. At the request of the Offshore Trust Company Association the Registrar of Companies is reviewing ways of simplifying the filing of returns to allow trust companies to be corporate directors or secretaries of offshore companies.
It is reported that Netherlands Antilles, although a civil law jurisdiction, has drafted a common law form of trusts in order to compete more effectively with Aruba and other West Indian neighbours. The government of Nevis has enacted its own International Trust Act with liberal protection provision. This law of 1994 is not as comprehensive as that drafted for the Federal Government of St. Kitts and Nevis and passed by the National Assembly but it was withdrawn after St. Kitts backed down and decided to allow Nevis to go its own way.
The law relating to foundations included under Panama and the chapter on Seychelles has been substantially re-written and describes the Seychelles latest Act, the Anti-money Laundering Act as 'one of the stiffest money laundering Acts in the offshore world'. A summary is given also of the other legislation in Seychelles of 1994 and the advantages of the Free Trade Zone and the Deep Water Port.
The chapter on Singapore draws attention to the co-operation between Indonesia, Malaysia and Singapore to form a 'Golden Triangle'.
The revised chapters cover many other countries. The interesting part of this three-volume loose-leaf encyclopaedia, despite its antiquated habit of using the term Tax Haven, is that it does present comprehensive descriptions of the offshore centres and, although the trust sections are not adequate for trust practitioners, the other topics provide very useful and necessary background.
Tax Havens of the World, Release 88 August 1996. Walter H Diamond and D. B. Diamond. Matthew Bender & Co Inc. ISBN 0-8205-1722-4.
United Kingdom
This issue of TRUSTS & TRUSTEES contains articles relating to the new Trusts of Land and Appointment of Trustees Act. This Act brings the law of England and Wales up to date and removes, by abolishing entailed interests, one of the antique aspects of the law of real property.
Trust formation
A recent booklet by the Inland Revenue, Trusts an Introduction, Personal Taxpayer Series IR152, contains some of the basic principles of tax law. This is an elementary booklet prepared for taxpayers. One paragraph is worth commenting on. It reminds us that when the trust is created the trustee(s) should inform the Inland Revenue by completing an Inland Revenue form 41G(Trust). A copy of the trust deed is not required to be sent until the Inland Revenue ask for it.
This reminds us that, although trusts in the United Kingdom are not registered in any way, there is this requirement to 'inform' the Inland Revenue.
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