Tax Laws around the world have now become confiscatory. In the U.S. ordinary income taxes peak at a level of 39.6%, this amount combined with social security taxes and state income taxes put the burden on the highly compensated, wealthy person or corporation at over the 50% level. Estate taxes are now maximised at 55%. The effective rates of tax in Europe are not significantly different.
As a consequence, wealth is seeking a more benign climate for wealth accumulation, protection from extremes of litigation and the long-term preservation of capital. Major news publications comment on this flight capital and infer that the volume of capital exodus is reaching significant proportions.
There are many "experts" who advise on how to flee the highly taxed domiciles, but most recommend programs that rely upon non-reporting of the flight and hope that the revenue services do not track the funds and question their legitimate transfer. In the U.S. the IRS reserves the right to tax U.S. residents or citizens on any income earned anywhere in the world. Should you choose to change residence and citizenship, the IRS reserves the right to tax you for a period of ten years after the change of domicile with the possibility of harassment each time the person wishes to enter or leave the U.S.!
The key to using the offshore arena is to design and develop an offshore structure and method of operation that tackles current whilst anticipating future regulations designed to "corral" the wealth in the country of origin by restricting the flow of funds into offshore tax free jurisdictions.
It is essential when effecting transfer of assets to foreign climes, that the offshore professional complies with the regulations of the country of origin with respect to non-taxable transfers of property into non-taxable, non-reporting trusts or corporations. Once this has been achieved clients may then be advised on the most efficient use of assets and income while minimising taxes and possible unreasonable confiscation.
CHOICE OF JURISDICTION
When making the decision to utilise the tax advantages offered by an offshore jurisdiction the choice of where to locate the structure is of extreme importance. Several of the well known jurisdictions have signed an "exchange of information" treaty with the US. Recently, others, under the supervision of Great Britain, have just been told that a "Company Formation Agent" (CFA) must be used to form an exempt corporation and all information on beneficial ownership, directors and officers of corporations established in their jurisdiction must be recorded and on file with the CFA. This information must be made available to the Registrar or Financial Services Department of the jurisdiction on demand, while the information is not available to the public it may be passed on to the UK, the U.S. and other approved or authorised persons. Such information must be available to any "regulatory or criminal investigation, whether by the local authorities or, when permitted by law, by an overseas authority".
The jurisdictions covered by the UK edict are:
Bermuda, the Caymans, the British Virgin Islands, Turks & Caicos, Gibraltar, Guernsey, Jersey, and Isle of Man.
Those jurisdictions that have signed the exchange of information treaty are:
Bermuda and Barbados.
To make the selection one must first be comfortable with the stability of the region. This is followed in importance by the sophistication and capability of the financial infrastructure. Last, but not least, are the personnel with whom you would be working. Obviously, confidentiality of your personal situation should not be available to any authorities unless they have a sustainable claim of criminal fraud.
In the event that you do not wish to have information potentially available to the UK or US authorities, your choices are now somewhat circumscribed. The island of Nevis is emerging as a significant force in the field and is independent. The Bahamas are independent and Panama is emerging from their "dark ages" and becoming a viable jurisdiction again despite the potential for the US to apply pressure to the government.
Obviously, one can have business activities in any of the jurisdictions without revealing the details of the owners of the foreign corporation or trust that is engaged in that business activity. This enables the use of Bermuda to act as custodian or broker for securities. BVI can be used for the creation of a corporate protector. Recently due to the considerations above Nevis has become a primary site for trust and corporate formation.
Designing the Offshore Structure
The basic concept in designing an offshore structure is to develop a structure that is not tainted by the client or his heirs and assigns (the Client).
The best tool for holding and handling assets is one of various types of Limited Liability Company. Unfortunately there are precedents that look through the corporate veil to the ultimate beneficial owner. Thus ownership of the company even in nominee form by the Client is unacceptable.
The solution is to have an ownership vehicle that removes any possibility of being tainted by the Client. Most practitioners use a Trust to own the shares of the underlying company.
However, in most developed countries anti-trust tax legislation has been put in place, where the revenue services deem a trust to be originally from the country of the settlor or beneficiary or both. Taxes are assessed on income or wealth whether or not the settlor or beneficiaries have received any benefit at all.
Whilst this is a tax neutral situation, and the trust provides asset protection from litigation and creditors, it provides little to defer tax or handle estate duty problems.
THE FOREIGN PURPOSE TRUST
The solution is the use of a trust that is not tainted by the settlor (deemed or otherwise), beneficiaries, trustee or protector to own the underlying company.
The settlor and beneficiaries may be eliminated from the trust by having a foreign trustee create a purpose trust by declaration and appointing a foreign protector whose job is to keep a weather eye on the trustee.
This technique effectively pulls the whole structure outside the purview of the country of origin, as the Client has nothing to do with the formation and set up of the structure. This anticipates changes passed and proposed by onshore countries attempting to enfold Foreign Trusts in their regulatory and tax net.
As an example the U.S. passed changes to the Internal Revenue Code that resulted from the Small Business Job Protection Act and the Health Insurance Portability and Accountability Act. These new Acts require reporting from a) US grantors of foreign Trusts, b) US beneficiaries of distributions from any foreign trust, c) receipt of gifts exceeding $10,000 in any one year.
The use of the foreign purpose trust format for the last few years has avoided any of the above reporting or taxation requirements. A purpose trust is based on UK law and was initially devised to enable family members to use the funds in the trust to acquire burial plots. Its usage has since been expanded but its purpose must be considered to provide a social or community benefit. It has a finite life and a minimum charitable funding amount.
There are two controlling factors;
a) The Protector who ensures that the trustee is fulfilling the purpose of the trust and is able to terminate the trust prior to its expiration date. When the trust is terminated, the Protector has the responsibility to appoint remaindermen for the funds remaining in the trust or to appoint another trust with specified beneficiaries.
b) The authority to change the Trustee to any foreign person, excluding themselves, or to change the jurisdiction of the trust. These last powers can be assigned to the Client or their representative if so required but frequently a foreign fiduciary is used to handle that task. In the U.S. the IRS conceded that the power to change the Trustee and jurisdiction are not sufficient to make the protector a grantor of the trust (Rev. Rul. 95-58).
It is recommended that the Protector be a foreign fiduciary corporation (Bank, Trust Company or Law Firm) who will be responsive to the counsel of the Client for direction. In the event that the Protector (sometimes called an enforcer) resigns or dies, the Trustee can appoint a new Protector as long as he is not an onshore person.
As was ably explained by Paul Egerton-Vernon in Trust & Trustees article "Purpose Trusts" Dec97/Jan98. With the exception to the rule for charitable trusts, there was a general principle in Law that it was not possible to have a trust for a specific purpose.
This led to the development of the purpose trust for specific purposes by the introduction of legislation. The Cook Islands was the first jurisdiction to introduce this legislation followed, in 1989, by Bermuda.
Technically under the trust acts that are being passed in many offshore jurisdictions, a purpose trust may be created for the sole purpose of owning the shares of an underlying company. It has been mooted that the "holding of the shares in ZYX Ltd" is not so much a purpose as a description of how the assets in a trust are to be held.
The use of the word "Charitable" has connotations in law that would be overlooked by the layman, such as the relief of poverty, advancement of education, advancement of religion, protection of the environment, advancement of human rights and other purposes which are beneficial to the community. The use of the word charitable in the trust deed will therefore turn the interpreters of the law to these specific terms and definitions.
Thus in drafting the trust we wish to escape the pitfall of "not having a purpose" and also be careful not to call the trust a charitable trust, but still use the concept of a purpose trust with philanthropic and social purposes.
Most clients have organizations that they would like to support. Some of them may be registered charities and others may not be. We must therefore give our purpose trust bona fide purposes. The problem with including a specific known charity (Red Cross, United Way, etc) is that the trustee is obliged to inform them they are beneficiaries of the trust. In the event that the protector decides to terminate the trust, he may well be challenged by one of these charities as to whom and what is distributed to the remainder men.
The solution to this is to create another offshore company in your jurisdiction of choice (but outside that of the trust and the underlying company) which will be a Foundation and beneficiary of the purposes of the trust. This solves the problem of ensuring that the purpose is capable of performance and ensures that the protector and Trustee will not get blind-sided by some fringe group claiming to have an interest due to their Charitable activities.
Source of Funds
Having developed and constructed the structure it is necessary to get the assets into the trust without it being tainted by the "donor". This is achieved by using an arms length third party contractual agreement that ensures that the transaction is a transfer of assets at market value. These may consist of, but not be limited to, annuity contracts, term life products or a combination thereof. The objective is for the underlying company to receive from the client any asset at market value in exchange for an agreement to perform in the future.
Once the funds are in situ, the Company may make arrangements to provide loans to the Client as one of its investments secured by the contractual agreements.
These unique tax planning tools have largely been ignored by the professionals as the transactions are unsecured and the buyer could take the property and be unable or unprepared to make payments. With intelligent choice of buyer, these methods may become very sophisticated methods of tax avoidance.
Finally one of the added benefits to this type of structure other than asset protection is that it is flexible and may easily be adjusted to be tax efficient for differing situations and can ensure continuity of wealth through future generations.
Co-authored by
Robin H. Cotterell FCA TEP Hanver Trust Company Suite 1, Barclays Building Charlestown, Nevis Tel No: 869-469-0200 Fax No: 869-469-0201 E-mail: Hanverco@caribsurf.com Web: www.namcs.com/hanver Peter Peggs Financial Resources Group 216 Common lane Prides Crossing, MA 01965 Tel No: 978-927-4427 Fax No: 978-922-8744 E-mail: Peterpeggs@frg.com
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
