People and assets increasingly cross international borders. Wealthy families are doing business and moving to places they might not have imagined a decade ago. They also own property and assets in a number of countries and often find themselves scattered across various jurisdictions. This mobility and ownership of foreign sitused assets have created a range of planning needs that were not prevalent, and for many, did not exist, in years gone by.

A growing number of wealthy individuals residing in civil law countries (for example, Europe and Latin America) are interested in understanding how they can protect their wealth, minimize tax liabilities and have a proper international estate plan — without losing complete control and flexibility over the management and enjoyment of their assets. Traditional wills used in isolation don't fit the bill anymore. But there are two ways to help these individuals: Consider using private family foundations (private foundations) and explore the benefits of “reserved powers” trusts, an old idea that is gaining new ground, especially for those living in civil law jurisdictions.

DRAWBACKS TO WILLS

Wills are often the object of family disputes and conflicts of laws, particularly in the context of multi-jurisdictional estates. In fact, an improperly signed will — something not uncommon in the international environment — ultimately could thwart a decedent's wishes. To be legally valid and fully enforceable, a will must have been duly executed in accordance with the applicable laws and formalities of each jurisdiction where the decedent and his family members reside, as well as where the decedent's assets are sitused. In the case of a challenge, a court must apply conflict-of-laws principles to determine which jurisdiction's laws will prevail. This leads to delays and difficulties in estate administration.

For wealthy families that reside in forced heirship countries (countries in which family law dictates how the inheritance of an individual's estate will be distributed) and have assets sitused in civil law jurisdictions, using a will to dispose of such assets may not be a concern for the beneficiaries. That's because under the civil law principle of universal succession, a decedent's estate is treated as a single mass that is immediately and automatically vested in the decedent's heirs. However, things get tricky when a decedent from a civil law jurisdiction uses a will to dispose of assets sitused in a common law jurisdiction. That's because common law countries require probate1 to be duly fulfilled before the beneficiaries can claim their succession rights.

Wealthy families are beginning to appreciate the problems associated with probate, namely, high costs, the overall length of the process and the loss of confidentiality due to the publicity that often attaches to high-profile probate proceedings. Families also recognize that probate of a decedent's estate may occur not only in the decedent's jurisdiction of last residence and/or domicile, but also in jurisdictions where companies are incorporated and/or resident and where assets are held or sitused. There's also the risk that an intended inheritance may be substantially reduced by applicable foreign estate taxes.

WILL SUBSTITUTES

So what's a wealthy individual living in a civil law jurisdiction to do? Consider both private family foundations and trusts — flexible will substitutes that can achieve international fiduciary solutions. They are instruments that can help families and individuals implement their personal planning strategies and mitigate potential exposure to foreign probate and foreign estate taxes.

The essence of estate and tax planning generally involves some degree of separation of the control and ownership of assets from their legal owner. In other words, the starting point of sophisticated planning is that the wealthy individual will likely not be able to own all of his assets in his own name for the rest of his life. If the owner is agreeable, this is easily accomplished with trusts, whose very nature necessitates such separation of ownership and control of assets. Historically, individuals living in common law countries have used trusts for their estate and tax planning, and to avoid probate. However, trusts don't always suffice for civil law families, because the Anglo-Saxon concept of the “trust” doesn't exist within the civil law legal framework. To date, in fact, few civil law jurisdictions have formalized their understanding and acceptance of trusts.2 Moreover, the concept of separating control and ownership of assets may often sound as an anathema to civil law individuals, because they are not used to the idea of someone else owning and controlling their assets.

But in a few jurisdictions, the use of private foundations as a means of family succession planning is permitted and increasingly utilized. Typically, however, in most countries around the world, private foundations are associated with charitable, educational, religious, or research purposes, and are also used as not-for-profit organizations. In the majority of the jurisdictions, this type of legal entity is still permitted only if at least one of these purposes is the principal scope of the private foundation's operations.

Private foundations are essentially a cross between companies and trusts: unlike a company, a foundation does not have shareholders, but similar to a company, a foundation can enjoy limited or perpetual existence. Like a trust, a private foundation may have a protector: someone who oversees the foundation's board and operations. Although it becomes irrevocable upon the death of its founder, a private foundation is often established as a revocable instrument. Only rarely is a foundation established as an irrevocable entity.

The buzz about private foundations is that in certain jurisdictions, such as Liechtenstein, Panama, Austria, the Netherlands Antilles, and recently the Bahamas, the use of private foundations as a means of family succession planning is now permitted and increasingly utilized.3 While a private foundation established in these jurisdictions is not allowed to conduct, per se, profit-oriented objectives, it can be established for the purpose of managing and preserving family wealth, and is entitled to own (either fully or partially) underlying corporate entities that undertake commercial activities and transactions. Thus, while traditionally used for charitable, educational, religious or research purposes, private foundations are developing more and more as an integral component of family planning structures. In fact, private foundations established in these jurisdictions are permitted to make distributions to beneficiaries without the requirement that such distributions have to be of a charitable nature.

It's interesting to determine what's driving private foundations as an alternative to trusts, in countries like the Bahamas that have a rich history and tradition as trust jurisdictions. One of the main attractions is flexibility (although that is a characteristic largely shared by trusts); another is the ability for the founder to effectively control the assets held by the foundation — although the greater the extent there is control in the founder, the less effective the foundation becomes as a solution to planning needs that necessitate a distinct separation between the founder and his ownership and control of assets. Perhaps some common law jurisdictions also are reacting to a market demand for other options and to an increased difficulty to use trusts as part of certain tax planning structures, as they increasingly are the targets of scrutiny of the onshore tax authorities.

KEY PLAYERS

A private foundation is a legal entity whose main purpose, as a will substitute, is to ensure the future distribution of the assets it holds in favor of designated beneficiaries. There are typically three parties involved in a private foundation: the founder, the board of the foundation or council (the board), and the beneficiaries.

The founder is the original owner of the assets, who transfers the assets to the foundation. A founder can receive distributions from the foundation, if desired. The board administers and manages the foundation's assets; its powers are set out and governed by the foundation's regulations or bylaws, a private document stating in detail the actions that the board may undertake. The board typically has to have at least two or three members and, depending on the jurisdiction where the foundation is established, at least one of them has to be resident in that jurisdiction. The beneficiaries are those who may receive distributions or can benefit from income and/or capital and/or of specific assets at specified times; they also are appointed by the founder through the regulations or bylaws. Beneficiaries who receive distributions are generally not taxed in the jurisdiction where the private foundation was established and operates, though they may be taxed under the laws of their home jurisdiction. The beneficiaries are appointed as per the founder's instructions and can be removed and replaced until the founder's demise.

To establish a private foundation, in addition to regulations or bylaws, there must be a mandate agreement or memorandum of association that is registered, typically at a public registry. A private foundation (similar to a company) has its own legal existence upon its registration. Statutes, or articles of the foundation are typically deposited with the local designated government body of the jurisdiction where the foundation is established. In certain jurisdictions, the name of the founder together with the name of the foundation have to be registered, though in some of these jurisdictions the nominee company of a bank and trust company or financial and corporate service provider may serve as the founder, therefore providing the economic founder with some level of confidentiality.

TRUST CONCEPTS

In common law jurisdictions, trusts are already a popular estate-planning legal instrument. Today's modern trusts are the product of many centuries of Anglo-Saxon jurisprudence enhanced by recent legislative developments, both onshore and offshore. Countries governed by civil law are increasingly facing the need to recognize and accept the legitimacy of trusts.4 Global wealthy individuals and families living in those civil law jurisdictions are beginning to see that trusts are one of the most effective vehicles for preserving and enhancing private wealth.

A trust connotes a relationship among three parties: the original owner of the assets (the settlor); the party who receives assets from the settlor (the trustee which, in the international context, is often a professional fiduciary provider); and the parties with respect to whom such assets will be managed and distributed (the beneficiaries.) A trust is legally created upon the transfer of assets to the trustee; these assets constitute the trust fund. A trustee assumes a fiduciary role to properly manage the trust assets in accordance with the trust deed: the document that evidences the intention to create the trust and the terms upon which the trust must be administered. There are two types of ownership of a trust's assets: legal and beneficial. A trustee has legal ownership of the assets, which allows him to act only in relation to the assets. A beneficiary has an equitable, beneficial ownership of the assets, which is enforceable at law.

Trusts can be created either by will or inter vivos. Those created by will — known as testamentary trusts — limit their benefit until after the settlor's demise. Establishing an inter vivos trust, however, allows a settlor and his family to experience the benefits of trust planning during the settlor's lifetime, including the avoidance of probate in relation to trust assets, and if desired, continuing in existence long after the settlor's death.

RESERVED POWERS

In the 1990s, the trust law of several jurisdictions, such as the Cayman Islands, evolved to address the needs and concerns that many wealthy individuals, especially those from civil law countries, had in relation to the use of trusts. Such individuals were unfamiliar with the common law concept of trust and related concepts of “transfer” of legal ownership of assets, and grant of “full or partial discretion” over the management of assets to a third party trustee.

Legislation (referred to as “reserved powers trust legislation”) developed in an attempt to clarify the concept that a settlor can retain or reserve certain powers over trust assets — powers that would typically be thought of as trustee powers. Reserved powers trust legislation provides that, under a trust agreement, a settlor may reserve various powers without fear of creating a sham trust; the law specifically recognizes the validity of reserved powers trusts under the laws of the local jurisdiction.

Powers that may be reserved include: the power to revoke the trust; the power to instruct the trustee how to deal with trust income; the power to control how the trust assets are invested; the power to amend the trust with the written consent of the trustee; the power to remove and appoint new trustees; and the power to remove and add beneficiaries.

Reserved powers trusts are used like “normal” trusts, with the caveat that when planning requires a distinct separation between the settlor and the trust assets — such as in the case of pure asset protection trusts — this form of trust will be less useful. It's most useful for individuals in civil law jurisdictions who are willing to forego some of the potential estate planning benefits in exchange for greater influence over the trust assets.

LET'S COMPARE

Both private foundations and trusts (reserved powers or traditional) are similar estate- and tax-planning tools that allow individuals residing in civil law countries to retain some level of control over the management of their wealth, while providing a proper estate-planning solution for themselves and their families. Both are similar tools in that a private foundation established in one country may be redomiciled in another jurisdiction, provided the latter has a foundation law; similarly, the governing law of a trust can be changed. As with trusts, a private foundation's assets are no longer considered to be owned by its founder, therefore providing the essential ingredient to gain some level of wealth preservation and asset protection. But there are some differences between private foundations and trusts, which individuals and families should keep in mind.

For example, a founder of a private foundation, similar to a settlor of a trust, can give instructions to the board, via a letter of wishes. Unlike a trust, however, these instructions can be very specific without creating any concerns over the validity of the foundation. The founder of a private foundation therefore is able to retain a certain degree of control over the management of the foundation's assets and distributions.

Second, beneficiaries of private foundations don't have equitable rights to enforce the foundation, as they do with trusts. This means the role of the board and protector are very important in private foundations, especially after the death of the founder.

Unlike for trusts, there are no limits to a foundation's life because there are no perpetuity periods in foundation law. There's also no statutory requirement for private foundation accounts to be kept or for an external audit to be conducted, unless a foundation's charter so requires. Also, foundation law in some jurisdictions is complemented by a statute of limitations. From an asset protection perspective, a short statute of limitations (for example, three years under Panama private foundation law) enhances the preservation features of foundation planning.

Especially for common law jurisdictions, trusts have served as commonly used estate-planning tools in the international financial world for many, many years. Now, in this fast evolving global environment, wealthy individuals and their advisors are seeing private foundations as another form of a valuable estate-planning tool. Private foundations and trusts, when properly integrated within a well thought-out tax plan, also can be effective components of a more complex solution for multi-jurisdictional holdings when the objective is to minimize the impact of foreign estate taxes.

Fiduciary service providers and estate planners are embracing the change in their clients' needs, focusing on offering more choices. A common misunderstanding is that foundations and trusts are two completely different legal concepts and that they have to be utilized and managed in a completely different way. But not only are they both fiduciary solutions and effective will substitutes, but also they are flexible tools that can be used as part of an overall international estate planning solution for families residing in civil law countries. The fact that a number of common law jurisdictions around the world have created new laws in relation to private foundations and reserved powers trusts, demonstrates that the planning jurisdictions understand the needs of their modern day clients and are moving to fulfill them.

The author thanks Murray A. Shapiro, senior manager, Global Trust, Royal Bank of Canada, for his assistance with this article.

The views contained herein are solely of the author and not Royal Bank of Canada, its affiliates or subsidiaries. This article is intended as general information only and is not intended as taxation, legal, investment or other professional advice. This article is not an offer of any product or service provided by Royal Bank of Canada, its affiliates or subsidiaries.

Endnotes

  1. “Probate” typically refers to the legal process in which a will is reviewed to ascertain its authenticity and validity. A court appoints an executor named in the will to collect a decedent's assets, pay his liabilities, and distribute assets to beneficiaries.
  2. Because not many civil law jurisdictions have formalized their acceptance of trust law, a good start is to ratify international conventions on private comparative law. The main objectives of such conventions is to prevent future conflict of law issues.
  3. In The Channel Islands, Jersey issued a consultation paper last year with a view to introducing legislation to allow the creation of private foundations under Jersey law. A consultation paper is not law; it's an official study that analyzes legal issues and provides solutions. But it does signify the Channel Islands' interest in, and commitment to possibly recognizing private foundations.
  4. For example, Italy is one of the few civil law countries that has signed and ratified the 1985 Hague Convention on the law applicable to trusts and on their recognition.

Collectors' Spotlight

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