Taxation of Offshore Trusts

Trusts are used by private individuals and corporations from different countries for asset protection, asset distribution, inheritance planning, estate planning, and tax burden reduction. Do trusts pay taxes in the country of incorporation? Are the taxes levied in the country where the trust property is located? Who pays taxes on trust income?

Some people believe that because trusts are not legal entities, they are not taxed. They think that a trust is a legal instrument that allows avoiding payment of taxes. The truth is, however, that trusts are only capable of reducing your tax burden but some taxes are due anyway. Besides, national legislations governing trusts differ greatly. While some countries are tax-friendly to trusts, others tax them heavily. As far as the property owner’s information confidentiality is concerned, trusts do not give a 100% guarantee of information confidentiality protection.   

When you create an offshore trust, you can reap some benefits but certain conditions need to be satisfied. Choosing the best country to register a trust is not a simple matter. The tax burden will depend on where the trust asset is physically located and where the trust settlor, the trustee, and the beneficiaries reside for tax purposes.

Let’s discuss what taxes an offshore trust has to pay and when tax obligations arise. We will try to find answers to the most popular questions that our clients ask: ‘How does a trust pay taxes?’ ‘Can a trust help me save on taxes’ and ‘What country should I choose to create an offshore trust?’

General definition of a trust

In British Common Law, a trust is a fiduciary relationship between the Settlor of the trust and the Trustee. In accordance with the trust agreement, the Trustee shall managed the property put in trust by the Settlor in the interest of the trust Beneficiary (or Beneficiaries).  

When a trust is created, a Deed of Trust is issued. This document sets the terms and conditions under which the trust property shall be managed, distributed, and/ or disposed of. Depending on the type of the trust (revocable, irrevocable, bare, discretionary, and so on), the tax obligations can lie with the Settlor, the Trustee, or the Beneficiaries. The type of offshore trust that you are planning to create will also have a bearing on how efficient it is going to be in protecting your assets from greedy or overspending relatives, foreign creditors, and courts of law.

How income from a trust is taxed: taxation principles in different countries

When real estate, art objects, stocks, bonds, bank accounts, and other assets are put in trust, tax obligations do not disappear. Tax payments may be postponed, tax rates may be reduced, but any income exceeding a certain threshold is always taxed. You know about death and taxes, don’t you?

Here are some factors that determine the tax consequences for trusts:

• The country of trust registration: national legislations contain articles that govern the taxation of the property held in trust and the tax rates can be rather diverse.
• The country of the trust Settlor tax residence.
• The country of the trust Beneficiaries tax residence. A trust beneficiary has to pay an income tax on the income that he or she receives from the trust at the rates applied in his/ her country of residence. In some cases, the beneficiary is also taxable on inheritance that he/ she obtains via the trust as well as other trust property.  
• Sometimes (though not always) the tax residence of the Trustee also matters. As the Trustee is the legal owner of the assets in trust, he/ she can also be taxable. If a trust has undistributed incomes, the Trustee is responsible for paying the taxes.

Anglo-Saxon countries have legislations regulating the taxation of trusts. You should bear in mind, however, that some other countries do not allow creating trusts at all and consequently, they do not have any tax regulations for trusts.

There are some offshore jurisdictions that would be optimal for creating trusts there. At the same time, there is no universal solution that would suit everybody. Every situation is going to be unique and each case has to be treated individually.

To create a trust of the right type and register it in the right country, please contact our experts and use the following opportunities:

• Choose the country to create a trust;
• Open a foreign bank account;
• Acquire a consultation on opening a trust bank account;
• Hire a reliable trustee (a company specializing in trust management);
• Acquire a consultation on choosing the trust type depending on your goals.

How are trust funds taxed?

No universal principles of taxing trusts exist but there are some commonly applied rules that are often found in national trust-related legislations:

• The trust beneficiary pays an income tax when the trust income is distributed to him/ her. This applies both to physical persons and to legal entities acting as trust beneficiaries. 
• The trust Settlor can be taxable if he/ she also acts as the Trustee or he/ she is listed among the trust beneficiaries.
• The Trustee is often taxed on the income accumulated in the trust and not distributed to trust beneficiaries within the fiscal year.
• An offshore trust is not taxable in the country of registration on the condition that neither the Settlor nor the trust Beneficiaries are tax residents of the country. They are taxed in the countries where they reside for tax purposes.

These are only general rules. You have to study very carefully the trust-related legislation of the country that you are considering for creating a trust there. We will be happy to help you with that.

When setting up a trust in a foreign country, you should also think of the country where you want your bank account to be opened. In some jurisdictions, the capital on the bank account can be taxed heavily or there can be balance limits that can constrain your operations with the trust property.

We will gladly help you compare the service conditions that banks, neobanks, and payment systems in different countries offer. You also have to take into account the tax regulations that apply in your home country because they can affect your offshore trust. 

Taxes on offshore trusts

Many offshore jurisdictions do not levy taxes on the incomes of the trusts registered there. There is capital gains tax on trusts nor inheritance tax. Besides, the personal information of trust settlors and beneficiaries is well protected in these countries.

Below please find the most reliable offshore jurisdictions where you can securely create a trust and pay nothing in taxes:

• Nevis;
• Cook Islands;
• Belize.

The assets kept in trust in these countries are well-protected from foreign courts of law. Decisions made by foreign judges are simply ignored by the law courts in the jurisdictions. To sue a trust registered in Nevis, the Cook Islands, or Belize, the foreign creditor has to file a suit with a local law court. 

Doing so is very expensive for the foreign creditor. In Nevis, for example, he or she has to make a payment of US$ 100,000 before the proceedings can be started. As there is no guarantee that the case will be won, this is a serious deterring factor for the creditor.

However, to be able to pay nothing in taxes, the trust settlor as well as the trust beneficiaries have to be tax residents of a foreign country. Besides, the trust income has to come from foreign sources to remain non taxable in the country where the trust is registered.

Please request a consultation from our experts if you would like to learn more about the taxation principles applied to offshore trusts.

Is money received from a trust taxable in Cyprus?

If the trust beneficiaries are not residents of Cyprus and if trust incomes come from foreign sources, the trust profits are not taxed in Cyprus. If the trust settlor or a beneficiary is a tax resident of Cyprus, taxes are due.

An offshore trust registered in Cyprus is tax-exempt if the following conditions are satisfied:

• The trust settlor and beneficiaries have not been residents of Cyprus for one year before the trust is created. 
• The trustee is a tax resident of Cyprus over the whole period of the trust’s existence.

How are European trusts taxed?

Trusts registered in onshore European countries normally have to carry some tax burden. At the same time, if the trust is registered by a foreign national, the trust beneficiaries are also foreign nationals, and the trust income comes from foreign sources, trusts registered in Europe can also qualify for tax benefits.

Below we list the countries in Europe where foreign nationals often register trusts:

• Great Britain;
• Switzerland;
• Liechtenstein.

However, you have to know the local tax-related legislation very well to avoid paying too much in taxes if you would like to register a trust in a European country. Our experts will gladly advise you on the matter.

Please find out how trusts are taxed in Great Britain by following the link.

Do trusts help to save on taxes?

An offshore trust can be used as a legal tool that allows paying less in taxes. However, this is not applicable in all cases nor in all countries. The choice of the offshore jurisdiction where you would like to set up a trust will largely depend on your top priorities. Some countries offer attractive conditions for inheritance planning via trusts while others will suit asset protection purposes especially well. In some countries, your trust will be tax-exempt while in others taxes will be due. Creating a foreign trust is not necessarily the best way of saving on taxes. In some instances, you’d be better off setting up an offshore company instead or establishing a foundation. You can also consider the opportunity to change your tax residence.

Each case has to be treated on an individual basis. If you’d like to create an offshore trust, you should seek some professional assistance without doubt. The legal world is rather complicated.

For example, if you create a trust in an offshore jurisdiction and the real estate in trust is located in Europe, the estate will remain within the legal boundaries of European courts. If a creditor of yours makes a claim, or if sanctions are applied to your property, your real estate in Europe can be arrested and even expropriated.  

As you can see, there is no universal answer to the question ‘How are foreign trusts taxed’. The issue needs deep analysis.