- Uses of trusts
- Four types of trusts for asset protection
- How are trusts taxed?
- Would you like to protect your assets in the most efficient manner?
Since medieval times, trusts have been used as instruments of asset protection and control. Trusts can be classified by different criteria but whatever type of trust you look at, you are going to find both strong and weak sides.
If you would like to create a trust for asset protection, estate planning, or handing down property to your heirs, you have to study the trust-related legislation of your country carefully. In particular, you have to find out what information about the trust beneficiaries is going to be available to the public and how efficient the intended trust is going to be in protecting your assets. Below we provide basic information about various trust types.
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on offshore structures and jurisdictions that would best meet your asset protection goals.
Uses of trusts
To create a trust means to transfer your property such as real estate, securities, cash, and so on to a separate legal entity. The person transferring the property acts as the trust Settlor and the entity that gains control over the property acts as the Trustee. Theoretically, a single individual can act as the Trustee but normally this function is undertaken by a group of people or a legal firm. The Trustee has instructions from the Settlor on managing the assets and distributing the profits to the trust Beneficiaries.
The Deed of Trust signed at the moment when the trust is created serves as the central instruction manual for the trustee. It specifies how exactly the property is to be managed, who the trust beneficiaries are and what shares of profits (the property) are due to each of them. In addition, the Deed of Trust sets all other conditions that pertain to the functioning of the trust.
Great Britain is the country where trusts came from. The British legislation allows setting up the following types of trusts: Bare Trusts, Discretionary Trusts, and Interest in Possession Trusts.
Please seek our advice on choosing the best country to create a trust.
Bare trusts are normally used for transferring property (any property) to children and grandchildren. The defining characteristic of bare (sometimes also called ‘naked’) trust is that the Trustee does not have the power to manage the entrusted property at his or her discretion. The Trustee has to follow the Settlor’s instructions to the letter. The trust beneficiaries are the owners of the property kept in trust.
This implies that the beneficiaries are taxed on the profits that they obtain from the trust property. However, if the trust beneficiaries are underage children, the trust Settlor is taxable on the profits that the trust generates until the children come of age (turn 18, in most countries).
Although formally the property kept in bare trust is under the Trustee’s control, he or she has little factual powers to dispense of the property or distribute the profits. The trust Settlor decides how the assets are to be managed and who benefits from the trust property. Once the trust beneficiaries have been appointed, the decision becomes irrevocable. No changes to the list of trust beneficiaries can be made.
Discretionary trusts do not have fixed lists of beneficiaries: new people can be added to the lists and removed from them. As the name suggests, the Trustee can manage the entrusted property and distribute the profits at his/ her discretion. However, the Trustee shall conduct business operations with the trust property in the interest of the beneficiaries.
The Trustee has the authority over the following issues:
- What portion of the income shall be paid to the trust beneficiaries;
- Which beneficiaries (members of a group of people) shall be paid;
- How often the payments shall be made;
- What conditions shall a beneficiary satisfy (if any) to be paid.
Discretionary trusts are sometimes created for the sake of some future needs that may arise later but that are unknown at present. In other cases, discretionary trusts are set up for the benefit of underage children or legally incapable persons.
You have to bear in mind, however, that in case the Settlor is listed among the trust beneficiaries, the trust property will be qualified as the property of the Settlor and inheritance tax will be due when the Settlor dies. Besides, the Settlor will also be taxed on the profits that the trust makes. At the same time, if the profit occurs due to the actions of the Trustee, the Settlor will not be taxed on that.
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Accumulation trusts are normally created by people preparing to retire. They are see-through entities and the Settlors can add capital to the trust or withdraw it. This is an instrument of preserving your property for future generations.
This is a type of trust where the Settlor obtains benefits from all or some property kept in trust. That is to say, the Settlor has an interest in the trust property. The following kinds of trusts can be settlor-interested trusts:
- A trust that allows the Settlor and his/ her spouse/ partner to benefit from the trust property;
- An accumulation trust that allows adding capital by the Settlor and/ or their spouse/ partner;
- A discretionary trust where the Trustee is to make payments to the Settlor and/ or their spouse/ partner.
If you have created a trust that brings profits to you personally (or your spouse/ partner), it means that you have to pay an income tax on the income obtained by the trust even if no income has been distributed to you by the Trustee.
At the same time, if the trust has some property that the Settlor has no access to, he or she is taxable only on the income made from business operations with their part of property kept in trust.
As the name suggests, parental trusts are created by parents wishing to pass their assets on to their children. The beneficiary of a parental trust shall be below legal age and single (not married).
Parental trusts can take the following forms:
- Bare trust: the child is entitled to use the property at his/ her discretion when he/ she comes of age;
- Interest in possession trust: the child can use the profits that are derived from the trust property;
- Accumulation trust: the parents as well as the Trustee can accumulate funds for the child’s future;
- Discretionary trust: the Trustee decides what part of the trust profit goes to the child.
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Trusts for vulnerable beneficiaries
Sometimes trusts are created in the interest of those people who are unable to protect themselves. Trusts of this type enjoy tax reliefs in many countries.
The following persons can be considered vulnerable beneficiaries:
- Mentally or physically disabled people;
- Children under the age of 18;
- Underage orphans.
If the trust is created in the interest of a vulnerable beneficiary, the Trustee can count on reduced income tax rates. However, the trust must conform to certain requirements. In particular, if the trust Settlor can obtain an income from the trust property, the trust will not qualify for tax reductions.
The assets kept in trust in the interest of a vulnerable beneficiary (money, land, real estate, and any other property) can be used only for the benefit of the vulnerable beneficiary. No other person can benefit from the trust if it is to qualify for tax reductions.
Trusts for vulnerable beneficiaries can come in the following forms:
- Testamentary trusts: the property that belonged to the deceased parent(s) of an underage child can be kept in trust until the child comes of age. After that, the property becomes the child’s possession.
- In England and Wales, there are special laws regulating the inheritance matters in the cases when the deceased parents leave no last will. Trusts are created to hold the property until the child turns 18.
If the trust has a vulnerable beneficiary among other beneficiaries, the vulnerable beneficiary’s property has to be defined and used separately from other property kept in trust and only for the benefit of this particular individual. Reduced tax rates apply only to the property belonging to the vulnerable beneficiary.
A mixed trust can combine the characteristics found in different types of trusts. For example, the trust Settlor can be the beneficiary of one half of the trust property while the other half can be in discretionary trust. In this case, the trust incomes will be taxed in accordance with the laws governing each trust type.
Four types of trusts for asset protection
As you can see, there are different types of trusts and they serve different purposes. Probably the main goal that trusts help to achieve is asset protection. Below we discuss four types of trusts and show which of them suit asset protection purposes in the most efficient manner.
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The property kept in revocable trust remains the property of the trust Settlor. He or she is free to add new property to the trust or extract certain assets at his/ her discretion. This characteristic makes a revocable trust an unreliable asset protection instrument. Why? Because the property legally belongs to the Settlor, who has a free hand in managing it, which means the property can be expropriated on a court decision. If you have to pay back a loan or a debt in accordance with a legal judgement, the property kept in revocable trust can be used for covering the loan/ debt. If you declare bankruptcy, the property will be sold to pay whatever you owe to creditors.
Thus, setting up a revocable trust would not be the best idea if your main intention was to protect your assets. You can create such a trust if you want to plan inheritance or manage a business company via the trust. Revocable trusts are suitable for these purposes because you can freely alter the list of entrusted assets.
When you create an irrevocable trust, you transfer you property to a separate legal entity – the Trustee. The property does not legally belong to you any longer. Rather, it belongs to the trust. Does it mean you have let go of your property and just donated it to somebody else? No, it does not! The Trustee is going to manage the entrusted property in accordance with your instructions that are clearly specified in the Trust Deed.
People set up irrevocable trusts for the following plain reason. Because you have put your property in a trust, you are not a legal possessor of this property. This means that this property cannot be expropriated from you in case a creditor files a lawsuit against you and wins it. At the same time, if your irrevocable trust has some profit-making property, you can continue using the profit! You can make new debts if you wish. You couldn’t sell the property kept in trust to pay back the debts even if you wanted to. It’s not yours.
Countries where Common Law is applied as well as many other jurisdictions (even though not all of them) legally allow creating trusts. So you may be able to set up a trust in your home country – the country where you live and where your assets are located. However, it’s not going to be the most efficient asset protection mechanism even if you set up an irrevocable trust. If a court of law finds a connection between the trust Settlor, the beneficiaries, and the trust property, the judge may rule that the property be expropriated. You must agree that it would be unfair if a person could seal the property from creditors, make debts, never pay them back, and get away with that. Domestic trusts are good for inheritance planning and asset management but not for asset protection.
The most secure asset protection instrument is an irrevocable trust registered in a suitable offshore jurisdiction. Places such as Nevis, Belize, or the Cook Islands, among others, have trust-related legislations that protect the property kept in trust in the most efficient manner.
What is more, it is very difficult for a creditor from a foreign country to file a suit against a trust registered in one of these jurisdictions. When filing a suit, the claimant has to pay a considerable sum of money to cover the costs of the court proceedings in advance. If the claimant loses the case, they simultaneously lose the money too and we are talking about tens or even hundreds of thousands here. As far as foreign court decisions are concerned, they are totally irrelevant for the judges in Nevis, Belize, or the Cook Islands. They just don’t care about foreign court rulings.
For instance, a trust in Nevis can protect your property from foreign creditors perfectly well. A foreign plaintiff has to pay US$ 100,000 if he/ she wants to sue a Nevis-based trust and this payment doesn’t give the plaintiff any guarantee that he/ she can win the case.
How are trusts taxed?
Whatever country you choose to set up a trust and whatever goals you pursue, you have to find out what tax implications the establishment of the trust is going to have. If you think that trusts can be used to avoid paying taxes, you are mistaken. The property kept in trust is not usually taxed. However, there can be exceptions from this rule. Whatever type of trust you are planning to create (discretionary, irrevocable, offshore, etc.) you have to find out what the local legislation says about the taxes that trusts have to pay there.
In Anglo-Saxon countries (UK, USA, Australia, etc.), the tax implications of creating a trust are well defined in the corresponding legislation. Trusts in these countries are taxed in accordance with the rules described below.
In addition to tax liabilities, you have to take into account the costs of creating a foreign trust. It might be the case that instead of registering a trust you should think about opening a foreign bank account or registering an offshore company. We will be happy to assist you in any of these matters.
Income tax payable by different kinds of trusts
- Bare (naked) trust. The Trustee can make profits from investments, bank interests, dividends on securities, land or real property rent, and so on. The tax is due when the income is distributed to the beneficiaries. Each beneficiary is responsible for declaring his/ her income and paying a tax on it. However, the Trustee can also be empowered to pay the tax on behalf of the trust beneficiaries.
- Discretionary and accumulation trusts. The obligation to declare the income and pay the tax lies with the Trustee. The Trustee has to file annual tax returns. The tax rates will depend on the country and if there is a vulnerable beneficiary, tax reductions are usually available.
- Trust whose Settlor is a (the) beneficiary of the trust. The trust Settlor has to pay taxes on the trust income even if the income has not been paid to him/ her. The tax rates depend on the country and the trust type.
- Parental trust. The tax rate will depend on whether the child is the only trust beneficiary (lower tax rate) or his/ her parents also benefit from the trust (higher tax rate).
- Mixed trusts. As we have noted above, each ‘section’ of a mixed trust is taxed in accordance with the tax rates that apply to each type of trust in the country.
Capital gains tax
Capital gains tax is payable when a piece of property is sold at a higher price than the one that was paid when the property was purchased. This tax is applicable to trusts too. In Great Britain and a number of other countries, the capital gains have to exceed the annual tax allowance for the tax to become due.
With bare trusts, the Settlor is responsible for paying the capital gains tax. With other types of trusts, usually the Trustee is responsible for that.
The trust beneficiary is responsible for paying the inheritance tax. Until the trust property is distributed to the beneficiary, it belongs to the trust and it isn’t taxed. We are talking about irrevocable trusts registered in offshore jurisdictions such as Nevis or the Cook Islands, for instance.
If you want to hand down property to your heirs via a revocable trust, the property remains in your possession, which means it remains taxable at the rates applied in the country of the trust registration. You always have to find out how the country where you want to create a trust taxes trusts. In the USA, for instance, there is a gift tax that is payable at the moment of transferring property to a trust. The person who’s transferring the property is liable to the gift tax.
If the deceased person lived in the USA, the inheritance tax is levied on all his/ her property. If the deceased person had some property in the USA (including shares of American companies) but he/ she didn’t live in the country, the inheritance tax is levied only on the property located in the USA.
Please find out how you can use a trust for inheritance planning.
Would you like to protect your assets in the most efficient manner?
Creating a trust can bring a number of benefits as far as asset protection is concerned but this task is much more complicated than registering a Sole Proprietorship, for example. You will be well-advised to apply for professional assistance especially if you would like to set up a foreign trust. Please write to firstname.lastname@example.org and we will gladly help you to create a trust in the right jurisdiction.
What trust type should I choose to protect my assets?
The most efficient asset protection mechanism is an irrevocable trust registered in an offshore jurisdiction. Property kept in trust becomes inaccessible for creditors.
What is the best offshore trust?
Nevis, Belize, and the Cook Islands have trust-related legislations that are probably the most efficient ones for asset protection purposes.