- Legal vs Beneficial Ownership of Companies
- Beneficial Ownership for US Tax Purposes
- Trusts and Foundations do not Have Owners
- Beneficial Ownership versus Persons of Significant Control
- Can a Company Have a Nominee Beneficial Owner?
- Identifying the UBO or PSC of a Trust or Foundation
- When is the Trustee the Ultimate Beneficial Owner or PSC of a Trust?
In the offshore world, we often hear about ‘Beneficiaries’ and ‘Beneficial Owners.’ These terms are frequently used interchangeably, but to do so is incorrect. Beneficiaries and Beneficial Owners are not the same thing. In this article we explain the difference.
The terminology arises from different concepts:
- A “Beneficiary” or the “Beneficiaries” is a concept from trust law, a branch of law that has developed over centuries. Beneficiaries of a trust are those people who are supposed to receive distributions of assets or income from a trust.
- “Beneficial owner” is a much more recent term, that developed with Anti-Money Laundering and Counter Terrorism (AML-CFT) laws, that really only became known in the last 20-30 years.
Sometimes, as you will see in this article, there is a conflict between old trust law and modern AML law, making it hard to define Ultimate Beneficial Ownership of companies, trusts, foundations and the like.
Legal vs Beneficial Ownership of Companies
Let’s start from a point that should be clear to everybody: every company has one or more legal owners. In a classic company limited by shares, known in some countries as a Public Company or Joint Stock Company, the legal owners are the shareholders. In an LLC, there are no shares, but there are still Owners – in the case of an LLC they are called Members. The legal owners’ names are typically written on share or membership certificates issued by the company. Legal owners may, of course, be individuals or other companies.
So far so good – but it’s been quite common over the years to try to disguise ownership of companies by putting a “nominee” owner in place. A nominee is a person whose name appears on the share certificate, but is not the “real” owner. Often this is done for completely innocent reasons – because share registers are public in many countries. We believe in the inherent right to privacy. If some nosy third party wants information on another’s private financial business, they should justify the need. Someone going innocently about their normal business should not have to justify why they want financial privacy. It is a basic human right.
In some cases, of course, people try to hide ownership for nefarious reasons – like tax evasion or money laundering. Over the years, there have been increasing demands for transparency – usually from people who are poor but prefer to spend their time being jealous of the success of others instead of building their own wealth.
Where a nominee holds shares for another person, whether it is documented by a formal agreement or simply by a verbal agreement or handshake, this creates a basic trust under common law where the rights of both parties are protected.
The basic concept of a trust is that the “legal ownership” is separated from the “beneficial ownership”. Beneficial ownership is the right to enjoy the benefits from the property, while legal ownership is simply the right to be recognized as the owner.
Common law systems such as those in the USA and UK recognize and protect these two different forms of ownership, but the legal systems of many civil law countries only recognize one type of ownership – legal. In some civil law countries, it may even be illegal to use nominee arrangements.
The concept of “Beneficial Owner” becomes relevant when it comes to nominee ownership. The Beneficial Owner is the technical term for what might be colloquially described as the “real” owner, whereas the nominee is the “Legal Owner.”
If the ownership is held through a series of companies, the term “Ultimate Beneficial Owner” or “UBO” refers to the Beneficial Owner at the top of the pyramid. A beneficial owner can be a company, but an Ultimate Beneficial Owner should be an individual.
AML law generally requires banks, professionals, trust companies and the like to know and document the ultimate beneficial ownership (as well as the Legal ownership) of any company they do business with. This is to make it harder for bad actors to operate, since if they are identified they are more likely to be caught.
Companies do not have beneficiaries. They can, for the reasons outlined above, have Beneficial Owners who are different from the Legal Owners.
A pedant might correctly argue that the beneficial owners are at the same time the beneficiaries of a simple trust that is created by the nominee agreement, but under no circumstances is it correct to say that a company itself has beneficiaries.
Beneficial Ownership for US Tax Purposes
If you’re not a US citizen, why would you care about US taxes? Simply because, almost any bank in the world will ask everybody to fill out a US form W8 or equivalent when they open a bank account. There are different types of W8 form for individuals, companies and trusts.
The official name of the W8 form is: Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting
It’s important to note that Beneficial Ownership for IRS purposes is different from the globally recognized concept of Beneficial Ownership under AML law.
On IRS guidance FAQ, to the question “Who is a beneficial owner?” the answer is:
The beneficial owner of income is generally the person who is required (under U.S. tax principles) to include the payment in gross income on a tax return.
If you read further it is clear that:
(i) they are talking only about income, not ownership of the company
(ii) a beneficial owner can be a company or other legal entity that is required to submit a tax return. It doesn’t have to be an individual in this case.
Therefore, bear in mind when opening an offshore bank account that you might be required to declare one beneficial owner on the W8 form, and a different one on the bank’s AML forms – again because different countries and entities use different definitions of beneficial ownership and ultimate beneficial ownership.
Trusts and Foundations do not Have Owners
Under trust law, neither Trusts nor Foundations have owners, nor beneficial owners.
A Trust is simply a legally valid contract that conveys certain ownership rights of certain property from one party (called the Settlor) to another, called the Trustee, for the benefit of one Beneficiary or multiple Beneficiaries.
Compare this, for example, to a purchase-sale agreement for a piece of real estate. The purchase-sale agreement conveys ownership of the real estate, but the agreement itself doesn’t have an owner. A trust is the same.
Another interesting analogy for those familiar with blockchain technology: a trust is a kind of manually executed smart contract. A smart contract is self-executing on the blockchain: so when a certain trigger event occurs, then another process is set in motion automatically, either immediately or after a certain period of time.
With a trust, when the trigger event happens (death of the settlor would be a typical trigger) then the trustee is legally obliged to execute follow-up actions as written in the trust deed (such as distributions to beneficiaries). Again, with this analogy, we can see that trusts themselves are not capable of having owners – it is the assets within the trust that have owners.
Foundations, on the other hand, are based on civil law. Foundation law gives legal personality to certain assets or properties, that are managed by a Council for the benefit of Beneficiaries. Foundations also do not have legal owners – in simple terms, they own themselves and the property within them.
This lack of ownership is sometimes hard for people to get their heads around. Some people think that evil “filthy” rich people and oligarchs “own” offshore trusts. Nobody can own a trust, but without a doubt people can control trusts. A well-known saying in the industry is “wealthy people do not own great wealth – they just control it.”
Unfortunately, however, AML laws around the world, as a result of political pressure, seek to identify “beneficial owners” of trusts, foundations and other similar entities like Endowments or Settlements.
Beneficial Ownership versus Persons of Significant Control
The term “beneficial ownership” applied to trusts or foundations is not legally correct in our opinion. The spirit and intention of the law is to identify the person or persons who control specific assets.
Nonetheless, many countries – including major jurisdictions in the trust business such as Luxembourg – try to do so. Luxembourg’s recent AML Law uses the following definition of “Beneficial owner” for both companies and trusts: “any natural person(s) who ultimately owns or controls the customer and/or the natural person(s) on whose behalf a transaction or activity is being conducted.”
This definition just muddies the waters even further, as it explicitly breaks down beneficial ownership to specific transactions and activities. Put yourself in the shoes of the poor compliance officer at a bank for a moment – it’s not enough for him to identify the UBO of the company that is his client, because that company might in turn be carrying out a specific transaction as agent of another party – someone who is the beneficial owner of just that one transaction.
We much prefer the UK’s terminology regarding beneficial ownership. The UK does not have a register of beneficial ownership, but rather a register of “Persons of Significant Control” or PSCs. PSC is a more easily understood term that is also more precise, by being more general. PSC can accurately refer to those who control Companies, Foundations, Trusts and more.
If a case goes to trial, it is clear that the spirit of the AML legislation is to identify the people who call the shots, who are controlling the assets or the business from behind the scenes. Throwing ownership into the equation and using terminology from trust law out of context just confuses the average person. As we said, wealthy people do not own great wealth, they just control it!
Now that we have explained the terminology, let’s consider that the terms beneficial owner, UBO and PSC can be used interchangeably.
Can a Company Have a Nominee Beneficial Owner?
The short answer is no. The term “nominee beneficial owner” implies an intent to mislead. If someone goes to a bank and claims to be the ultimate beneficial owner when really they are acting on behalf of a third party, then both parties are lying and might well be committing a crime, depending on AML legislation of the jurisdiction in question.
How about the long answer? As we’ve already seen above, Luxembourg law amongst others acknowledges the fact that someone might be the true ultimate beneficial owner of a company, but at the same time carry out transactions that belong to someone else. This is absolutely true, and furthermore it’s a normal commercial practice that has been going on for centuries. It is based on the concept of agency law and is recognized in the fiscal systems of every country. One company is allowed to invoice on behalf of another, and this relationship might be disclosed or undisclosed.
We have therefore seen that in recent years that “renting” of companies has become popular. For example: Mr Brown is the legal owner of ABC Widgets Inc. He is the shareholder, he is the only signatory on the bank account, he lives in the country of registration, deals with the book-keepers, auditors, tax authorities and bankers and sometimes travels to business meetings to sign documents.
Mr Brown then makes a deal with Mr Smith, whereby Mr Smith rents the company for a monthly fee, much like renting an apartment. During the time Mr Smith is paying rent, he can use the company as he wishes. Customarily, the rent is supplemented by a commission on turnover.
There is nothing legally flawed in this agreement: it is clear that Mr Brown is the UBO of the company, because if Mr Smith cancels the rental agreement, it is Mr Brown’s company. He might rent it to someone else the following month. Mr Brown is also taking a substantial legal risk, because his neck will be on the line if something goes wrong with the transactions of a previous “tenant”. On the other hand, Mr Smith is the beneficial owner of the actual transactions carried out while he is renting the company.
This is a complex area of law that requires specialist advice. We can say, however, that the agency “rent a company” concept is frequently used these days in international commerce. Examples include:
- Freelancers or digital nomads who need an official company through which to invoice
- Offshore companies who need an onshore address and bank account to receive payments
- E-commerce companies that are based offshore but need to have different agency companies in different jurisdictions to qualify for credit card merchant accounts
Identifying the UBO or PSC of a Trust or Foundation
A trust or a foundation cannot legally have an owner, so artificially “creating” one to comply with AML legislation is always going to be problematic. Arguably, this legislation might be shooting itself in the foot, because it also introduces the possibility for money launderers to get creative.
But if we return to the idea that the law is really trying to identify the person with control, then things become clearer. To experienced compliance officers this is obvious – but you might be unlucky enough to come across a “check the box” compliance officer who seeks to use some illogical manual or rulebook to identify the PSC or UBO of a trust or foundation.
Who, then, is the PSC of a trust or foundation? For this, there is simply no one-size-fits-all answer. ‘Beneficial Ownership’ has to be decided case by case, looking at the facts of each individual trust or foundation.
In most cases, when trying to decide the PSC of a Trust, the Settlor is the first person to examine. It is the settlor’s assets that created the trust, and the settlor exercised at least some degree of control when setting up the trust. But how much control does the settlor realistically exercise? What if, for example, the settlor is dead?
It’s also perfectly possible that the real person behind the trust hired someone else to settle an irrevocable trust with a nominal amount – meaning the “nominee” settlor has no real influence.
What about the Protector? Protectors are a relatively new innovation in trust law. They can often exercise a lot of control. For example, the right to veto decisions of the trustee or even remove the trustee. However, there is no obligation to appoint a Protector.
And beneficiaries? It’s a very big leap from beneficiaries to beneficial owners. Whilst in some trusts, beneficiaries clearly exercise control and influence, in others the beneficiaries might be unaware that they are beneficiaries – or maybe they are not even born yet. It’s quite common to list future grandchildren, for example, as beneficiaries of a generation-skipping trust.
The same analysis applies to foundations. Beneficial ownership always has to be decided case by case.
When is the Trustee the Ultimate Beneficial Owner or PSC of a Trust?
In a trust structure, the trustee holds the assets for someone else. It would therefore be inaccurate in almost all cases to call the Trustee a Beneficial Owner. However, it’s quite likely that the trustee is the PSC – making all business decisions on behalf of the trust.
What if the settlor created an irrevocable trust, and then passed away? There may be no Protector. Beneficiaries could be new-born babies or even a class such as “future offspring of Mr and Mrs X” or “future graduates of Harvard University.”
In this case, the Trustee is clearly the only party who can be considered UBO / PSC. PSC is a fair description in this case, but UBO is very misleading terminology.
In fact, it’s correct and logical in many cases to list the Trustee as UBO. In the case of Serbian endowments (similar to trusts) for example, it is clear in Serbian law that the person who has to be declared as the Beneficial Owner is the Manager (akin to the Trustee)
Overall, it’s fair to see that not only is there a lot of confusion over terminology when it comes to Beneficiaries versus Beneficial Owners, but there are also big differences between jurisdictions. These differences might allow jurisdictional arbitrage for creative planners and their clients seeking privacy, but there are also many legal pitfalls to be aware of. Proceed with caution and with professional advice!
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