Trust and Trustee Services

Families have been using trusts for wealth management and wealth protection for the benefit of their heirs for centuries. Trusts provide people with a means of protecting their assets and controlling how they are used after they have been given away.

Unlike corporate vehicles, the lack of rigid formal requirements for the creation and operation of trusts, and the tremendous flexibility of trust instruments, make them uniquely useful for estate and succession planning.

Although many of the tax benefits that were associated with trusts have been eroded by anti-avoidance legislation in recent years, they still offer great advantages – particularly for high net worth individuals who are changing, or planning to change, their domicile, residence or citizenship; those with families resident abroad; those seeking asset protection; and those whose principal motivation is not to avoid taxation but to dispose of their estate on death freely and without recourse to a lengthy and expensive probate procedure.

The ‘Trust’ Concept

At its simplest, a trust is an arrangement whereby property or assets are transferred from one person (the ‘settlor’) to another person (the ‘trustee’) to hold the property for the benefit of a specified list or class of persons (the ‘beneficiaries’). A trust can be created solely by verbal agreement but it is usual for a written document (the ‘trust deed’) to be prepared. This evidences the creation of the trust, sets out the terms and conditions upon which the trustees hold the trust assets and outlines the rights of the beneficiaries.

The practical advantages of a trust are gained from the distinction that is drawn between the formal or legal owner of property, the trustee, and those people that have the use or benefit of the property, the beneficiaries.

It is vital that the trustee remains independent and exercises proper control over the trust property. A trust may be deemed to be invalid if the settlor continues to exercise power over the trust assets by retaining benefit or control, or by giving directions to the trustees.

Those unfamiliar with the trust concept are often concerned at the prospect of transferring ownership of their property to a trustee. This concern can be alleviated if the trust concept and the distinction between legal and beneficial ownership is properly understood and it is clear that the trust is governed by a reliable trust law that can be enforced in a reputable jurisdiction.

The trustee holds the legal ownership interest in the trust property separately and apart from his own personal property and therefore trust assets are insulated from the trustees personal creditor.

Trust law imposes strict obligations and rules on trustees. There is a basic rule that a trustee may not derive any advantage, directly or indirectly, from a trust unless expressly permitted by the trust – for example, where a trust provides a professional trustee with the right to charge for its services. Full disclosure of the basis and amount of charges is required.

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Trustees must follow the trust deed and are subject to very strict rules governing the way in which their powers and discretion may be exercised. The courts regard a trust as creating a special relationship that places the most serious and onerous obligations on the trustee.

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Best interests of beneficiaries – Trustees must at all times exercise their powers in the best interests of the beneficiaries of the trust, and disregard the interests of others, including the settlor.

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Act prudently – Whether or not a trustee is remunerated, they must act prudently in the management of trust property and will be liable for breach of trust if – by failing to exercise proper care – the trust fund suffers loss. In the case of a professional trustee, the standard of care that the law imposes is higher. Failure to exercise the requisite level of care will constitute a breach of trust for which the trustees will be liable to compensate the beneficiaries. This duty can extend to supervising the activities of a company in which the trustees hold a controlling shareholding.

Uses of Trusts

Estate planning

Trusts can be used individually or as part of an overall strategy. A properly drafted and managed trust can confer advantages under any or all of the following heads:

Estate planning

Failure to plan your affairs in advance of death can mean leaving your estate in disorder. Many people seek to order their affairs by making a will but the probate process can result in lengthy delays, high administration costs (typically around 4% to 6% of the total value of the estate) and often tax liabilities. The best alternative is to set up a trust during their lifetime. Many people do not want their assets to pass outright to their heirs, whether chosen by them or as prescribed by law, and prefer to make more nuanced arrangements. These might include: providing a source of income, but not capital, for a spouse for life; making provision for the education of children but not letting them have access to capital until later in life; or providing a fund to protect members of the family in the event of sudden illness or other calamities. A trust is probably the most satisfactory and flexible way of making arrangements of this kind.

Tax planning

Assets and funds transferred into trust are no longer considered as belonging to the settlor, so the income and capital gains generated by those assets are taxed according to the rules governing the legal owner – the trustee(s). Inheritance tax can be eliminated because the trustee(s) continue in existence after the death of the settlor. Anti-avoidance legislation in the home country of the settlor or in the location of the trust assets may seek to counteract this outcome, but a correctly structured and administered trust may offer substantial tax efficiencies.

Confidentiality

Proving a will is a public procedure. Domestic authorities will need to receive a complete list of all the property owned by the deceased in order to assess the amount of estate duty payable before the property can be transferred to the executors for distribution. This procedure is entirely unsuitable for those who wish to keep details of their assets confidential. The only other legal form of transfer is via a trust and this would generally save estate duty and keep the trust assets confidential.

Asset protection

Trusts can be one of the most effective ways to protect assets. In simple terms, if you transfer property to a properly constituted trust, it will no longer form part of the settlor’s property and therefore cannot be seized by creditors if a settlor gets into financial difficulties. A court may, under certain circumstances, order the transfer into trust to be set aside and the trust assets returned to the settlor, but a trust can form an important part of a risk-mitigation strategy.

Avoiding forced heirship

Many civil law jurisdictions and countries of Islamic tradition have ‘forced heirship’ provisions, which create a legal obligation to distribute a certain proportion of a deceased’s assets to their next of kin and/or children. If forced heirship rules are at odds with your intentions, a trust will enable a wider or different distribution of the estate.

Protecting the vulnerable

A trust is a useful vehicle for people who may want to provide for those who are unable to manage their own affairs, such as infant children, the aged, the sick or disabled. Trusts can allow for the independent support of those who require it most.

Preserving family assets

Preserving family assets, or growing them, is often a motive for setting up a trust. An individual may wish to ensure that wealth accumulated over a lifetime is not divided up amongst their heirs, but rather is retained as one fund to accumulate further. A trust offers a mechanism for preserving family assets while offering the flexibility to allow payments to beneficiaries as the need arises. This can be further enhanced with a unified fund for investment management.

Continuing a family business

An entrepreneur who has built up a business will often be concerned to ensure that it continues after their death. If the shares in the business are transferred to trustees prior to death, a trust can be used to prevent the unnecessary liquidation of a family company while providing for payments to be made to members of the family from dividend income. This may be particularly advantageous where family members have little business experience of their own or where they are unlikely to agree on running the business. This is never more applicable than in an Initial Public Offering (IPO) situation where the creation of a pre-IPO trust for major family or employee shareholdings can offer a raft of benefits.

Increased flexibility

The best-laid plans can rapidly become obsolete due to unforeseen circumstances, but a discretionary trust can provide a mechanism for managing property that is capable of adapting as conditions demand. No beneficiary has any fixed or absolute interest in the trust assets under a discretionary trust. Instead, the settlor can simply nominate a class of beneficiaries and give the trustees discretionary powers to distribute trust assets as and when they see fit. Beneficiaries only have a contingent interest and ordinarily would avoid any tax liability until such time as they receive a distribution.

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Disadvantages of a Trust and Solutions

The major disadvantages that are associated with trusts are their perceived irrevocability, the loss of control over assets that are put into trust, and their costs.

In fact trusts can be made revocable, but revocable trusts generally has negative consequences in respect of tax, estate duty, asset protection and stamp duty. Revocability is a matter to be discussed when the terms of the trust are considered.

Many potential settlors are reluctant to transfer assets to trustees because they fear relinquishing control. For those who wish to continue to exercise effective control over the trust assets after the transfer, careful planning – together with an understanding of the fundamental legal requirements of a trust – is required if the trust is to remain valid or useful for its intended purpose.

If a settlor retains too much control, there is a risk that the trust will not be effective and the settlor will continue to be regarded as the legal owner. If this happens all the advantages of having the assets held in trust may be lost. There are, however, varying degrees of control and information rights that may be retained to give comfort to a settlor:

Memorandum of Wishes

When setting up a discretionary trust it is common for the settlor to indicate to the trustees how the settlor would have dealt with those assets if they had retained ownership. The trustees will make a comprehensive note of these wishes in a written memorandum, to which they will refer when dealing with the trust property. The wishes of the settlor will not be binding on the trustees but, in practice, trustees would be reluctant to deviate unless a change in circumstance or other matters would make it clearly disadvantageous to the beneficiaries to act in such a way.

Protector

A ‘protector’ may be appointed to exercise some degree of control over the trust property. It is usual for a trusted friend, family relative or professional adviser of the settlor to be appointed, but it is also becoming increasingly common to use the services of a professional trust company. Sovereign is able to serve as a professional protector where we are not retained to act as trustees. In our view, it is unwise for a protector to be given anything other than powers to veto decisions or actions of the trustees. A protector that is empowered to direct the trustees actively might be deemed as a ‘quasi-trustee’ and this could have harmful consequences for the trust.

Two-tier company and trust structure

Greater flexibility can sometimes be achieved if the underlying assets are owned by a company that is in turn owned by a trust. The settlor, or an appointee of the settlor, can act as the director of the company, enabling them to exercise day-to-day control over the underlying assets with minimal interference or need to refer to the trustees. This two-tier structure can be used to good effect in certain circumstances but might have tax and other disadvantages if the director of the company is resident in a high tax country.

Joint trustees

A trust can be structured using joint trustees such that the agreement of both is required for any action. The second trustee could be the settlor or a company controlled by the settlor. Again, there may be negative tax or other consequences resulting if the settlor is resident in a high tax country. Alternatively, a ‘check and balance’ may be obtained by having two different professional trust corporations acting as joint trustees. This can be cumbersome and expensive but it may be suitable for certain trusts.

Private Trust Companies

A Private Trust Company (PTC) is a company formed for the specific purpose of acting as trustee of a single trust or a group of related trusts. Family members can participate in the management of the PTC and therefore in the decisions that need to be taken by the PTC as trustee, including decisions relating to the control and management of companies owned by the trustee.

Where a third party professional trust company may not be in a position to offer the settlor the degree of flexibility and the speed of response that they require and will not be as familiar with the business of companies owned by the trust as the family members themselves, a PTC structure can assist. Directors that are familiar with the business can make the decisions and, if a change of direction is desired for the management of the trust, this can be achieved by changing the board of the PTC. A PTC can therefore provide greater comfort for the settlor that their objectives in creating the trust will be met.

It is usual and advisable to have at least one director who is a trust expert to add substance and credibility to the PTC and to ensure that the PTC – and the trust(s) it administers – is run correctly. All decisions taken by the directors of the PTC in relation to the trust must be in the interests of the beneficiaries as a whole.

More important than the constitution of the board will be the ultimate ownership of the PTC because this will, if the owners feel it necessary, allow them to remove directors and replace them. However the settlor will retain a significant degree of control if they are acting as sole or majority shareholder or alternatively the guarantor member of the PTC. Careful consideration of the overall trust, PTC and family structure must therefore be undertaken if the objectives of settling the trust are to be met.

Many jurisdictions specifically exempt PTCs from the requirement to be licensed and regulated provided that the PTC acts solely as trustee of a specific trust or group of trusts, and does not solicit from, or provide trust company business to, the public. In most cases there is also no requirement to submit any reports or accounts to any statutory body of either the PTC itself or of the trusts for which it acts.

The costs of establishing both a PTC and a trust (or trusts) will generally be higher than the cost of simply establishing a trust. However the ongoing costs may be less than the trustee fees that would be charged by an independent third party trustee. This is particularly the case where trust assets are very substantial because independent trustees will often charge fees based on a percentage of the assets.

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Types of Trusts

Trusts are inherently flexible. They can take many legal forms and have multiple practical applications. The following legal forms are among the most commonly encountered:

1. Family Trusts

A family trust is a trust that is set up for the benefit of family members. It can help protect a family’s assets and enable wealth to be passed on to family members more efficiently. Common reasons for setting up a family trust include:

Setting funds aside for future generations.
Passing assets on to a child or grandchild, but not until they are older.
Protecting assets when entering a marriage.
Ensuring that a spouse can benefit from family assets for the rest of their life before assets are passed on to children.
Passing assets on to family members tax-efficiently.
Protecting assets against claims from future creditors.

Family trusts typically take the form of either Fixed Interest Trust or a Discretionary Trust, as follows:

Fixed Interest Trust

Fixed Interest (‘non-discretionary’) Trusts are where the interests of the beneficiary or beneficiaries are determined by the settlor at the outset and the trustee must distribute the trust income and capital in accordance with the trust deed. The most common type of fixed trust is a life interest trust, under which one individual – usually a spouse – will have a right to all of the trust’s income during his or her lifetime. On this individual’s death, the trust property will then generally be payable to named capital beneficiaries. Another type of fixed trust is one contingent upon the beneficiaries satisfying certain conditions, such as reaching a certain age. When this condition is satisfied, the beneficiaries will typically have an absolute interest in the capital.

Discretionary Trust

Discretionary Trusts provide more flexibility. A carefully worded discretionary trust gives trustees the power to decide how much beneficiaries get from a trust and when they get it. They may also have the power to add or exclude beneficiaries. The settlor of the trust should set out his / her intentions in a ‘letter of wishes’ to provide clear guidance for the trustees to follow. A ‘protector’ can also be appointed to enforce this. The discretionary powers enable the trustees to adapt to changing family circumstances – births, deaths, marriages, divorces and bankruptcies – or to changes in tax or legislation. It also means that the beneficiaries have no interests that can be transferred or attacked by creditors or divorcing spouses unless the trustee decides to make a distribution.

2. Excluded Property Trusts (EPTs)

EPTs currently provide long term protection against UK Inheritance Tax (IHT) to foreign nationals, including British National (Overseas) visa holders from Hong Kong, who have recently moved – or who are in the process of moving or are intending to move – to the UK. They can also provide IHT protection to British citizens who have succeeded in shedding their British ‘domicile of origin’ in favour of a new ‘domicile of choice’ in the country in which they currently reside.

A trust will be an EPT provided that the trust fund comprises only non-UK assets and provided that the settlor was not domiciled in the UK at the time the trust was created. Assets held within an EPT will then remain outside the scope of IHT even if the settlor subsequently becomes UK domiciled.

Any income earned by the trust can be capitalised and retained within the trust and will also be excluded property, allowing for significant potential tax-free growth over time. EPTs can hold a diverse range of assets including cash, shares and non-UK real estate.

It is essential to maintain the ‘excluded property’ status of an EPT. This means that no further assets should be settled into the trust once the settlor’s domicile has changed. Any investments in overseas companies that themselves invest in UK residential property should also be avoided because these investments may remain within the scope of IHT, regardless of the domicile of the trust.

3. Employee Benefit Trusts (EBTs)

EBTs can be used to assist employers to incentivise and reward employees through types of share option plans such as Employee Share Option Plans, Restricted Share Plans or Restricted Share Unit Schemes. The choice of EBT will largely be driven by an employer’s objectives and business plans, the existing and anticipated share structure of the company, the number of intended beneficiaries, and any relevant legal and tax issues.

An EBT is useful if a company wants to make share awards to employees without the need for an instant cash settlement. The EBT facilitates the long-term holding of a number or percentage of shares on behalf of employees and can creates an internal market for the company’s shares. This means that if shares and repurchased from participating employees who are leaving the company, settlements can generally be made from surplus profits in the trust.

Where to establish a Trust

There are a number of different countries worldwide that have enacted trust legislation but the quality and suitability of that legislation can vary. When selecting the best jurisdiction for establishing a trust it is important that it should offer:

A strong tradition of enforcing trusts
An English common law system
An established reputation for trust business
Modern legislation, including contemporary trust concepts
Low or no taxation for trusts.

Some jurisdictions are not recommended due to legal or political uncertainties or because their courts or professionals have limited trust experience. Other jurisdictions, whilst being noted for their expertise, have not kept pace with the modern trust legislation that offers additional benefits and protection to trust assets or are unsuitable because of high tax regimes.

Sovereign generally recommends that Gibraltar, Hong Kong, Guernsey, Malta, Singapore, Cyprus, the United Kingdom and the Isle of Man are among the best available options and Sovereign is fully licensed to act as professional trustees in all these jurisdictions.

Why use a professional Trustee company?

There are many reasons why a client may wish to appoint a corporate trustee rather than rely on advisers, a family member or friend. The day-to-day management, record keeping and reporting obligations of trusts have grown exponentially over recent years, even for simple trusts, and have the potential to take up significant time. More complex trusts require in-depth legal and fiscal knowledge.

Corporate trustees provide a professional service that is simple and easy to use, removing the burden from lay trustees trying to fulfil this role. They will carry out trust administration, whilst ensuring the settlor’s and the beneficiaries’ interests are balanced appropriately, and the trust reporting, tax returns, accounts and registration.

Licensed corporate trustees must adhere to certain standards and meet various statutory obligations. They are are also impartial and discreet. Importantly, they can serve as a neutral party in the event of a dispute by considering the views of all parties in equal measure.

It is often assumed that the costs of running a trust are prohibitive. It is true that many of the major banks and other financial institutions charge substantial fees for setting up a trust, while also charging a percentage of the trust assets in annual administration fees together with basis points fees for the underlying trust’s cash investments.

The fees charged by independent trust companies are generally more reasonable and make trusts affordable even to relatively modest estates. As specialists, independent trust companies offer a more tailored approach that will allow settlors and beneficiaries to achieve their objectives. It also means they can be consulted on technical matters and are free to select the best investments for the trust without being under pressure to place trust money with in-house investment advisers to secure disguised remuneration.

TRUST JURISDICTIONS

Sovereign has licences to administer trusts in 9 jurisdictions and the types of trusts provided in each jurisdiction vary.

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