The EEIG is a new example of a fiscally transparent entity. The phrase describes an entity which is disregarded for the purpose of ascertaining how much tax is to be paid, even though the assessment to tax may be made on the entity. In general a branch is transparent. So is an “S” company in the US. Some trusts are fiscally transparent – a bare trust for instance, but by no means all. In the UK, quite elaborate pooling arrangements have been held to be transparent for capital gains tax.
Sometimes an entity may be opaque in one jurisdiction and transparent in another – eg a GmbH may be treated as a corporation in the US and as a partnership in Germany. Sometimes an entity may be transparent for one tax not another – eg an EEIG may be transparent for tax but not VAT. A Spanish property holding company is generally transparent; a French Societe Immobiliere may be treated as transparent or not at the option of the shareholders. Transparency takes many form and is commonly used in anti-avoidance measures – eg in the controlled foreign corporations of various countries.
Transparency or opacity may be useful for reasons not concerned with tax – the asset protection trust is essentially opaque; the nominee can disguise from the public the identity of the true beneficial owner. But transparency is a phenomenon replete with tax problems. Does a partnership have a residence? Does the partnership or do the partners claim the benefit of a tax treaty? If a partnership is treated as a corporation in one country, how are distributions to a partner resident in another country to be treated?
The most important recent case in this area decided in the UK is Padmore. There it was held that because the income of a Jersey partnership had the benefit of the treaty with the UK, the UK partner’s share was not taxable. The US has a plethora of rules for distinguishing entities to be treated as corporations and those to be categorised as partnerships; much turns on the provisions in the constitution of the entity concerned.
Transparent entities useful for international tax planning include the Dutch CV, the Barbados branch of the Netherlands finance company, the unlimited company which is a partnership in the US but a group company in the UK, offshore partnerships obtaining treaty relief or giving rise to income taxable on a remittance basis.
The US has a great hunger for capital, but the US government has placed a number of tax obstacles to inward investment – notably the anti treaty-shopping articles in recent tax treaties – provisions preventing “bunching” of interest charges, the scrutiny of interest charges under the arms length rules, the promulgation of regulations of varying and sometimes retrospective effect, the introduction of the “branch level withholding tax” which treats the US branch as if it were a US subsidiary of a foreign corporation. One solution to this last problem (and avoiding other provisions applicable t corporations) is to utilise an entity which is treated in the US as a partnership.
The Swiss and Netherlands treaties with the US seem likely to continue in their present forms. However, treaty benefit is lost if back-to-back loans cause the intermediary to be treated as a mere conduit; a Netherlands company with a Barbados branch pays on the 2.5% tax in Barbados on the corporate profit, though a further cost of a little less than 10% is incurred to take out the profit by way of dividend. The interest article in the Netherlands Antilles is still in force. But the Antilles tax cannot be avoided by back-to-back loans. However, a dividend on preferred stock may be treated as deductible; so also may a notional interest charge on an interest-free loan. The zero-tax companies in Aruba do not benefit from the treaty.
Short term loans, with a term of 183 days or less, yield tax-free interest. This treatment is available to loans between related parties but is not available to a demand note having no express term. Interest payments on Eurodollar bonds are protected by express provisions. The statute was broadly drafted and the portfolio interest exemption is widely available. The lender must not be a bank, a 10% stockholder or a controlled foreign company; the interest must be payable in the US. If these conditions are satisfied in details, the interest is free of US tax in the hands of the foreign recipient. The interest may be fixed or vary in accordance with the performance of the borrower, but the Treasury has said that the present proposed regulations may be extended to deny the exemption to the variable element.
A foreign trust may invest in US real estate. If the grantor makes a fixed interest loan to the trust, the interest does not have a US source.
The opportunities for investment in the U.S. were perceived, rightly, as attractive for many decades. More recently some opposition to foreign investment has grown up in the U.S.; tax laws have become less favourable to foreign investment and tax treaties abrogated.
The U.S. taxes “effectively connected income” of local business and imposes a basic 30% withholding tax on income from passive investments. Tax planning through treaty shopping, the use of a U.S. branch in preference to a U.S. corporation, back-to-back loans and other devices have stimulated anti-avoidance measures. The incidence of estate tax is a serious deterrent to investment by alien individuals. The 1986 Act curtailed the use of foreign corporations for the ownership of real estate and other assets situated in the U.S..
From October 1988 the rate of estate tax was changed to a graduated rate which escalates quickly from 37.5% to 55% at the Federal level, with additional tax being charged to heirs in some states. Where no land is involved, this risk is simply eliminated by use of a foreign company, or by staying with portfolio debt and other exempt assets. The problem may be eased by lifetime gifts (a U.S. citizen’s gift to a non-citizen spouse not being exempt from gift tax). The grantor trust rules may operate in favour of non-resident aliens, where the trust income is attributed to the non-resident alien grantor notwithstanding that it may be paid to a U.S. citizen. The rules may on the other hand penalise a grantor-beneficiary who subsequently becomes a U.S. taxpayer by reason of a change of residence or citizenship. Trusts are severely taxed in other ways too: accumulated income carries a surcharge tax on distribution; “generation skipping” and “adverse party” trusts create other quagmires. Letters of wishes may be treated by the IRS as part of the trust instrument.
For the future, it seems unlikely that any major changes are envisaged, but benefits may well be eroded in the areas of forum and treaty shopping, foreign trusts and anonymous ownership of assets by banks and other nominees.
Note: the $600,000 lifetime exemption for U.S. citizens has been increased to $1,000,000 over a 10-year period (March 1998).
Offshore trusts are frequently used by persons wishing to minimise the risks of expropriation or other confiscatory measures to which the assets of a Settlor may otherwise be exposed in his or her home country. Favoured locations for a discretionary offshore trust include Jersey, Guernsey, Isle of Man, the Cayman Islands, the British Virgin Islands, Cook Islands and other jurisdictions whose laws are based on English common law principles.
The trust mechanism requires the Settlor to transfer the legal ownership of property to Trustees. The Trustees hold the property for the benefit of persons designated by the Settlor. Nevertheless, the Settlor often wishes to retain some form of control over trust assets. Several solutions are available. For example, the Trust Instrument may allow the Settlor to amend or revoke the Trust in whole or in part. Permitting a Settlor to exercise such drastic steps may call into question the legality of the Trust. Additionally, Settlors are often encouraged to address a Letter of Wishes to the Trustees. However, such letters are not legally binding upon the Trustees.
The Protector mechanism has been found to be a useful approach for Settlors who wish to maintain anonymity while retaining some form of control over the disposition of trust assets. Protectors are frequently favoured by Settlors who are resident in civil law jurisdictions and are, therefore often unfamiliar with the trust concept. The Protector, generally resident in a jurisdiction other than that of the Settlor, acts as an intermediary between the Settlor and the Trustee. The Protector may be given power to give or withhold consent to certain kinds of acts by the Trustee. Moreover, the Protector may, in some instances, have positive powers such as changing the jurisdiction of the Trust, requiring distributions or even triggering the termination of the Trust. Protectors tend to be physical persons although corporate Protectors are not unknown.
The Protector concept has not often appeared in the reported cases. However, statutory examples appear in legislation of jurisdictions such as the Cook Islands and Jersey. The duties of the Protector are generally not of a fiduciary nature. On the other hand, if the powers of the Protector are too broad, he may be viewed as a co-trustee. If that occurs, there may be adverse tax and other ramifications which were not foreseen by the Settlor.
The talk in Dublin in 1991 ended with the comment that the world was still waiting for the jurisdiction with the ideal trust law. It is still waiting.
At the time of delivering that talk, the President of the ITPA and the author were working on the draft of a new Trust Law for Belize. This was subsequently enacted in the summer of 1991. Without undue modesty, one can say that it has not become the paradigm or benchmark for trust laws around the world (or, perhaps, has not yet become the paradigm or benchmark). It has been copied in one or two other jurisdictions (Anguilla in 1994, for example), and bits of it have clearly inspired legislators in other jurisdictions. However, there is still no ideal trust law which provides a benchmark for legislators (in the way, for example, that the BVI IBC Law has provided a benchmark for offshore company legislation).
There have, however, been several developments in the years since 1991.
First, there is a growing feeling that in some jurisdictions the legislators have gone a step too far with their reform of trust law. There have been a number of articles and commentaries which suggest that certain legislation has removed the essential elements from “trusts” governed by the local law, resulting in something which is either invalid entirely or which would be regarded as a bare nomineeship or deposit. As yet, these comments have not translated into court decisions striking down “trusts” as invalid.
One area, in particular, where the legislators may have gone too far in some states is in the field of asset protection legislation: certain litigation (for example, the South Orange Grove cases in the Cook Islands) show that superior courts are disinclined to uphold this legislation in practice.
The second development, which, frankly, should have been predicted in 1991 was the rise in trust litigation. With many reforms of trust law introducing innovations, it was only a matter of time before some of these innovations would be tested by litigation. We are now seeing reports of some of that litigation proceeding (one of the happy developments in the intervening years has been the appearance of a new set of law reports – the Offshore Financial Law Reports – which reports these trust decisions).
Meanwhile, offshore jurisdictions have continued to amend their trust laws. Appended to this short note is a list of most of the trust law amendments that have been enacted since the beginning of 1991 . Few of these amendments have introduced any great novelties in the area, and none appears to have produced the ideal trust law. In many cases, the reforms are either “me too” copies from other jurisdictions, or they remedy perceived defects in earlier legislation. The impetus for innovation in offshore centres appears to have shifted to the development of non-trust entities such as limited liability companies and partnerships. Perhaps a pause for thought in the field of innovative trust legislation is not a bad thing
ANGUILLA(a) THE TRUSTS ORDINANCE 1994Provides for the law relating to trusts and trustees and related matters.
(b) FRAUDULENT DISPOSITIONS ORDINANCE 1994Amends the law relating to dispositions made with intent to defraud
ANTIGUATRUSTS ACT 1996To provide for a modern trust law.
BAHAMAS(a) FRAUDULENT DISPOSITIONS ACT 1991To amend the law relating to dispositions made with an intent to defraud
(b) TRUSTS (CHOICE OF GOVERNING LAW) (AMENDMENT) ACT 1996To amend the Trusts (Choice of Governing Law) Act 1989.
(c) PERPETUTIES ACT 1995An act to modify the law relating to the avoidance of future interests in property on grounds of remoteness.
(d) TRUSTEE BILL 1997 – (passed by House of Assembly, due in force imminently)
BARBADOS(a) INTERNATIONAL TRUSTS ACT 1995To provide for the creation and regulation of international trusts and related matters.
(b) INTERNATIONAL TRUSTS (AMENDMENT) ACT 1995An Act to amend the International Trusts Act. Amendment provides that for the purposes of section 17 of the Income Tax Act an international trust is deemed not to be domiciled in Barbados.
BELIZETRUSTS ACT 1992An Act to codify the law of trusts in Belize.
BERMUDACONVEYANCING AMENDMENT ACT 1994To make provision in respect of certain voidable dispositions.
BVITHE TRUSTEE (AMENDMENT) ACT 1993An Act to amend the Trustee Ordinance
CAYMAN ISLANDS(a) TRUSTS LAW (1996 REVISION) PRIMARY LEGISLATION
(b) TRUSTS (FOREIGN ELEMENT) (AMENDMENT LAW) 1995 – now incorporated in 1996 Revision.
(c) PERPETUITIES LAW 1995To modify the Law of the Cayman Islands relating to perpetuities.
(d) SPECIAL TRUSTS (ALTERNATIVE REGIME) LAW 1997 (STAR LAW) Permits the creation of non-charitable purpose trusts designed for a particular purpose rather than for the benefit of a particular beneficiary.
(e) PERPETUITIES (AMENDMENT) LAW 1997Overrides the Perpetuities Law 1995 for special purpose trust set up under the STAR Law 1997 by exempting them from the rule against perpetuities.
COOK ISLANDS(a) INTERNATIONAL TRUSTS AMENDMENT ACT 1991Amendment to section 13B of principal Act (1984) ITA
(b) INTERNATIONAL TRUSTS AMENDMENT ACT 1995-96
(c) INTERNATIONAL TRUSTS AMENDMENT ACT (No. 2) 1995- 96
CYPRUSINTERNATIONAL TRUSTS LAW 1992To make provisions for international trusts.
DOMINICAINTERNATIONAL EXEMPT TRUST ACT 1997To make provision for international trusts.
GRENADAINTERNATIONAL TRUSTS ACT 1996 To make provision for international trusts.
ISLE OF MAN(a) TRUSTS ACT 1995An Act to make further provisions relating to the governing law of trusts; for the exclusion of foreign law in relation to trusts governed by Manx law; and for connected purposes.
(b) PURPOSE TRUSTS ACT 1996An Act to make provisions for the creation of valid purpose trusts.
JERSEY(a) TRUST (AMENDMENT No.2) (JERSEY) LAW 1991To provide for implementation of the Hague Convention 1987.
(b) TRUSTS (AMENDMENT NO.3) (JERSEY) LAW 1996 Introduction of non-charitable purpose trusts.
LABUANOFFSHORE TRUSTS ACT 1996Allows non-residents to register offshore trusts in Labuan IOFC with non-Malaysian assets.
MADEIRADecree Law 149/94 on the registration of trusts.
MALTARECOGNITION OF TRUSTS ACT 1994(i) to enable Malta to ratify the Hague Convention(ii) to make certain amendments to the Offshore Trusts Act.
MARSHALL ISLANDSTRUST ACT, 1994To make amendments to the law of trusts.
MAURITIUS(a) OFFSHORE TRUST ACT 1992To provide for offshore trusts.
(b) FINANCE ACT 1996 – AMENDED 0TA 1992To allow offshore trusts to make a non-resident declaration to gain exemption under Income Tax Act 1995. Also introduced provisions for protectors of trusts and clarified the law in relation to letter of wishes
(c) FINANCE ACT 1997 – AMENDED OTA 1992(i) Resident Offshore Trusts liable to tax on chargeable income at 15%(ii) Non-resident trusts continue to be exempt(iii) Resident and non-resident beneficiaries are exempt.
NEVISINTERNATIONAL EXEMPT TRUST ORDINANCE 1994 To make provision for international trusts.
NETHERLANDS ANTILLESTRUST ORDINANCE 1997To create new quasi-trust structures.
NIUETRUSTS ACT 1994To codify the law of trusts.
PANAMAAMENDMENT TO THE LAW ON TRUSTS Decree Law 5 of 1997To allow authentication of trust documents by notary, regardless of nationality and jurisdiction.
ST. KITTSTRUSTS ACT 1996Provides for trusts, trustees and beneficiaries; are tax exempt if all transactions are with non-residents.
ST. VINCENTINTERNATIONAL TRUSTS ACT 1996Offers exemption from taxation, freedom from forced heirship and asset protection.
SAMOAINTERNATIONAL TRUSTS BILL, 1997To make provision for international trusts.
SEYCHELLESINTERNATIONAL TRUSTS ACT 1994To make provision for international trusts.
RUSSIAEDICT OF THE PRESIDENT OF THE RUSSIAN FEDERATION 24/12/1993 ON TRUST OWNERSHIP (TRUST)
Ireland has had a variety of tax incentives since 1956. Their purpose has always been to encourage business and create employment. When Ireland joined the EC, the Community agreed that the 10% rate of tax on manufacturing should replace the export and Shannon tax relief.
The 10% rate also applies to enterprises operating in the International Financial Services Centre. Some premises are already occupied and building is continuing. Over 160 projects have been approved and 100 are operative, employing some 2000 people. In language, in membership of the EC and EMS, and in company and banking law, Dublin is similar to London; between them is the second busiest air route in Europe. Inflation in the year to February 1991 was at the rate of 2.6%.
The tax privilege of the IFSC is available to “relevant” trading operations – banking, asset finance and leasing (including aircraft leasing), fund management, insurance (including captive insurance), treasury management – until the year 2005. Other features are – no property tax for 10 years, double deduction of rent, 100% writing down on equipment, no withholding tax on interest. There is an approval procedure, which takes 4-8 weeks. Advance corporation tax is payable at 1/18th on dividends, but not on dividends paid to a 75% parent in a treaty country. Ireland has 22 tax treaties.
The “coathanger” structure is used to obtain finance at a lower cost: where the lender, by paying 10% in Ireland, has no further tax to pay in his base country, the borrower and the intermediary can expect to share the lender’s tax advantage in the form of a lower rate of interest and a service charge. Captive finance companies have developed on the model of the captive insurance company. An IFSC company may be established to provide financial management for other companies operating in the Centre. An IFSC company must deal at arm’s length with associates overseas.
The uses of the IFSC are still developing. A German company recently utilised an IFSC company to finance the acquisition of a U.K. company with a substantial reduction in funding cost.
UPDATE AS OF MAY 1998
The IFSC has grown significantly since the last report to the I.T.P.A. There are now over 360+ companies approved and operating, employing over 4,000 people. The Irish double tax treaty network ahs expanded considerably with 30 treaties operable and a further 3 due to come into effect in 1999. Regarding the corporation tax regime, the current 10% incentive rate is due to expire in 2005, but the government has now received the approval of the European Commission to the introduction of a universal rate of 12.5% corporation tax on trading income which will apply to 2025.
The function of an international tax library is to start the practitioner off in the right direction. It can help practitioners to adapt in one jurisdiction a planning technique used in other. Good filing is an essential. “International” in the title can be misleading; Tax Planning International is truly international and not merely an overseas perspective e.g. from the U.S.
As a minimum, the practitioner needs copies of relevant treaties and basic information about cross-border dividend and interest flows. One must be wary of wrong information in publications: a good test is to look up a point one knows about oneself.
“Freebies” are useful. The Price Waterhouse ones are of high quality. So also are many publications of other major accounting firms, but sometimes the information can be out of date. The Price Waterhouse International Tax Review is excellent. Tax Notes is the best US magazine for the practitioner who needs only one U.S. publication. IFA and other institutions publish valuable material. The IFA bibliographies are especially useful; the library in Amsterdam of the Bureau of Fiscal Documentation is the finest tax library.
It is necessary to have some system of checking that everything which should be received has actually been received. Any circulation of material within the office needs very careful control. Publishers are generally helpful in locating material – though not always.
Are publications worth their cost? This needs to be carefully watched. Renewals can be extremely expensive; a new subscription can be cheaper, and publishers can be receptive to complaints and will often do a special deal rather than lose a customer.
The jurisdictions commonly used have the merit that information about them is freely available and circulates rapidly. Where should one incorporate a private company whose foreign income is tax-free? (Public companies, banks, trust companies, mutual funds, shipping companies and other specialised companies have particular requirements and restrictions not considered here.) The basic choice is between the zero-tax haven, the jurisdiction which taxes on a territorial or remittance basis or the country which has an IBC or other exempt companies. Other tax considerations include absence of withholding tax on outgoing interest or dividends, absence of inheritance taxes, a favourable attitude of government, good prospects for continued freedom from tax, guarantees against possible future taxes, or acceptable treatment under controlled foreign corporation rules of any relevant high tax countries.
General factors to consider include political and economic stability, freedom from exchange controls, ability to establish management and control and otherwise conduct substantial business activities, communication, transport, the time zone and distance from the client’s base, banking and professional facilities. Language, legal system, the degree of secrecy, and the existence of treaties containing provisions for exchange of information and mutual legal assistance.
There are various corporate law factors which may be important. A modern corporate law is desirable. So too is rapid incorporation, the costs involved, the kinds of shares permitted and the requirements for directors and accounts. Is there an ultra vires rule? Is it easy to find an acceptable name? Are there optional endings for the company name? May the name be in a foreign language? It is important that the entity will be recognised by other countries and it may turn out to be useful to be able to redomicile the company elsewhere.
A short list of jurisdictions to consider would include the Bahamas, Bermuda, BVI, Cayman, Channel Islands, Gibraltar, Ireland, the Isle of Man, Liberia, Liechtenstein, Luxembourg, Panama, Turks and Caicos and Vanuatu, but there are many other possible places.
The situation is generally unchanged. There are of course many new jurisdictions one might now consider.