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Risk management regarding Offshore Trust Planning

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Risk management regarding Offshore Trust Planning

The following is the edited and finalized text of a speech/presentation I made at the 4th Family Investment & Citizenship Planning Asia Retreat 2017 held in Bali, Indonesia in September 2017 and represents my views only.

In today’s world there must be risk management for all offshore planning, not just with regards to trusts. Trusts, however, must be established properly because of the unique risks involved and increasing scrutiny they are facing by tax and regulatory authorities, especially where the beneficiaries and settlors are domiciled in jurisdictions such as across here in Asia.  This is because the concept of a trust, which is an Anglo-Saxon creation, is not fully and properly understood by tax and other governmental bodies.  It is important to ensure that planning is executed in a legal manner so that persons involved may avoid criminal charges of tax evasion.

The starting point for risk management for offshore trust planning is the stage at which the trust is being domiciled or settled. The first step that the settlor should take, along with receiving advice from his legal team and tax advisors, is to ascertain and divulge his/her citizenship, tax residency and domicile and those of the beneficiaries.  The information gleaned from this analysis will determine not only if the trust should be settled but also where.  This is an often overlooked step in the decision-making matrix when it comes to establishing a trust. The settlor must understand how his/her establishing a trust will affect his/her reporting obligations to tax authorities, if any, whether and how distributions and capital accumulations will be taxed and how distributions will affect the beneficiaries to whom they are made.

The next step is to assess the various offshore jurisdictions to ascertain which one is the best fit for the settlor and beneficiaries and the goals the settlor is seeking to achieve.  While jurisdictions are very similar not all fit every settlor and beneficiary.  Some high profile jurisdictions may have a good or bad reputation with different banks, brokerage houses and regulators.  While lesser known jurisdictions may also suffer because said institutions and persons are unfamiliar with them, their jurisprudence, court systems and the legal/trustee skills-sets, in order to engender confidence in potential trust clients.  Further, some jurisdictions may have legal provisions such as settlor reserved powers or modifications to the rule in Hastings-Bass which may or may not be beneficial to certain settlors and beneficiaries under varying circumstances.

The next issue, in my opinion, is to decide whether the settlor wishes to domicile the trust in a jurisdiction where trustees are regulated or where they aren’t. This is key to risk management. It is obvious that a trustee which is licensed and regulated is a better choice than one which is not.  When issues arise, the settlor, beneficiary or any interested party will be able or more able to complain to a regulator who would have some statutory powers to resolve them.  Where a trustee is not regulated, then the only recourse for a concerned or aggrieved interested party is slow, time consuming and expensive litigation.

After the decision is made as to jurisdiction, then comes that of who should be the trustee. However, often this assessment is made even before a decision is taken as to if or whether or not the settlor should proceed with establishing the trust.  There are many factors to consider when choosing a trustee. These include the competence and reputation of the trustee; whether the trustee is a firm or an individual; if the trustee is licensed or regulated; if a firm whether the trustee is a multi-jurisdictional one; the costs associated with the particular trustee; the citizenship and residence of its key personnel who may have control over the trust assets and where the trust assets are located.  Of particular current concern that must be examined when discussing risk management for offshore trust planning, are the cyber-security polices, plans, procedures and capabilities of the trustee to prevent more cyber-leaks. Following the Panama Papers[1] and the recent US Court decision in Sergeeva,[2] the choice of trustee is crucial and should not be overlooked.  I have discussed the Panama Papers and the Sergeeva decision in articles which links are set out below and I commend them to the reader for further reading and analysis.

The next step, although this may come before the selection of trustee, but should be done in consultation with said trustee to some extent, is the drafting of the trust deed.  Usually the settlor and his/her lawyers and advisors are involved in this process as well.  The deed must be drafted carefully in line first and foremost with the laws of the jurisdiction under which the trust will be governed, and goals, objectives and circumstances of the settlor and the beneficiaries.  In my opinion, specific clauses that reserve too many powers to the settlor should be avoided since they may lead to the trust, if challenged, being determined by a court to be a sham or the settlor being unable to say truthfully that the trust assets aren’t his if a tax authority challenges the trust or his/her settlement of it.

Both the trust deed and documented intentions of the settlor and trustee must be such that the trust operates in a way where legal ownership and control vest in the trustee and the trustee exercises independent control and discretion in accordance with the deed and the governing law. This will avoid accusations of the trust being a sham.

There are a few specific issues related to risk management that I will now turn to.  The first are the reporting obligations of the settlor, beneficiaries and trustee to regulatory and tax authorities.  Depending on citizenship, tax residence and domicile, settlors, beneficiaries and others are required to report their associations with an offshore trust and make the necessary filings or tax payments.  Failure to do so may open one to charges of tax evasion and criminal penalty.  Thus, even where the trustee is honest and won’t run away with the money or dissipate trust assets, settlors and beneficiaries must be careful that they themselves don’t run afoul of the law.  One must always be aware that tax evasion in many offshore jurisdictions is a predicate offense to a charge of money laundering which in and of itself is another offense with separate criminal penalty.

The next issue to consider in mitigating risk with regards to an offshore trust concerns the need to balance control to ensure that the trustee is not doing anything wrong to damage the trust property with trust in the trustee.  This is a very hard balance to strike even for persons in jurisdictions where trust law is clear, familiar and has been developed over centuries, thus the practice of reserving powers to the settlor in deeds. It is even harder here in Asia where trusts are only now being understood widely it seems, by high net worth individuals.  As stated earlier, reserving powers, in my opinion, is not the best way for a settlor to keep the trustee in check because of the risks involved.

A better way is to empower settlors and or beneficiaries or a protector via the trust deed where the jurisdictional legislation does not provide for it, to have access to certain information and approve certain actions of the trustee especially where the actions involve dissipating major trust assets, within reason of course.  After all, if a beneficiary or settlor under the deed has too much power, it raises the question of whether or not the beneficiaries and settlors are themselves trustees. It is always wise, as a risk management or mitigation strategy, to choose a jurisdiction where the law grants powers to these functionaries even if the trust deed does not grant them.

The best way to manage risk when setting up an offshore trust however, besides not establishing it obviously, is to form a licensed trust company to become the trustee of the trust that the settlor establishes.  Such an entity would be best regulated and the settlor and or beneficiaries could be the shareholders and directors.  Once all the parties comply with their tax reporting and other obligations, there are no issues with regards to the conduct of the trustees since they would fulfill this role.  As a regulated entity, they would have access to the regulator to resolve disputes and thus could avoid court.  They would of course still have access to the court if they so desire.

The final issue I will raise has to do with the Common Reporting Standards (CRS) on offshore trusts. Based on my understanding of CRS and the implementing legislation that I have looked at, albeit in a very cursory manner, mainly from Anguilla which is where I am from, while a registered agent, based on the nature of its business, has no reporting obligations, a trustee of an offshore trust qualifies as a FFI (foreign financial institution) and has to report details of all underlying trusts for which it acts as trustee. The same would apply to a private trust company.

Thus, if privacy is an issue, the settlement of a trust in today’s world must be considered carefully.  Whereas before, there may have been no reporting obligations based on the settlor’s and beneficiaries’ particular circumstances, now under CRS, with the establishment of a trust, a settlor and others may have them or reports on their financial data may be reportable and thus reported. Settlors or rather potential settlors may wish to consider this before they proceed or choose to establish a simple offshore company or a private foundation.  Neither of these entities causes the registered agent, subject to what I said above, to report under CRS. However, with trusts the situation is different.

I commend these thoughts to the reader for due consideration.






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