Law & Society

The concept of a trust is an arrangement whereby property is transferred from one person (the Settlor) to another person (the Trustee) who holds the property for the benefit of specific people (the Beneficiaries). A Trust Deed sets out the terms and conditions under which the Trustees hold the trust assets. It also outlines the rights of the Beneficiaries. The concept of a trust is an arrangement whereby property is transferred from one person (the Settlor) to another person (the Trustee) who holds the property for the benefit of specific people (the Beneficiaries). A Trust Deed sets out the terms and conditions under which the Trustees hold the trust assets. It also outlines the rights of the Beneficiaries.

A trust is not dissimilar to a will except that assets are transferred to trustees during lifetime rather than assets being transferred to executors on death. The Trust Deed is comparable to the will.
Those unfamiliar with the trust concept may be concerned about transferring ownership of their property to a Trustee. This concern can be alleviated if the distinction between legal and beneficial ownership is properly understood and the trust is governed by sound law enforced in a reputable jurisdiction.

Legal and Beneficial Ownership

For formal legal purposes the Trustee is recognised as the legal owner of the property. The persons who have the benefit of the property are the Beneficiaries. These are important distinctions. The Settlor may retain an interest in the trust – for example, be an actual or potential beneficiary – but this can have tax disadvantages for the Settlor. The Trustee must remain independent and exercise proper control over the trust property. If the person who sets up the trust continues to exercise control over the trust assets the trust may be rendered void.

Accountability of Trustees

The law imposes strict obligations and rules on Trustees. A Trustee may not derive any direct or indirect advantage from a trust, unless expressly permitted by the trust deed. For example, a professional Trustee may charge for services but these charges – and the basis for them – must be fully disclosed and agreed with the Settlor.

Duty of Trustee to Obey Trust Documents

The Trustee is required to obey the directions contained in the trust deed, regarding who is entitled to what and the management of the trust property. Trustees are also subject to very strict rules governing their use of power and discretion.

Fiduciary Relationship of Trustee

The Trustee has serious and onerous obligations and is subject to the following rules:

No private advantage
A Trustee is not permitted to use or deal with trust property for direct or indirect private advantage. If necessary, the court will hold the Trustee personally liable to account for any profits made in breach of this obligation.

Best Interests of Beneficiaries
Trustees must exercise all their powers in the best interests of the beneficiaries of the trust. They must disregard the interests of others – including the Settlor.

Act Prudently
Trustees must act prudently in the management of trust property. If, by failing to exercise proper care, the trust fund suffers loss, the trustee will be liable for breach of trust. Professional Trustees are expected by the courts to exercise a high standard of skill and failure to do this will constitute a breach of trust for which the Trustees will be liable to compensate the beneficiaries.

Advantages of a Trust

Trusts are a powerful tax-planning tool but they also have many other uses that are of equal if not greater importance. A properly drafted and managed trust can be advantageous for any or all of the following:

Asset Protection
Trusts can be one of the most effective ways to protect assets, as assets transferred to a trust no longer form part of the Settlor’s property. This means the assets cannot normally be seized if the Settlor gets into financial difficulties, for example, as a result of bankruptcy or divorce.

The rules of many onshore jurisdictions may, in certain circumstances, order the trust assets to be transferred back to the Settlor. This could arise if a creditor is able to prove that the Settlor transferred assets into trust with the intention of avoiding a current or future liability, or if the liability arose within a statutory period after the transfer into trust.

To overcome this problem many offshore jurisdictions have enacted legislation creating the ‘Asset Protection Trust’. This protects assets transferred into trust as long as the Settlor is solvent at the time of the transfer and does not become insolvent as a result of it. For maximum security it is important to set up a trust in an offshore jurisdiction that has enacted this type of legislation.

Tax Planning
A correctly structured and administered trust may produce substantial savings in income tax, capital gains tax and inheritance tax/estate duty.

Avoiding the Expense and Delays of Probate
In most common law jurisdictions an individual’s estate must go through the probate procedure. This can cause delay, expense, publicity and upheaval. By establishing a trust, probate can be avoided. Death has no effect on the trust property, which will continue to be held and managed in confidence by the Trustee.

Confidentiality
Proving a will is a public procedure and therefore entirely unsuitable for those wishing to keep details of their assets confidential. The only legal alternative form of asset transfer is via a trust. This would generally save estate duty and keep the trust assets confidential.

Avoiding Forced Heirship
Forced heirship is a particular problem in continental Europe and other civil law jurisdictions, as well as in countries of Islamic tradition. A trust can be used to overcome this problem if care is taken to select a jurisdiction for the trust that has an appropriate trust law.

Estate Planning
Many people prefer to make more complex arrangements for the distribution of their assets. These might include providing a source of income for a widow or making provision for the education of children. A trust is probably the most satisfactory and flexible way to make arrangements of this kind.

Protecting the weak
A trust allows a person to provide for those who may be unable to manage their own affairs such as infant children, the aged, or persons suffering from certain illnesses.

Preserving Family Assets
Preserving family assets, or increasing 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 the heirs, but retained as one fund. The fund can then accumulate further with provision for payments to members of the family as necessary, while preserving some assets for later generations.

Continuing a Family Business
A person who has built up a business will often want to ensure that it continues after their death. If the company shares are transferred into a trust prior to death, the unnecessary liquidation of the family business can be prevented.

In a situation where family members have little business experience, the Trustees could be instructed to retain the shares, keep the company running, and provide payment to members of the family from dividend income. The terms of the trust will ensure that the individual’s wishes are observed.

Gaining flexibility
A discretionary trust can provide a structure that is capable of rapid change as circumstances demand.

Jurisdiction

A trust can be set up in many jurisdictions – both offshore and onshore – but it is important that the jurisdiction:

has a strong tradition of enforcing trusts
has an English Common Law system
has an established reputation for trust business
has enacted modern legislation which embraces the newer concepts of trusts – particularly asset protection imposes low or no tax on the trust
Only a small number of jurisdictions are able to offer all the important elements, such as Netherlands Antilles, Cayman Islands, British Virgin Islands, Gibraltar, the Turks & Caicos Islands and the Isle of Man.

Disadvantages and Solutions

Irrevocability
It is not correct that trusts cannot be revoked. Trusts can be made revocable, but this usually has tax, estate duty, asset protection and stamp duty disadvantages. Revocability should be discussed when the terms of the trust are considered.

Loss of Control of Property
There are many people who like the idea of a trust but want to continue to exercise effective control over the trust assets, despite the transfer to the Trustees. If too much control is retained, however, the person who set up the trust may be regarded by law as the owner. This may make the trust invalid. The following are devices that may reassure the Settlor about the concept of a trust and the transfer of assets:

Memorandum of Wishes
It is common for the wishes of the Settlor to be noted in a written memorandum. This outlines how the assets would have been managed had the Settlor retained ownership. The wishes of the Settlor are not binding, but in practice most reputable Trustees would follow them unless a change of circumstances makes it disadvantageous to the beneficiaries to act in that way.

Protector
When setting up a trust it is possible to appoint a protector who has some degree of control over the trust property. We recommend limiting the protector’s powers to vetoing the decisions or actions of the Trustees, rather than having power to force the Trustees to act in a particular way as it is important to avoid the protector being considered a quasi-Trustee and possibly causing tax disadvantages.

It is usual for a trusted friend, relative or professional adviser of the Settlor to be appointed protector. It is also becoming increasingly common to use the services of a professional trust company.

Two Tier Company and Trust Structure
Greater flexibility can sometimes be achieved by having the underlying assets owned by a company whose shares are owned by a trust. The Settlor may act as the director of the company and therefore exercise day-to-day control over the underlying assets with minimal need to refer to the Trustees.

This two-tier structure may have tax and other disadvantages where the director of the company is resident in a high tax country but can be used to good effect in certain situations.

Joint Trustees
A trust could be structured so that there are joint Trustees, with the agreement of both needed in order to take any action. The second trustee could be the Settlor or a corporation controlled by the Settlor. There may be negative tax or other consequences resulting from such a structure if the Settlor is resident in a high tax jurisdiction but this may be a solution worth considering.

Costs
Many people believe that the costs of running a trust are prohibitive. But the level of fees charged by independent trust companies generally makes the advantages of setting up a trust available to those with even relatively modest estates. Non-institutional trust companies offer a more personalised service and also benefit from the fact that they are truly independent.