International business arrangements help many stakeholders to achieve a number of goals: to ensure the confidentiality of assets, to protect them from the claims of creditors, and at the same time retain control over them, to optimize the tax burden. The creation of an international trust is often chosen as a tool to help achieve these results. It can also be used to resolve a number of issues with property inheritance.
However, many people believe that if the trust is not considered a legal entity, it is 100% exempt from paying taxes. It should be remembered that it is not always possible to achieve optimization of the tax burden with the help of this tool, because everything depends on the country of creation of the legal institution. In this article, we will discuss whether trusts are taxable, what obligations arise with their creation, and in which country is it best to create a trust.
What is a trust?
A trust is a fiduciary legal relationship under which a trustee holds and manages property for the benefit of beneficiaries. The terms of ownership of the property are prescribed in trust instruments (trust instrument/trust deed/trust agreement). The success of this structure will depend on what conditions and restrictions will be prescribed in the trust agreement.
At the same time, the trustee of the trust usually isolates his own assets from the trust assets and clearly specifies what part of these assets will belong to him as payment for his management activities.
What is a trust for?
Usually, the creation of a trust has one key purpose – to preserve and/or manage the assets of the settlers for their benefit or for the benefit of their family. Also, foreign trusts, in which taxes do not need to be paid in most cases, are used to optimize the tax burden.
Some other reasons for creating trusts are:
- To protect assets from creditors and other encroachments. If you choose the right jurisdictions to implement a trust, you can safely protect your assets. For example, Nevis, Belize, and the Cook Islands do not recognize foreign court judgments.
- Ensuring confidentiality, and anonymity. In a number of offshore jurisdictions information about beneficiaries is not transferred to the register.
- Possibility to accumulate capital through a trust. It allows the structure can own a commercial enterprise, open bank accounts, and make investments.
- Succession planning. It becomes possible to create a multi-level inheritance scheme, which is not realizable within the framework of an ordinary will.
Trusts are also attractive due to their versatility, as any type of property can be transferred to trust management: cash, stocks, bonds, real estate, intellectual property, etc.
Does the trust have to pay taxes?
It is worth noting at once that the transfer of assets to a trust does not guarantee that the tax liability on the property is leveled. The need to pay taxes on these assets may be slightly suspended or the amount of these tax deductions may be reduced. However absolute exemption from taxation should not be expected.
What determines what the tax consequence of a trust will be? First of all, the amount of tax will depend on the legislative norms and tax code of the country where the trust was created. Also, a significant role in this issue is played by the tax residency of which country is the founder of the trust or the settlor.
In some countries, the tax residency of the trustee is also taken into account. Sometimes the trustee may also be tax liable for the ownership, custody, accumulation, and distribution of assets.
Jurisdictions that apply Anglo-Saxon law prescribe the tax consequences for trusts in their laws. But there are countries that do not use the definition of “trusts” in their laws at all.
It is believed that the optimal jurisdictions for the creation of a trust are offshore zones. But there is no universal country that would suit absolutely everyone who is thinking about establishing trust. Each case must be studied on an individual basis.
How do trusts pay taxes?
As reported above, each country has different laws regarding the taxation of trusts. However, there are still a few common points that are most often found in trust legislation:
- If neither the trustee nor the beneficiary are tax residents of the country of the structure’s foundation, the trust is not required to pay taxes.
- If a certain level of income has accumulated in the trust account but has not yet been distributed to the trust beneficiaries at the end of the tax period, the trustee must pay income tax in some cases.
- The beneficiary is required to pay taxes as either an individual or a legal entity beneficiary of the distributed income.
The requirements may vary depending on the types of trust relationships, taking into account the tax residency status of the participants and their domicile. Of great importance is the country in which the trust bank account is held. If the amount of income in the foreign account exceeds the allowable limit, tax liabilities may also arise.
Offshore trusts and taxation
The popularity of offshore jurisdictions among trust founders is due to zero inheritance and capital gains taxes, a high level of privacy, and asset protection. If the property of a certain person is claimed by creditors in the country of his tax residency, then by creating a trust, for example, in Nevis, he will be able to organize optimal protection of his property. Nevis does not recognize court decisions of other jurisdictions and requires the claimant to file a lawsuit in the local court. This process involves certain difficulties and requires significant financial investments. In addition, even if the court decision is positive, it is not certain that it will be accepted for execution by the local authorities.
Experts recommend opening trusts in Nevis, Belize, or the Cook Islands. Not only the assets of the settlor but also his confidentiality are most reliably protected here.
However, it should not be forgotten that a zero tax rate will apply if the trustee and the settlor are not residents of the country of the foundation of the trust, and their income will be generated from foreign sources. Similar rules apply in Cyprus. Tax liabilities arise provided that the beneficiary and/or settlor of the trust is a resident of the Republic of Cyprus.
As far as European trusts are concerned, only founders and beneficiaries with tax residency in another country can also receive tax benefits. The income and tax revenues of their own residents are carefully controlled by these countries.
So, trusts of any type are not always required to pay taxes. In some cases, structures are exempt from taxation if a number of conditions are met. But with the help of this international instrument, you can not only optimize taxes but also protect your assets from the encroachment of third parties, accumulate capital, keep confidential information about the beneficiaries, and much more.
The main thing is to choose the right jurisdiction of the institution, comparing the legislative norms with your current tasks. In any case, it is better to take the help of professionals who will advise the best way out of the situation, taking into account the wishes of the client. Sometimes a trust is not the best way out, and it is worth using alternative options in the form of a foundation, registration of an offshore company, partnership or change of the country of tax residency.