Changes to the structure and diversity of trusts offered by offshore financial services centres aim to close loopholes and protect the client. Bob Reynolds looks at how this has prompted other jurisdictions to tighten policy, improve services and boost uptake
The UK government called for more talks on the revision of its policy on trusts law in March this year. Part of its objective was to bring business back from international financial centres such as Jersey, Cayman and the British Virgin Islands, where a great deal of family trust money resides. The tax authorities in Britain also want to improve enforcement and limit the flow of funds away from the UK.
In island jurisdictions, especially those close to the British Isles and in the Caribbean, the last two years have seen a dramatic change in the structure, effectiveness and diversity of trust products. A key reason for this change has been regulatory. International agencies are keen to improve transparency, hinder criminal movement and deposit of capital.
Rather like with the operation of corporate tax regimes, jurisdictions have taken such opportunities to modernise their trust product portfolios. Trusts have always worked well as a key stream for several leading centres. But for some they were hardly the most exciting area of business. The need to find new models has given product designers a new impetus.
Another factor has been the promise and eventual implementation of avoidance legislation in places such as the UK, Canada and the USA. Britain's reform of trust rules was announced by the treasury. In his 2004 Budget, chancellor Gordon Brown announced that the tax rate applicable to trusts would be raised to 40% to combat tax avoidance. He also said that there would be new measures to prevent this change increasing burdens on trusts that have vulnerable beneficiaries.
Two measures were announced – a new tax regime for certain trusts with vulnerable beneficiaries, and a standard rate band of £500 for all trusts paying tax at the rate applicable to trusts. Several other proposals included a set of common definitions and tests for trusts, and the streaming of income through trusts. These measures simplify, the treasury says, the taxation of trusts and were widely supported during consultation in 2004. However, during subsequent consultation, the finance industry raised concerns about some of the detailed aspects of the proposals. The regime for trusts with vulnerable beneficiaries is backdated to 6 April 2004; the standard rate band came into effect from 6 April 2005; and other measures are likely to start from 6 April 2006.
Four major proposals
The income of discretionary trusts and accumulation and maintenance trusts (except a settler-interested trust, one from which the UK resident settler or the settler's spouse may benefit) is to be taxed at 32.5% if dividends and otherwise at 40%, unless distributed by 31 December following the tax year in which it arises; when it is taxed as the recipients' income.
Income distributed to beneficiaries by 31 December 2005 following the tax year (termed 'streamed income') will be taxed within the trust at 10%, 20% or 22% as appropriate, such tax being treated as paid by the beneficiary. But trusts for the most vulnerable may elect to have their income and gains taxed as though they arise to the beneficiary. Those affected are trusts for a person who is disabled or in receipt of an attendance allowance or disability living allowance and those for an infant established either under the child's parent's will or intestacy or under an approved pension scheme.
Capital gains of a trust for a UK resident settlor's infant child are to be taxed to the parent. Currently this only applies to income paid to or for the benefit of the child. Capital gains arising in a deceased person's estate in administration in the year of death and next two tax years are to be charged at 20% (rather than the present 40%), up to a prescribed figure yet to be announced.
The test to determine a trust's residence for capital gains tax is to become the same as for income tax. Many trusts now not resident for capital gains tax but resident for income tax may become resident for capital gains tax. Existing trusts affected are to have a year's grace in which to decide which way to jump.
The principal victory for professionals will be the streamlining of the trusts law. Users of trusts and professionals who administer them may welcome this development. But UK trusts remain a long way behind those innovative new vehicles launched by OFCs competing for market share in a highly vibrant market.
Jersey's wholesale reform of trusts is a case in point. Voisin & Co, a Jersey law firm, which specialises in trusts, comments: "The economic development department of the States of Jersey has published two consultation papers: the first proposes significant amendments and enhancements to the island's trusts law, the second proposes the introduction of a law that will allow the creation of foundations under Jersey law."
The paper on trusts aims at five main amendments, invites comments on a further possible change and proposes some minor amendments to the existing law. These include changing forced heirship rules and the guidance regarding the investment advice given by settlors and beneficiaries to the trustees. The paper proposes that article 25 of the trusts law should be amended in line with recommendations made by the Jersey Law Commission. This means that the terms of a trust may argue that beneficiaries do not have a right to request information.
In the last few months, Jersey has been the subject of some attention over its plan to introduce foundations as part of its plan to revise trust law. Unlike a trust, a foundation is a distinct legal entity with its own separate legal personality: it is able to hold assets, contract with third parties and sue or be sued in its own name. It is, in that respect, similar to a company. However, unlike a company, it has no shareholders but instead has beneficiaries who have a right to receive distributions from the foundation – in that respect, it is like a trust. In other words, a foundation has some features of a company and some features of a trust.
The paper proposes that a Jersey foundation will be governed by its constitution: a combination of the Foundations Law, its charter and (if adopted) a set of rules. The Jersey financial services sector is positive about foundations. Voisin & Co says: "Foundations will offer clients a good alternative to trusts and the introduction of the proposed Foundations Law will be of benefit to Jersey's financial services industry." Jersey is not the only island jurisdiction to reform its trusts arrangements. Last year, in a bid to emerge as a key player in the trusts market, the British Virgin Islands announced three new laws: Virgin Islands Special Trusts Act, 2003; Trustee (Amendment) Act, 2003 and Property (Miscellaneous Provisions) Act, 2003.
At the core of the initiative was the launch of the VISTA trust, a direct competitor for the hugely popular STAR trust in the Cayman Islands. Christopher McKenzie, of Harneys, a BVI-based law firm, which helped the government to draft the new laws says: "While the trust has always been regarded as one of the best succession vehicles, the use of the trust to cater for the succession of shares in companies has been impeded by a rule of English trust law, which is designed to help preserve the value of trust investments. This rule, which is known as the 'prudent man of business rule', has traditionally made the trust an unattractive vehicle to hold assets which settlors intend trustees to retain. Another aspect of the rule requires trustees to monitor and intervene in the affairs of underlying companies; this creates difficulties both from the settlor's standpoint and from that of the trustees."
The Virgin Islands Special Trusts Act enables VISTA trusts to be created, which circumvent these difficulties. To make BVI trusts more attractive commercially, a number of new sections, which relate to dealings between trustees and third parties have been added to the Trustee Act. The Act repeals section 83 of the Trustee Act and replaces it with a new set of conflict of rules relating to trusts. The new section contains robust provisions protecting BVI trusts (and dispositions to their trustees) against forced heirship claims. These provisions also prevent foreign judgments based on such forced heirship claims from being enforced in the territory.
The BVI changes are mainly in response to the success of the Cayman islands. Wendy Stenning, associate at Walkers, says: "Trust law in the Cayman Islands is governed primarily by the Trusts Law (2001 Revision). The act consolidated various earlier pieces of trust legislation, which had the effect of simplifying and adding to the user-friendliness of trust law. In addition to the more commonly known types of common law trusts, the trusts law permits the establishment of certain more specialised types of trusts, including STAR trusts and exempted trusts."
A STAR trust must have at least one trustee that is a trust corporation licensed in the islands. STAR trusts are not subject to the rule against perpetuities. Beneficiaries of a STAR trust do not have standing to enforce the trust, nor an enforceable right against a trustee or to the trust property. Those rights are given to an enforcer as provided for under the STAR Law. The enforcer is defined under the STAR law as the person who has standing to enforce the STAR trust and an enforcer is appointed in accordance with the provisions of the trust deed.