This report is compiled by Bill Ahern in Asia, Justine Markowitz and Rachel Mainwaring Taylor in Europe, and Steven L Cantor, Giev Justin Askari and Stanley Barg in the US
Tax and succession planning for family business owners is a constantly evolving area, where new developments can have serious consequences. Families in Business highlights the most recent tax changes in relation to trusts around the globe
Wealthy families around the globe have long used trusts administered in Asia as part of their tax and estate planning. The professional trust administration centres in Asia are Hong Kong, Singapore, New Zealand, Labuan, Western Somoa and the Cook Islands, of which Hong Kong and Singapore are the two most important.
Hong Kong abolished estate duty in early 2006. This former duty – a maximum of 15% on assets over $1.53 million (€1 million) – had been on Hong Kong's statute books since 1915 and the maximum rate had, in the past, been as high as 52% of the value of assets passing on death. Although the duty was restricted to Hong Kong situated assets, it contained very complicated anti-avoidance provisions aimed at countering the use of non-Hong Kong entities to house local assets and thus take them outside the tax net.
The abolition has naturally made things much simpler as far as trusts are concerned. For local people, or those from outside wanting to put Hong Kong situated assets into trust, gone is the need to sell rather than gift the assets, to restrict the transferor's powers under the trust deed or to exclude the settlor as a beneficiary of the trust. It means that for foreigners in particular, Hong Kong has become a more attractive place to administer a trust from. It has also just commenced the reform of its trust laws to make them more competitive with other trust administration jurisdictions, such as Singapore and the Channel Islands.
The fact that Hong Kong is not part of the European Savings Directive (ESD) has also increased its attractiveness to families in the EU. It is unlikely that Hong Kong will sign up to the ESD in the foreseeable future as it lacks the taxation and banking mechanisms, not to mention the self-interest, to do so.
Hong Kong has begun to embark on a double tax treaty negotiation process. It now has treaties with Belgium, Thailand and China, which enhance the tax position of Hong Kong resident trusts making investments in these countries. One obstacle Hong Kong is facing in negotiating double tax treaties with OECD countries is the terms of exchange of information. These high tax countries want Hong Kong to agree to collect and share a lot of information that the Hong Kong tax authorities presently do not have.
To comply with these demands, Hong Kong will need to change its laws and there is little political appetite for this. Nevertheless, Hong Kong continues to attract a respectable share of trust business and hopes to increase that share by building on its strengths with the upgrade of its trust laws over the next year or so.
Singapore has done much since 2000 to increase its attractiveness as a place to administer private family trusts. In 2004, it lengthened the permitted duration of trusts to 100 years, clarified the investment powers and duties of trustees, introduced provisions to ensure the validity of trusts in cases where certain limited powers are retained by the settlor, and made it harder for people to challenge Singapore trusts claiming rights under foreign forced heirship laws. It has also made it clear that Singapore-based trusts established by foreign settlors for foreign beneficiaries are tax free on non-Singapore sourced profits and even some locally sourced income.
Although Singapore has a low rate estate duty (5% up to $8.2 million and 10% thereafter) applicable only to Singapore domiciliaries, it is rarely an issue for foreigners as they are only subject to Singapore estate duty on Singapore real estate with an exemption of $6.1 million on residential real estate.
Like Hong Kong, Singapore has so far steadfastly refused EU overtures to sign up to the ESD citing similar reasons to Hong Kong. Unlike Hong Kong, however, Singapore has a large number of double tax treaties. This allows Singapore resident trusts to get reduced withholding taxes on investment flows from Singapore's treaty partners. It also means that the exchange of information provisions in those double tax treaties apply to Singapore-based trustees, although they may not pose a big threat to confidentiality of the affairs of a Singapore-based trust. This is because the relevant exchange of information provisions in Singapore's treaties are in limited form, which, combined with the limited information that the Singapore tax authority has on the foreign income of Singapore-based trusts (because it is exempt), means that they are of limited use to the querulous tax authorities of Singapore's treaty partners.
Singapore also has strict statutory rules on bank and trustee secrecy which are left to the vagaries of the common law in Hong Kong. This has led to criticism of Singapore by the EU, OECD and other supranational bodies intent on brushing aside calls for legitimate confidentiality by equating them with some form of inevitable wrongdoing. It will be interesting to see how Singapore reacts to this continued pressure. Most industry commentators feel Singapore is unlikely to yield much in this area going forward but time will tell.
The supranational bodies continue to pressure Singapore and Hong Kong (and no doubt Labuan, New Zealand, the Cook Islands and Western Somoa) on matters of information exchange and joining the ESD. The domestic laws of these jurisdictions are continually being revised with a view to more easily attributing the income, gains and assets of foreign trusts to beneficiaries in their jurisdiction.
However, given the amount of private wealth being created in this region, it is unlikely that the trust will do anything but prosper and continue to find a willing home for its care and development.
These are interesting times for planning with trusts in Europe. Traditionally a creature of common law and most popular with Anglo-Saxon planners, in the last year or so developments in Continental Europe have potentially made the trust more appealing throughout the continent.
Switzerland's ratification of the Hague Trust Convention on 1 July 2007 makes it an even more popular jurisdiction for succession planning using trusts. The ratification, together with new laws introduced at the same time, means that Swiss courts are now able to recognise trusts as trusts (rather than contracts), apply foreign trust laws when dealing with trust disputes and recognise the decisions of foreign courts in trust-related matters.
Initially there was some uncertainty as to how Switzerland would tax trusts, but guidelines published on 22 August 2007 (Circular 30) make it clear that the mere presence of trustees or a protector in Switzerland will not render the trust fund subject to Swiss tax, and neither will the fact that a trust is administered in Switzerland. Circular 30 also makes it clear that trustees resident in Switzerland should not be taxed on the trust assets.
Care should be taken, however, where the settlor or beneficiaries are Swiss resident. The final version of the guidelines have not been published but Circular 30 is widely understood to be in final form. This improved clarity along with high levels of expertise in wealth management makes Switzerland an increasingly attractive jurisdiction.
Italy was the first civil law country to ratify the Hague Trust Convention back in 1992, and since then trusts have become a popular and useful tool in Italian wealth planning. The tax treatment of trusts, however, was unclear until new legislation came into effect on 1 January 2007. With this new law, Prime Minister Romano Prodi re-introduced gift and succession tax and initially there was concern that this might limit the use of trusts going forward. However, guidelines issued by the Italian tax authorities on 6 August make it clear that this will not be the case. It is now understood that:
- Tax will be charged on transfers into trusts at rates between 4% and 8% depending on the relationship between the settlor and the beneficiaries. There is also an exemption of €1 million ($1.4 million) for each beneficiary (although it is not yet clear how this will be calculated where there is an open class of beneficiaries).
- The rules for residence of trusts are similar to those for companies. Generally, an offshore trust holding exclusively non-Italian assets should not be deemed to be resident in Italy. However, trusts established in countries not on Italy's "white list" will be deemed to be Italian
resident. It is worth noting that while the UK is on the white list, Switzerland, for example, is not.
- Income will only be attributed to beneficiaries who have been identified as the recipient of that income – ie, when a distribution is made rather than on an arising basis (as was initially feared).
But it wasn't just Italy and Switzerland that had a busy summer. In France, the French Supreme Court (Cour de Cassation) decided the case of re Tardieu Maleyssie on 15 May 2007, ruling that the creation of an irrevocable trust in a settlor's lifetime does not necessarily trigger an immediate charge to gift tax, as had previously been thought.
The last 18 months have also seen significant changes in the taxation of trusts in the UK. These began with the Budget on 22 March 2006, when Gordon Brown (then chancellor of the exchequer) announced a complete overhaul of the inheritance tax treatment of trusts.
The new rules, applicable from that date but introduced by the Finance (No 2) Act 2006 later in the year, impose an initial charge of 20% on the creation of all new trusts where the settlor is domiciled or deemed domiciled in the UK or where UK situs assets are being settled.
In addition, under the relevant property regime all trusts (except those where an interest in possession was in existence on Budget day) will be subject to an inheritance tax charge of up to 6% on each 10-year anniversary of the creation of the trust and on distributions between anniversaries. Further changes were announced in the Pre Budget Report on 9 October 2007. While these do not apply exclusively to trusts, they will have an impact on people resident in the UK who rely on offshore structures as part of their wealth and tax planning.
The full impact of these changes is not yet clear, but key issues include:
- Changes to the taxation of UK resident non-domiciled
individuals, including an annual charge of €43,000 payable by those who wish to claim the remittance basis after having been resident in the UK in seven out of the last 10 tax years.
- Severe limitation of opportunities for effectively remitting income tax free, including the abolition of the source-ceasing rules and the closure of a loophole under which it was possible to remit income tax free by claiming the remittance basis one year but not the next.
It remains to be seen exactly what impact all of these developments will have but it is interesting that while England, known as the home of trusts, curbs the use of trusts for tax planning, other jurisdictions in Europe (notably Switzerland and Italy) are reinforcing their role in the development of trusts by making more positive changes.
Tax and succession planning, particularly for international family-owned businesses, has become a significant issue with trust and estate practitioners, especially with the continued use of family offices and private trust companies as structures for centralising the management of family affairs. For these clients, proper tax planning is not simply about minimising taxes, but also about business continuity, preservation of wealth, and the avoidance of a family fight over assets in an estate.
The US Supreme Court is reviewing William L Rudkin Testamentary Trust v Commissioner of Internal Revenue to resolve a split among the federal circuits concerning the deductibility of investment advisory fees paid by a trust. The dispute centres on whether the deduction for advisory fees paid to investors is limited by a 2% threshold pursuant to the Internal Revenue Code (IRC), or whether it is fully deductible as an exception to the general IRC rule. This dispute has been litigated in several circuit courts, and the Sixth Circuit is the only one to agree that these fees are deductible. While a decision is still pending, trustees and tax planners are cautioned to refrain from treating these fees as fully deductible, as claims of this nature may result in litigation with the Internal Revenue Service (IRS).
Elsewhere, the IRS has released a Proposed Treasury Regulation dealing with the inclusion of trusts in a deceased settlor's taxable estate where the settlor retained the use of the trust property. The Regulation examines two Revenue Rulings, and explains that, under certain circumstances, only part of the trust needs to be included in the taxable estate by taking the income stream that the decedent was receiving and then determining what amount of trust principal would have been required to produce that income. If the amount of trust principal needed would be less than the value of the entire trust corpus, only that statutorily defined amount would be included in the decedent's taxable estate.
The IRS has further issued Notice 2007-84, warning against trust arrangements that are designed to help closely-held businesses avoid income and employment taxes through purported welfare benefit funds. The Notice discusses welfare benefit funds that provide post-retirement insurance benefits on a non-discriminatory basis, but in operation, will primarily benefit the key employees of the business. The employer's deduction for contributions to one of these plans is often based on a calculation of a reserve associated with each of the plan participants. The calculation is based on an unreasonable assumption that all of the covered employees will eventually receive post-retirement benefits under the plan, however, where in fact only a few employees will ever receive those benefits. Since the IRS has issued its intention to challenge these purported trust arrangements, the benefits may not be worth the associated risk and cost of litigation.
A recent New York decision has required tax planners to consider not only the children that a settlor has while they are alive, but the ones they may have after they are dead. In Matter of Martin B, a New York surrogate court ruled that two children conceived by the settlor nearly six years after his death through in vitro fertilisation should be included as beneficiaries of the settlor's trusts, and therefore entitled to a share of the settlor's trust.
Looking towards the future, and with a new Democratic majority in Congress and the potential for a Democratic presidency in Washington, it is likely we could see additional changes, particularly for wealthy families. For a number of years we have heard about the potential repeal of the estate tax. Although one would never know it from the press, the estate tax actually affects a surprisingly small number of people. Only estates in excess of $2 million (€1.4 million) are subject to the tax and the exemption will increase to $3.5 million in 2009. Currently, the estate tax is to be eliminated in 2010 and reinstated with a $1 million exemption in 2011. It is very likely that these provisions will be amended, but, at this stage, it is unknown what form these amendments will take.
Please bear in mind, however, that gift tax continues to apply with only a $1 million exemption. There may be little reason to incur a gift tax if it is likely that the amounts in question will escape estate tax at the time of the individual's death, given the exemptions that apply for estate tax purposes.
Several bills have already been introduced into Congress that would substantially revise the tax consequences for those who relinquish US citizenship, or for green card holders who have held their green card in at least eight of the last 15 years. Although many of these provisions vary, they all generally impose an exit tax at the time of the expatriating event. This Draconian legislation could have a substantial adverse impact on individuals desiring to leave the US.
In addition, Congress is currently considering bill entitled the Stop Tax Haven Abuse Act in which so called tax haven jurisdictions are singled out, greatly restricting anyone's ability in the US to do business that involves such jurisdictions.
At this point, it is too early to know what part of this legislation will be enacted, or if provisions not yet introduced will be added to the mix, but it is virtually certain that any trust and estate planning, particularly involving international families, will be subject to increased scrutiny in the coming years.