_{Setting up a Trust}

There are many forms of trusts. The essential characteristic is that a person (the settlor) transfers property, or declares to another, or others (the trustees), property which he already holds, is to be managed and controlled for the benefit of someone else (the beneficiary).

This idea is not unique to English law, and to those countries with laws which follow English law on this. It is estimated that approximately half of the independent wealth in the world is held through one form of trust structure or another.

Many jurisdictions have similar arrangements but trusts governed by equity (a body of law originated in England – see below) are the trusts with which we are concerned on this website.

Trusts are recognised as one of the most flexible and versatile vehicles for holding and managing assets. It is not surprising, therefore, that many countries that have not naturally inherited the English tradition of trusts have created a trust law of their own. This is seen particularly in civil law countries that have introduced, by legislation, the concept of a trust. These countries include Liechtenstein, which was a pioneer in 1924 of introducing trusts by statute and followed in many other countries around the world, in particular those interested in becoming investment centres.

The nature of a trust is frequently misunderstood. Misinformed politicians, journalists and civil law lawyers see trusts only as a means of hiding assets. They consider the placing of assets in the hands of a trustee is an act by the settlor of deceit. This is wrong. When a settlor places assets in a trust he ceases (or should cease) to have any interest in them. The benefit passes to the beneficiaries or is held on their behalf: the terms of the trust ie, the instructions of the settlor to the trustees’ dictates when income or capital on other property is handed to the beneficiary. Trustees usually have some discretion in most trusts and the matter is entirely up to them in discretionary trusts. The ill informed consider a beneficiary to be a person of dubious legality. The idea that a beneficiary is hiding assets or having them hidden on his behalf is a misconception. Trusts may be used for illegal purposes but so may companies, partnerships and any other legal structure.

Tax planning and trusts

By transferring assets to another the transferor may cease to be taxable. This is the feature of trusts which has led to most claims of abuse. This has led to trusts being used for tax planning and, in some cases, criminal tax evasion. The classic example is where a settlor in a high tax jurisdiction transfers assets to a trustee in a low tax jurisdiction which then accumulates the tax-free income for the settlor or the beneficiaries under the trust. This simple device has long been countered by anti-tax avoidance legislation. Even King Henry VIII had the same problem evasion and tried to remedy the situation (and failed) by the Statute of Uses 1535 – but we do not want to go into that fascinating saga.

Origin of Trusts

Trusts originate when assets are transferred to another person with instructions that the assets are used to benefit a third party.

Put in the simplest form, assets are transferred to a relation with the instructions that they are to be applied for the benefit of the transferor's children. A trust may even be set up by the owner of assets declaring that henceforth he or she holds them on trust and will hold them for the benefit of another.

The immediate question is how can the use of the assets and the benefit of another be guaranteed? Originally it couldn't; the transfer was the end of the matter and, despite the undertaking by the recipient to use the property to benefit others, advantage was taken of that position. The recipient had been endowed with the legal ownership of that property and those who anticipated receiving the benefit from that property could be in difficulty.

The Lord Chancellor to the Rescue!

How this was overcome marks the development of English law over all other systems.

A disappointed beneficiary could not hope to succeed by appealing to the law courts. He wouldn't get very far.

The legal ownership had been transferred and he had no legal title at all to the assets. Instead he appealed to the Lord Chancellor. In the early days the Lord Chancellor was a cleric and was known as "Keeper of the Kings Conscience". The Lord Chancellor was a powerful person. He had jurisdiction over spiritual matters and matters affecting peoples' conscience. He could not deny the authority of the law in the common law courts, and the rights that they conferred on others in respect of the property transfer. However, by an ingenious step, although whilst not denying the legal ownership, the Lord Chancellor could exercise his jurisdiction by saying to that person that if he did not honour his obligation this would damage his conscience. The Lord Chancellor would therefore feel he should take action to prevent this. He would enforce the beneficial rights of the person who the transfer was intended to benefit.

These beneficial rights become part of the title to the property; English law, therefore, adopted a split concept of ownership. There was the legal ownership by the person holding the assets, who became known as the trustee, and there was the equitable, or beneficial ownership held for the person, who became known as the beneficiary.

This is a simple explanation of a complex historical process but, nevertheless, upon this distinction between the legal and equitable ownership, the modern law of trusts has developed. This split in ownership is unique to the English legal system and is unknown in civil law systems.

Trusts in Civil Law Countries

It is a mistake however, to consider that civil law countries have not evolved vehicles of their own which serve a similar purpose to the English trust. What is more, many civil law countries have consciously adapted the English trust concept and have, by legislation, introduced an English type of trust. These are seen in many offshore centres and in many cases these trusts are very adequate. However, they lack the centuries of litigation and the development of the details that have occurred in English law countries and therefore lack some of the legal certainty of trusts governed by equity.

The International Trust

A modern feature is the development of the English international trust. By this term we mean a trust established by a person (the settlor) and the person holding the property (the trustee) for the benefit of others (the beneficiaries) when at least one of these parties, or the assets, are situated in different jurisdictions. This clearly produces complications.

Different rules may apply to each aspect of the trust formation and administration as well as to the transfer of the assets to the trustees. Part of the complication has been solved by the production of the Hague Convention on the Recognition and Enforcement of Trusts; this aims to resolve many of the difficulties. Unfortunately many countries have not yet joined and ratified the Convention and the Convention doesn't cover everything! It is, however, an influence in how to resolve difficulties.

Motive for setting up a Trust

A further modern development is that the trust is not now established entirely for the benefit of the beneficiaries.

The modern characteristic is that a trust is often set up to achieve an advantage for the settlor. It is, nevertheless, a trust. Although the motives of the settlor may not be to provide for his children or others, but for his own advantage, it is however a trust.

Another modern development is the use of the trust for commercial purposes. An everyday example of commercial trusts is in the mutual funds, where the assets are held by trustees and which are managed by the fund managers for the benefit of the investors. Nevertheless the trust remains a prime instrument in private asset planning.  

Do you really want a trust?

This question must always be asked. Ask also, "what do you want to achieve?" This usually indicates whether a trust is really justified. There may be little difference to the settlor if other means of achieving the aim are adopted. In the case of a trust the settlor parts with the legal and beneficial ownership of the assets but by passing them to trustees he denies the full ownership of the assets to the beneficiaries. As mentioned above, the beneficiaries have the beneficial ownership but not the legal ownership that means there is some severe restriction on the beneficiaries' powers to dispose of or to deal freely with the assets.

Although it is possible to establish conditional or revocable gifts, these are difficult to administer. The better way may be to establish a trust.

Although it is fundamental that the settlor parts with the legal and beneficial ownership of the assets, he is not prevented from influencing how the trust is administered and the income and capital distributed. The prime means of doing this is in the terms of the trust when it is set up. This is normally done either by deed or by will, where the settlor or testator indicates to the trustees how the assets are to be handled.

Where a trust is set up by a living settlor he may still influence how the trustees handle the assets but he must not control them. Excessive influence or interference by the settlor can result in the arrangement being disregarded at law. It is a sham: the apparent transfer of the assets to the trustee will be invalid; the settlor will not have achieved any of his purposes at all.

It is very clear therefore that after the transfer of the assets to the trustee, the trustee is in the driving seat. Under trust law he is responsible for the proper administration of the trust to the beneficiaries.

Important Points

Let us make this perfectly clear: it is the beneficiaries to whom the trustees must report. It is not the settlor.

Get these principles wrong and the whole system falls down. So often people claim that they have set up their trust and that their assets are in trust or that they own a trust. Whatever such a person means by this, it is meaningless in trust law, when taken literally, if there is a valid trust.

Important also, is that a trust is not a separate legal entity as is a company. When we talk about a trust we mean the relationships between the trustees and the beneficiaries. The word 'trust' is used but what it really should say is 'property held in trust'. If a trust were a distinct body then many of the advantages would be impossible although the private foundation comes near in some circumstances.

Some modern uses of trusts

Clearly one of the modern uses of trusts is the traditional use and where there is the transfer of the benefits of assets to a beneficiary but some of the legal attributes of ownership are withheld and given to trustees. This may be done to prevent the beneficiary wasting the assets or until a young person is of an age when it is felt that that person can handle the assets. It may be necessary to do this to secure an education, or the setting up of a person with a home, or where for some reason that person is incapable or unable to properly administer his wealth, in the case of ill health, disability or age.

Again, some modern trusts are set up more for the advantage of the settlor.

These include:

• Tax Planning. Where the settlor and the beneficiaries may be in different jurisdictions with different tax rates and regimes some substantial tax advantages can be (seen to be) possible. The settlor is no longer the legal owner and therefore no longer liable for taxation on the income and capital assets. When it is remembered that a settlor may be a beneficiary under the trust, this offers an apparently easy way of avoiding taxation. However, the tax authorities have seen through this and substantial anti-tax avoidance measures are in force in most countries. Nevertheless, trusts can still be a very useful tax planning vehicle, especially for persons moving from one jurisdiction to another and a trust is set up before tax residence is established in the destination.

• Asset Protection. This is a form of trust beloved, in particular, by American professionals. As the US courts are fond of awarding extravagant damages for professional misdemeanours, professionals, doctors, dentists and lawyers, among others, in order to preserve some of their assets from the reach of the courts, transfer their spare assets to trustees in a different jurisdiction. Again there are some severe laws on how effective this can be and an asset protection trust can now only be set up with great caution and, in any case, long before an opportunity for any claim arises.

• Forced Heirship. This is a system under some jurisdictions whereby a deceased person's assets must be divided according to the law. This may not suit a person who has his own ideas on how to dispose of his assets after death. He simply sets up a trust during his life making his chosen person the beneficiary. The assets are therefore taken out of his estate and hopefully away from the forced heirship provisions.

• An International Trust. This allows asset management to take place away from the settlor's place of residence and where various tax and other investment advantages may occur.

• Trading. If you look at the annual reports of most multi-national companies you will see that they have subsidiaries or operating companies around the world. A number of these are set up in offshore centres, many also involving holding assets such as intellectual property rights in trust and where, for example, a the royalty licensing company is incorporated. Individuals can operate instructions through a combination of an international business company and a trust.

This is all very well but one should not get carried away. An international trust requires reliance         upon, in particular, foreign trustees. As with all trustees, they should therefore be selected with care. There is expense involved both to set up the trust and annually to maintain the arrangement, and a trust should not be entered into lightly or frivolously.

Bleak House; contains was a good example of how a " dynastic" trust went wrong. A dispute amongst the beneficiaries led to bitter litigation in the High Court, which continued from court to court until the trust assets were all consumed in legal fees. Law reform, we hope would prevent this today. But, beware, trust litigation is increasing as trusts set up, say perhaps 20 years ago, are now being attacked by more aggressive beneficiaries who think they should have unrestricted rights to the trust property.

Remember also that trusts are very useful to avoid conspicuous ownership. Trusts are not always for selfish tax planning or asset planning reasons. A trust is a confidential arrangement and in days when high net worth individuals in many countries risk having their assets confiscated, or even being kidnapped, a trust is a commendable way of securing a new home for a substantial part of their assets.

Setting up a trust

Many people say they want to set up a trust. It is interesting to see why they say this; perhaps they have looked at this website and feel that a trust would be the answer to their problem. A trust is best decided upon after a thorough examination of the objectives to be achieved, the nature of the settlor and the amount of the wealth to be managed.

That may well be so, and although a trust does not have to be forever, it is not a short-term arrangement which can be cancelled when the mood changes.

The following suggestions will help before committing yourself to professional advice, but proper advice should be sought from a trust expert before committing your assets to trustees.

• Why do you want to set up a trust? What are your motives? Have you analysed what you want to achieve? And, what assets you wishto direct in a particular way?

• Having determined your motives, analyse the alternatives that may be used. You currently have control over your assets but you may find it is better to employ some contractual arrangement, set up a joint bank account, use hybrid companies, a foundation or perhaps set out your wishes in a will, or even a straightforward gift. More often than not this is a difficult situation and may need professional advice.

• If a trust is the ideal vehicle you then have to decide who will be the trustees. This is a very crucial step. Many professional trustees offer subsidiaries of banks or companies associated with professional firms.

• The next question is where to locate the trust?

Many factors are involved in this: the type of trust, location of the assets, and what you want to achieve.

There is no ideal jurisdiction for any trust. It depends upon location of the assets and the nature of the trust. The frequently asked question, "Where is the best place to set up a trust?" suggests that there should be a golden land ideally suitable for all trusts. This is not so. There are 60 or so jurisdictions administering English-types of trusts as well as some civil law countries where the alternatives are very attractive.

Numerous facts need to be taken into account; the calibre of available trustees, investment opportunities, time zones, exchange control and geographic considerations are just some of the factors involved.

Some large trust companies have branches or subsidiaries in many jurisdictions - this may make the choice easier but nevertheless, impartial advice is recommended.

Remember trusts are versatile, and a legitimate planning vehicle. Despite what the politicians and newspapers may say, trusts are not only used for tax evasion and other anti-social purposes.