1. The position and perception of offshore trusts
As a result of the global move towards tax transparency and the need for governments worldwide to increase their tax base, there has for the last decade or so been continued pressure on offshore trusts, and especially the way in which they are used for tax planning. There are many other reasons why people use trusts, be they onshore or offshore, and these include estate/inheritance planning, providing for beneficiaries who cannot manage their own finances, asset protection, simplifying ownership of large family businesses, charitable causes, and so forth.
These reasons are all legitimate. So are some of the tax planning principles that underpin the set up of many trusts, but it cannot be denied that trusts, and especially offshore trusts, have at times been used for tax evasion and money laundering, and this has been one of the main drivers behind the global clamp down on offshore trusts. It is however unfortunate that it also affects the legitimate users of offshore trusts. Everyone using offshore trusts is now subject to increased disclosure, increased regulation (and therefore costs) and penal tax treatment. On a positive note, because of better regulation it should now be more difficult, if not impossible, for someone to set up a trust in contravention of the tax laws of their country of residence.
2. Offshore trusts in South Africa
Having said that, there are many South Africans who are settlors (referred to as donors in the South African context) or beneficiaries of offshore trusts. The tax and foreign exchange control amnesty in 2003 caused many residents to declare their offshore trusts to SARS and many have kept those trusts given that they still provide protection from an estate duty perspective. Similarly, there are residents who are beneficiaries of offshore trusts set up by non-residents, or who have become entitled to an inheritance from a non-resident which has been transferred to an offshore trust. Of course, they need to pay tax on the income and gains they receive from the trust, but they benefit from the many other advantages a trust offers.
These offshore trusts will in most cases have a corporate trustee and will be administered from the jurisdiction of the trust or some other location where the trustee company has offices. Although most of the well known corporate trustees have skilled and experienced staff dealing with the day to day administration of trusts, there are many pitfalls from an administrative, legal and tax point and view, and some of these may have far reaching consequences for the trust and its beneficiaries.
3. Examples of pitfalls in the administration of offshore trusts
3.1 Sham trusts
One of the requirements for creating a valid trust is that the settlor must have the intention to create a trust, i.e., to transfer the control over the trust assets to the trustee. If the settlor never intended to give away control over the assets, and the trustee goes along with this shamming intention, the trust is not valid and is known as a “sham trust”.
Trustees should take care not to be a mere puppet of the settlor (or of the beneficiaries or a protector for that matter). Requests for distributions should be phrased as requests rather than instructions and the trustee should objectively consider whether making that distribution is in the best interest of the beneficiaries, taking account of all beneficiaries.
When it comes to investment of the trust fund, unless a discretionary investment management mandate has been given to a professional, trustees will of course have regard to the wishes of the settlor or adult beneficiaries, but they must be able to show that they objectively considered the merits of the investment requested and that they monitored the performance thereof. Under no circumstances should the settlor or a beneficiary be in a position to transact on behalf of the trust or have any access to the trust funds. Some jurisdictions have enacted laws to enable settlors to have more powers over the investment of the trust fund but whether such trusts would stand up to scrutiny in a foreign court is not always clear.
If a trust is not set up and managed properly it has a greater chance of being attacked successfully, e.g., by a divorcing spouse, a creditor, or the tax authorities.
3.2 Issues relating to Protectors
Many settlors of offshore trusts appoint a protector to the trust. This is an individual or company, independent of the trustee, who is given certain powers over the trust. The idea is to give comfort to a settlor who is giving away hard earned assets to a trustee he may not know well and who is located in another country. Note however that the protector is not there to provide a means for the settlor to exercise control over the trustee, instead he should ensure that the trustee does its job, i.e., that it administers the trust assets in the best interest of the beneficiaries.
Protector powers are mostly negative – the protector needs to consent to certain trustee actions. Common examples of such actions include the addition or exclusion of a beneficiary, variation of certain clauses in the trust deed, changing the governing law of the trust, shortening the trust period, the making of capital distributions in excess of a given amount, and so on. Many protectors also have the positive power to “hire and fire” the trustee, although this power can also be given to someone else such as the settlor. Care should be taken not to give the protector too many powers as this would hamper the administrative workability of the trust and the protector could even be considered a quasi trustee, with all the consequences that would entail. Having the power to change the trustees coupled with a number of consent powers is not considered problematic.
There are various ways in which to lay down the protector’s powers in the trust deed. The need for written consent, for example, can be mentioned in the relevant clause itself, there could be a separate clause or a schedule to the trust deed listing all the powers, or it could even be contained in a separate document, executed at a date after the execution of the trust deed. Furthermore, provided the trust deed allows this, the powers could be altered over time. For this reason, if a trust administrator does not know the trust documents very well, getting the necessary consent in the right format can easily be overlooked. This would result in the trustee action being invalid. In many cases all parties involved would agree to consent being given after the fact, but if a beneficiary, for example, wanted to attack the relevant trustee decision, it would make their case much easier.
3.3 Change of trustees
If a settlor or the beneficiaries are not happy with the way the trust is being run by the trustee, they would often ask the trustee to retire in favour of another trustee. In some cases this is straightforward but, depending on the law governing the trust, there may be specific requirements that must be fulfilled in order to properly discharge the retiring trustee.
For example, for trusts set up under Cayman law before 11 May 1998, the new trustee must be either a ‘trust corporation’ (basically a licensed Cayman trust company) or two individuals, unless a contrary intention appears in the trust deed. If this requirement is not fulfilled, the retiring trustee will not be properly discharged and will in fact retain its duties and obligations under the trust deed, although in practice a new trustee, whose actions are not valid, will be running the trust.
Similarly, under English law, a trust that owns land needs to have a trust corporation (as defined in English law) or two individuals as new trustee/s in order to discharge the retiring trustee.
Again, it may be possible to rectify the situation, but legal action and costs cannot be excluded.
3.4 Transfer to another trust
Quite often it may be necessary or desirable, for tax or other reasons, to transfer trust assets from an existing trust to another existing trust or to a newly set up trust. Most modern trust deeds allow this type of transfer provided one or more of the beneficiaries of the transferor trust can also benefit under the transferee trust.
Most offshore jurisdictions have a limitation on perpetuities (to prevent assets from being locked up in a trust forever, unlike the position under South African law) and such trusts will therefore have a trust period which will come to an end say 100 years from the date of the set up. However, because of the rule against perpetuities, you cannot transfer assets to a trust with a trust period ending later than the trust period of the transferor trust. Such a transfer would be invalid and therefore would not achieve its purpose.
If the transferee trust is a new trust, its trust period should therefore be defined so that it is shorter than the trust period of the transferor trust. If it is an existing trust, it should be possible to shorten the trust period to fit in with the trust period of the transferor trust, but this power is not always given to the trustee. Careful review of the documents is therefore required.
There are many other examples of pitfalls for the unwary trust administrator. The advice to resident settlors and beneficiaries of offshore trusts would therefore be to ensure that they have advisors with knowledge in this area, or perhaps to appoint a protector (if the trust deed allows this), who should ideally be someone with offshore trust knowledge. A good protector should know the content of the trust deed and have regular contact with the trustee, and this should go a far way in preventing mistakes of the kind mentioned herein.
Elizabeth has a BCom (law) LLB and LLM (all cum laude) and was admitted as an attorney in 2002 after completing articles at Hofmeyr Herbstein (Now Cliffe Dekker Hofmeyr). She then took up an associate position at Baker & Mckenzie in Switzerland and qualified as a solicitor in England and Wales in 2003. In 2004, she moved to Rothschild Trust in Zurich where she acted as Legal Counsel and then Director and Head of Wealth Planning. Elizabeth returned to South Africa and joined Caveat Legal in 2014.