Thursday, May 28, 2020

The Trust Mechanism

In legal terms, there is no mechanism quite as flexible and valuable as the trust. Usually an imperative asset in the tax-planner's tool box, the trust mechanism is a legal fiction that is present in the majority of jurisdictions across the world. It is in effective a tripartite relationship between a truster, a trustee and a beneficiary, although these names vary across jurisdictions.

The truster is the party transferring property, which then becomes property of the trust as an entity and hence is administered by the trustee, usually an accountant or investment banker, for the benefit of the beneficiary. Usually, they are used for charitable purposes, or indeed as a way to minimise potential liability and alienate assets to avoid creditor seizure. Unusually, the trust structure is relatively vague, and in many jurisdictions little more than a written deed is required to constitute a trust. In this article we will look at why a trust should have a more formal establishment criteria, and why it is as effective as it is as an invaluable legal instrument.

Trusts can be used, and are used widely in practice, to alienate assets. For example, if you are a wealthy businessmen, it may be wise to place your house in trust for the benefit of your wife, ultimately alienating it from your direct ownership whilst retaining the benefit. Alternatively, it can be a good way to escape the tax liability net on death, given that the deceased can order his wealth to immediately revert to trust for benefit of his offspring rather than subjecting it to tax, or alternatively, he can set up a trust during his lifetime (i.e. inter vivos) to give away certain of his assets before death. As you can see, the trust can be used for any number of purposes, and is particularly useful for the businessmen facing insolvency to retain his assets.

Unfortunately, most systems have relatively weak trust establishment procedures. The trust, as an entity is not considered a person in law as a company is, but rather it is granted quasi-personality, which has made it difficult for courts to rule for or against certain actions. For example, can the trust own property in its own right, or is it merely vested in the trustees for the benefit of the beneficiary? Indeed can a trust be sued, or can a trust sue, or is this again a mere action open to the trustees to pursue? It is suggested that perhaps establishing a more regulatory natured framework would benefit the set up of trusts at an international level to ensure fair play to creditors and to avoid potential cheats in bankruptcy. Additionally, it would certainly add more weight to the legal standing of the trust as an entity, which could be beneficial in litigation and related matters, and would certainly work to harmonise the legal structure of a trust with other bodies corporate.

In donating to a trust, it is vital that one considers the implications of gratuitous alienation in tax liability and bankruptcy. For this reason, it is always best to leave a foreseeable period of 10 years before likely death/bankruptcy to ensure the transaction is not disqualified. Of course, this varies between jurisdictions, and it would most certainly be advisable to consult a local legal specialist before embarking on such conduct. However, as a rule of thumb, it should be safe with a decade between the alienation and the relevant date of asset consideration.

Trust law is a particularly interesting branch of legal study, and it is one which is plagued with riddles and anomalies, despite its evolution over hundreds of years. Funnily enough, however, it is an ongoing successful model, and is used in almost all jurisdictions around the world for charitable public and personal purposes alike in boycotting personal insolvency, raising finances and saving on taxes in a number of business transactions.