By Paul James
Global Head of Citi Trust
November 4, 2015
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In this article, Paul James discusses why, in an era of increasing financial transparency, estate planning using discretionary trusts to hold investments is likely to become even more appealing.
Private-bank clients traditionally have established a trust for estate-planning purposes assuming that the trust will provide a confidential and a tax-efficient way to hold their investments.
The recent global trend towards tax transparency through the automatic exchange of financial account information between governments continues to gather pace. Clients would be well-advised to review their trust structures in light of these developments to ensure that they fully understand the impact on their personal situation.
Most people are now aware of the scale and reach of the US Foreign Account Tax Compliance Act (FATCA) legislation. FATCA was designed to ensure that financial institutions worldwide report certain information about their dealings with US taxpayers. FATCA has acted as a catalyst for other governments to pursue an agenda of tax transparency, with its reporting requirements serving as a blueprint.
The UK entered into a series of inter-governmental agreements with its Crown Dependencies and Overseas Territories to exchange information about financial accounts that was closely modeled on FATCA. The Organisation for Economic Co-operation and Development (OECD) and the G20 have developed a global Common Reporting Standard (CRS) which is designed to introduce automatic exchange of financial account information. The CRS is being adopted by governments around the world and will start to be implemented from 1st January 2016.
A major impact of these measures is that trusts are likely to be treated as “look-through” by CRS with a view to identifying the beneficial owner or controlling person. This could be the original settlor or a third party who would be treated as “account holders” and reportable persons.
What does the new era of exchange of information and greater transparency mean for clients? The simple answer, of course, is that all individual clients’ circumstances will differ and the need for independent professional advice becomes more imperative. Viewed from a general regional perspective, however, we see the following developing trends.
Countries such as Mexico and Brazil have evolved over time in their treatment of offshore trusts, leading to a wide variety of trust estate-planning vehicles being used in the region. We believe that more clients will be advised by their attorneys to simplify their existing structures and establish discretionary trusts for tax-planning and confidentiality purposes, driven in part by the CRS and the uncertain political situation in some countries in this region. With a discretionary trust, most key powers – such as the power to manage trust investments and make distributions – are held by the trustee, notwithstanding that these can only be exercised in favor of trust beneficiaries, who normally include the settlor who funds the trust.
Much wealth in jurisdictions like Hong Kong, Singapore, Indonesia, Malaysia and China still remains in the hands of the first-generation wealth creator, and the demand for estate-planning services is rapidly developing as this generation prepares to hand over to the next. Estate planning in the region is further complicated by the marked propensity for family members to live and invest overseas. Combined with still-generally permissive tax legislation, we believe that the trend toward increasing use of discretionary trusts will to some extent be driven by the desire to simplify structures for CRS reporting purposes.
Europe, the Middle East and Africa
Jurisdictions such as the UK have passed a series of tax-avoidance measures targeting offshore trusts in recent years. The attraction of discretionary trusts from a tax-planning perspective is well-established in some jurisdictions and is unlikely to change or be significantly impacted by CRS. Clients from the Middle East and Africa are likely to be least impacted by these global changes, as the general lack of punitive tax regimes allows clients to flexibly organize their affairs. However, the uncertain political situation in some jurisdictions will likely mean that CRS will raise confidentiality concerns for some clients.
The connecting factor for clients in all regions is the increasing tendency for family members to live overseas, making the practical distinction between “offshore” and “onshore tax regimes” increasingly blurred and less relevant. For example, a UAE-based family not impacted by the trend towards global tax transparency today, may be so tomorrow if a family member moves to a relevant jurisdiction such as the US or the UK.
We believe that global tax transparency in the form of exchange of financial account information between governments is here to stay. This does not mean that information will be available on a free-for-all basis to the public – private estate-planning vehicles like trusts will likely remain private. Careful planning, possibly through using discretionary trusts, can help to avoid unnecessary reporting. Under these circumstances, we are of the view that advisors in the future will recommend that clients establish discretionary trusts as one of the most tax-efficient means of holding investments.