The use of offshore trusts, usually in association with offshore asset holding companies, has become more and more common with increasing personal wealth around the world. The purpose of this paper is to review the use of offshore trusts and to highlight the main reasons for using them, some of the pitfalls to be avoided and some of the dangers that lie ahead.

A. OFFSHORE TRUSTS

There are many reasons for using an offshore trust. For most people, the reason which springs instantly to mind is tax planning of one sort or another. While it is true that the origins of the trust lie in the avoidance of feudal dues and therefore, from the earliest days, were concerned with tax mitigation, there are many other, possibly stronger, reasons for using trusts. What follows next is a discussion of the main reasons for using trusts.

Advantages

Prudent Asset Planning

Most wealthy people prefer to decide for themselves how their assets are to pass on death. For example, a wealthy individual will normally wish to provide for a source of income for his spouse, for the education of his children and perhaps also safeguards for any children or other relatives who suffer from disabilities. Such a person will probably wish to make gifts not only to relatives but also to charities and for other public purposes. Arrangements of this kind are best made before death even though they are intended to continue to have effect after death. While a will can achieve some of these objectives, a trust involving the transfer of ownership of assets to trustees with defined objectives as to how and for whose benefit the assets are to be held and administered provides a confidential and flexible basis for asset planning.

There may also be special problems for certain individuals governed by laws which dictate how assets are to pass to relatives at death. This is usually referred to as “forced heirship”. Forced heirship occurs under Sharia law in Moslem countries and also in civil law countries mainly in continental Europe where the concept of a trust is not always recognised. Forced heirship also occurs in Japan.

A trust can be a useful way of overcoming forced heirship rules although, as recent litigation in the Cayman Islands (Lemos v. Coutts Co. (Cayman) Ltd. unreported on the main issue but see (1992-93) CILR 5) has shown, reliance on the provisions of local trust laws which provide that forced heirship rights are not to invalidate a trust, may be of limited or no effect insofar as assets are in the forced heirship jurisdiction of the settlor or in a jurisdiction which is sympathetic to the forced heirship jurisdiction of the settlor. It should also be remembered that many jurisdictions which are not ordinarily regarded as having forced heirship laws nevertheless have legislation under which dependents can claim on the estate of a deceased person. This is the position in, for example, the United Kingdom and Hong Kong.

Providing for Continuity after Death

The death of a wealthy individual, can, and very often does, cause major disruption. In the absence of a trust, it will be necessary to obtain probate of any will, or if there are assets in more than one jurisdiction several wills, or in the case of intestacy a grant, or grants, of letters of administration. This is a bureaucratic process which normally involves delay, expense and publicity. Where an individual owns assets in several jurisdictions any will has to be proved for probate purposes in each jurisdiction. Alternatively, the individual may have left separate wills dealing with assets in each jurisdiction in which case probate in each jurisdiction will be necessary.

The problems of obtaining a grant, or several grants, of either probate or letters of administration can be overcome by the use of a trust. If properly drafted, the trust can provide for the enjoyment of income and other assets during lifetime and then the passing on of the enjoyment of the assets to other members of the family following the death of the settlor. The trust can therefore achieve continuity without the public process of obtaining a grant and also without the delay, bureaucracy and expense which so often occurs following death.

Care is, however, essential when setting up a trust designed to circumvent the need for a grant of probate. The risk is that where a trust allows the settlor to retain effective control until death after which the trustees are intended to administer the assets, the trust will be construed as an attempt to provide for a will which, if not executed according to the formalities required for a will, will be invalid (Re Pfrimmer’s Estate [1936] 2 DLR 460).

This is a dangerous trap for many so-called trusts under which the settlor retains effective control. Apart from being an invalid will such a trust might also be set aside as a sham as in Rahman v. Chase Bank (C.I.) Trust Company Ltd (1991) JLR 103 or the settlor might be treated as still the equitable owner of the trust assets (see Grupo Torras S.A. v. Sheikh Fahad ([1995] 1 Lloyd’s Rep.374 and [1996] 1 Lloyd’s Rep.7, C.A., High Court of Bahamas No. 72 of 1994-1/9/95) and Private Trust Company v Grupo Torras S.A. (1997/1998) 1 OFLR 443)). The trust assets would then fall into the estate of the “settlor” and the trustees would be acting unlawfully if they administered the assets without the authority of a grant of probate or letters of administration.

Tax Planning

Trusts are often a useful way of mitigating income, capital gains and inheritance taxes. In some jurisdictions, however, such as the US and the UK, the scope for avoidance of most taxes through the use of offshore trusts is now severely limited for persons domiciled in those jurisdictions. Moreover, as governments switch the emphasis of their tax systems from direct to indirect taxation, trusts and other forms of direct taxation planning become less effective. The trend towards the taxation of expenditure through sales and value added taxes will make the use of offshore jurisdictions less and less relevant for those who do not actually live in those jurisdictions. It should be remembered that in the eighteenth century, when taxes were levied on goods and services and not directly on income or capital gains, there were no offshore jurisdictions with low taxes. The effect of modern comprehensive valued added and sales taxes in the context of private wealth planning does not yet seem to have been appreciated by tax advisers or tax authorities conditioned to think only in terms of direct taxation.

Providing for Minors and Those with Disabilities

Trusts are frequently used to protect members of the family who are below the age of majority, who suffer from mental or other disabilities or who are thought to be irresponsible and not to be relied upon to look after assets given to them outright. Again, a trust can provide a useful way of providing for the needs of such individuals.

It should be added that where a person suffering from a disability such as mental illness is of full age it may be necessary to ensure that the person receives independent legal advice where a proposed trust affects property in which the individual already has a vested interest. This will be important where, for example, an individual suffering from a mental illness is to be persuaded by other relatives to settle his own property on protected trust for himself for life with a remainder to any spouse or children.

Protection from Potential Creditors

In recent years, offshore trusts have been used quite commonly in an attempt to protect an individual from the claims of future creditors. This has been, to a large extent, a development peculiar to the United States because of the huge awards of damages sometimes handed down by juries in civil cases. While there has been some interest in the use of trusts to provide protection from future creditors in other jurisdictions, asset protection trusts designed to frustrate creditors remain to a large extent a development driven by widespread and excessive litigation in the United States. A few jurisdictions, such as the Cook Islands, have gone out of their way to provide for legislation (described as “ineptly drafted” by the Cook Islands Chief Justice in 515 South Orange Grove Owners Association v. Orange Grove Partners and Others (CA 1/95 6/11/95)) which will facilitate the protection of private assets of US citizens in particular, from creditors. Unfortunately, it sometimes appears that there is no clear line drawn between establishing a trust to provide protection against possible, but as yet unidentified, claims and the use of trusts in an attempt to defraud existing creditors or creditors whose claims can reasonably be anticipated. It is becoming clear that asset protection trusts of this kind are not popular with judges, even in the Cook Islands. In the Orange Grove case the poor drafting of the two year limitation period enabled the Cook Islands Court of Appeal to uphold a Mareva injunction in favour of the creditors because the Court was able to commence the two year period from the date of the California judgment for the creditors rather than the date when the cause of action arose. Further proceedings in the South Orange Grove Case (No.2) (1997/98) 1 OFLR 3 were also successful in establishing the ineffectiveness of another asset protection trust (debtor protector trust?) in issue.

Those jurisdictions which have promoted trust legislation specifically designed to protect assets from creditors have attracted widespread criticism and in practice it may well be that such trusts will often be disregarded by courts in other jurisdictions at the behest of creditors. Indeed where, as in the Cook Islands and a few Caribbean jurisdictions, legislation permits the settlor to retain control over the trust assets, it is doubtful whether a trust, as generally understood, will exist and possible that a nomineeship, bailment of chattels or an agency will have been created. If this is so, and the trust assets are not physically situated in, say, the Cook Islands, the trust could well be disregarded or characterised as creating a different legal relationship by a court in another jurisdiction. A different approach was indicated in the Grupo Torras S.A. v. Sheikh Fahad litigation where the English courts ( [1995] 1 Lloyd’s Rep. 374 and [1996] 1 Lloyd’s Rep. 7, C.A.), the Bahamian High Court (1994 No.72, 1/9/95) and the Bahamas Court of Appeal (Private Trust Company v Grupo Torras SA (1997/1998) 1 FLR 443) indicated that it would be possible to bypass arguments based on limitation of actions or the validity of a trust and pierce the veil of the trust where justiace requires. This might be the case where the settlor or a beneficiary was in effective control. While this decision has been criticised as not reflecting the true facts, the principle that has emerged is one of general application.

What, therefore, is likely to matter most in practice is the location of the assets rather than the location of the trust and the particular law governing the so-called trust. This is illustrated by Duttle v. Bandler & Kass (1992 U.S. Dist. 23/6/92) where the U.S. District Court for the Southern District of New York decided that it had jurisdiction over a purported Liechtenstein trustee holding U.S. assets, despite the fact that the trustee refused to appear before the New York District Court. This was because, said the judge, it would be inequitable for a fraudulent settlor to keep assets from the jurisdiction of the U.S. courts by selecting a foreign trustee who would not submit to the jurisdiction. In two other recent cases in the U.S., trusts have been set aside as the alter ego of the settlor (see Deryll Wayne Pack v United States and United States v. Reinhard P. Muller). The alter ego argument was also applied in the Bahamian case involving Sheikh Fahad.

If the assets are not in the jurisdiction where the creditor brings proceedings but the debtor is physically present, the court might threaten to imprison the debtor for contempt of court if the assets are not repatriated by the trustee (see Re Larry Portnoy 201 Banker 685 1996). Thus the debtor settlor might have no alternative but to direct the asset protection trustees to return the assets. In the Anderson case (see Trusts and Trustees Vol 4 Sept 1998) Mr. And Mrs. Anderson were jailed for contempt following failure to repatriate trust assets.

The choice of a jurisdiction for an asset protection trust is no longer an easy one and before making a decision it should be remembered that trusts have always been concerned with protecting assets. It is only in the last ten years or so that the term “asset protection trust” has become a cliché meaning a trust set up with actual or potential creditors in mind. Such trusts do not enjoy universal support, indeed many trust companies and trust jurisdictions have deliberately decided to have nothing to do with them. An individual who is concerned about possible creditors' claims is probably most unwise to choose a jurisdiction which advertises itself as having asset protection trust legislation. Such a choice is likely to raise a presumption that the trust was an attempt to defeat creditors. A wiser approach is to use a straight forward trust jurisdiction with a reputation for sound trust law without any predisposition for particular types of trust business. Those jurisdictions with one or two year limitation periods designed to make it easier for debtors to escape their creditors will, when used, incur the wrath of judiciaries in other more conservative jurisdictions. It follows that jurisdictions such as the Bahamas, Nevis and the Cook Islands which have enacted trust legislation specifically designed to make recovery from debtors difficult for creditors, and claim the attractiveness of such legislation, may in reality have serious disadvantages where the trust assets are not actually in those jurisdictions.