Ensuring that family assets endure through several generations

There is an old saying that a family can go from “shirt sleeves to shirt sleeves in three generations”. In other words, the wealth generated by a self-made entrepreneur will have been dissipated by the third generation. There is no doubt that a trust can help to preserve a family fortune by preventing later generations from dissipating it. It is, however, essential to ensure that the trust is properly set up and that the assets have passed into the ownership of the trustees and are under their control. Failure to achieve this can result in the trust being set aside as a sham following proceedings by the second or third generation. This was illustrated in Rahman v. Chase Bank [1991] JLR 103, a decision of the Royal Court of Jersey (Channel Islands). The Rahman case has been a salutary reminder of the dangers of allowing a settlor to retain direct control of assets which allegedly have been transferred to the control of trustees. There are many trusts where a similar situation exists and therefore these trusts are at risk not only from other members of the family who claim the assets but also from tax authorities and creditors.

Very often the asset to be preserved through future generations will be a family business built up by a successful entrepreneur. While the entrepreneur will want the business to continue after his death, it may well be that the second or third generations will wish to liquidate the company which owns the business, distribute the assets and then squander the proceeds. By transferring a controlling shareholding in a family company to trustees and restricting the circumstances in which the shares may be sold by the trustees, it will often be possible to ensure that a family business will continue on through several generations. The wishes of the settlor are often indicated in a non-binding letter of wishes and further controls may be imposed on the trustees by the use of a protector whom the trustees must consult before taking any major decision, such as a significant change in the nature of the business, sale of the business to a take-over bidder or liquidation. However, the equitable rules affecting trustees and protectors in this sort of situation must be carefully observed. The trustees holding the majority shareholding must act responsibly and interfere if the directors contemplate a risky venture unsuitable for a company whose shares are held in a trust for the benefit of future generations. If there is a letter of wishes or protector the trustees must nevertheless exercise their proper and independent discretion in administering the trust and the protector must take into consideration the interests of the beneficiaries before exercising his powers. A protector does not usually owe any duties to a settlor who is not a beneficiary and therefore where a protector regularly takes instructions from the settlor which are then slavishly followed by the trustees there is a serious risk of the trust being void as a sham. Alternatively the protector and the trustees could be sued for breach of their duties owed to the beneficiaries.

Confidentiality

One of the major advantages of a trust is confidentiality. While the legal ownership is in the trustee and this will appear on various public records, the beneficial ownership and the various rights of the beneficiaries will not be a matter of public record because, unlike companies, there is no public register of trusts or beneficial interests. Indeed, most records of ownership such as those at a land registry or at a register of members maintained by a company, are usually prevented by statute from recording details of beneficial ownership.

Some jurisdictions however, now provide for registration of trusts but this does not usually require registration of particulars and is mainly used as way of recording the date of creation of the trust. The practice of requiring registration of trusts is not, however, widely used because it may erode confidentiality, or be thought to do so, and usually results in additional government registration charges and is wrongly seen as comparable with the incorporation of a company. Any such view is wholly misguided because it conflicts with the fundamental equitable principle that a trust arises whenever a trust relationship exits between a trustee and a beneficiary and not from the administrative action of a registrar.

Share Option Schemes for Employees

It is quite common for share option schemes to be used to motivate employees and for these schemes to be operated through an offshore trust. There may be tax advantages where trustees sell shares if the trustees are based in a low tax jurisdiction.

Pension Arrangements

Offshore trusts are sometimes used to provide benefits for employees who are employed outside their home jurisdictions. The advantages usually relate to the avoidance of tax in the home jurisdiction of the employees.

Disadvantages

Political Risk

It is important to think ahead when a trust is to be set up. Some of the offshore jurisdictions which now offer modern trust laws are not free from political risk. In the past 20 years, several small offshore jurisdictions have suffered political upheavals of various kinds. Cyprus, Liberia, Malta and Panama are examples. It is therefore important when preparing a structure which is intended to last for many years, to choose a jurisdiction which has a good record of political stability. In the case of Malta it is now clear that the political problems in the years shortly after independence are now very much in the past and the jurisdiction is setting very high standards of regulation.

Potential for Scandals

Many offshore jurisdictions have been anxious to attract business in order to generate revenue. Some, in their anxiety to generate revenue, have not established scrupulous systems of regulation and have enacted legislation which provocatively overrides fundamental trust principles in an attempt to be unduly user friendly. As a result, there are risks in some offshore jurisdictions that those who have established trusts, and also incorporated companies, have done so for the purposes of money laundering, unacceptable forms of tax avoidance, tax evasion and the defrauding of creditors. Where this has happened, it is inevitable that eventually there will be scandals and the jurisdiction used will be criticised. It is then likely that criticism will taint all users of the jurisdiction.

There is a further problem now that the OECD countries, together with a few other large countries, have formed a Financial Action Task Force to review those offshore jurisdictions which are regarded as under-regulated and uncooperative. This could lead to two tiers of offshore jurisdictions, those that are acceptable to the major countries of the world and those that are not acceptable. Those are not acceptable could be excluded from the world's banking system and financial markets, and their users pressured into moving to other jurisdictions. Clearly, it is very much in the interest of a person establishing an offshore trust, or incorporating an offshore company, that the chosen offshore jurisdiction is within the first tier.

Letters of Wishes and Trust Protectors

Reference has been made already to letters of wishes and to the appointment of protectors and it may, therefore, be useful to summarise briefly some of the considerations that are involved with the preparation of letters of wishes and the appointment of protectors together with the duties and obligations which might be imposed on such persons.

The commonest way in which a settlor will try to influence the decisions taken by the trustees is by a letter of wishes. This should be a non-binding confidential document which merely expresses the wishes of the settlor without binding the trustees to follow those wishes if the trustees feel that they should exercise their discretion in some other way. It is also prudent to prepare any letter of wishes some time after the trust deed has been executed in order to exclude any argument that the letter of wishes is in reality part of the trust instrument. This might be a possible inference if both documents are executed at the same time or within a short time of each other. As a result of settlors wishing to retain control over the trust assets letters of wishes are sometimes prepared in mandatory form requiring the trustees to act in accordance with instructions prior to death and after death in accordance with the settlor’s will. This may raise the question of the trust being a sham or indicate the retention by the settlor of a general power of appointment over the trust assets. In Hartigan Nominees Pty. Ltd. v. Rydge (1992) 29 NSWLR 405, it was suggested in a minority judgment that a letter of wishes was a trust document because it was used by the trustees when deciding upon their duties under the trust deed. While this argument was not accepted by the other two judges, the dissenting judge presented a compelling argument which might be followed in later cases. Where, as in Jersey, there is a statutory duty to disclose the trust accounts it may be that any letter of wishes will also have to be disclosed. The Jersey courts have interpreted the meaning of accounts to include all vouchers and supporting documents (see West v Lazard Brothers [1987-88] JLR 414 at 420 and Bhander v Barclays Private Bank & Trust Co Ltd (1997/98) 1 OFLR 497 where three letters of wishes were voluntarily disclosed).

A letter of wishes should be expressed to be a confidential document between the settlor and the trustees so that its contents should not normally be disclosed to the beneficiaries or to a third party. It should, however, be remembered that trusts are ultimately about enforcement by the beneficiaries who should have sufficient information about the trust and its administration to be able to compel enforcement. A blanket exclusion of information about a trust is probably repugnant to the trust concept and unenforceable. It may be that the trend towards disclosure of sufficient information to the beneficiaries will extend to letters of wishes which set out the essential guidelines for the enforcement of the trust.

There are also occasions when a tax authority will make inquiries about the existence of or contents of a letter of wishes. Provided it has been drafted carefully there should not be a problem in providing details, indeed refusal to co-operate is likely to add to any suspicion the tax authority may already have. Nevertheless, disclosure of the contents of a letter of wishes, whether to a tax authority or a beneficiary can cause problems for a trustee. It may assist a beneficiary in litigation against a trustee, particularly in the case of a beneficiary who wishes to challenge the validity of the trust or its proper administration.

A prudent alternative to a letter of wishes is for the trustee to record the settlor’s wishes in a file note. This will be a confidential and wholly informal record that is not signed by the settlor. It will not be a letter of wishes as normally understood although it may have much the same effect. It is also difficult to see how it could be regarded as part of the trust deed or as fettering the discretion of the trustee.

A settlor who wishes to take matters a little further might consider appointing a protector. That person might be a family professional adviser, such as a solicitor or accountant, a member of the family or an old friend of the family. The normal role of a protector is that of liaising with the trustee to ensure that in general terms the settlor's wishes are followed through the exercise of negative controls. It is, nevertheless, essential that the protector’s powers do not have the effect of removing from the trustees their overriding discretionary powers in relation to the administration of the trust. Where this is either provided for or can be shown to be the way the trust is in reality administered, the result may be that the trust is a sham or that in substance the protector is a trustee. Protectors are sometimes given powers which involve arbitrating in disputes between trustees and beneficiaries, reviewing the trust administration, advising on the migration of the trust to another jurisdiction and making decisions on the appointment of new trustees.

In general, a protector will have a duty to keep the trust under review. This duty probably does not have to be expressly set out in the trust deed because it arises from the fiduciary duty owed to the beneficiaries. A protector should keep a professional trustee up to the mark and, if not satisfied, will often have power to require the trustee to retire and be replaced by a new trustee. In exercising any power to dismiss a trustee and appoint a new trustee the protector will be under a fiduciary duty to exercise the power in the best interests of the beneficiaries and not for any other reason such as meeting the wishes of the settlor (see Von Knieriem v. Bermuda Trust Company Ltd. and Another (1994, Supreme Court of Bermuda, Civil Jurisdiction No. 154)). More recently in the Isle of Man High Court (Steele v. Paz Ltd. (1995, Unreported 10/10/95-CH 1992/95)) the fiduciary role of a protector was also confirmed. It is therefore dangerous to assume, as is often the case, that a protector is the agent of the settlor. Like the trustees he does not have duties owed to the settlor unless the settlor is also a beneficiary. This runs contrary to the assumption that the appointment of a protector provides a method of enabling the settlor to exercise control over the trustees, although it may in practice achieve this unless a dispute arises when the protector may be sued for breach of fiduciary duty owed to the beneficiaries.

It is of very great importance that the protector's role remains advisory only. If a protector is given powers which enable him to direct the trustees in matters relating to the control and distribution of income or capital so that he is in effect the agent of the settlor this could render the trust void under the Rahman principle or result in the protector being treated as a quasi trustee. If such a protector is resident in a high tax jurisdiction an attempt might be made to tax the trust income and gains in that jurisdiction.

A practical disadvantage of having a protector is that the appointment can add another significant layer of costs if a professional protector, as opposed to a member of the family, is selected. Where the protector is incorporated and in the same ownership as the trust company there is a greater risk of both the trustee and the protector being sued for breach of fiduciary duty.

In general, it appears that letters of wishes and protectors are less popular than they were in the 1980s and are now seen by many as creating potentially serious problems. A prospective settlor is probably best advised to select a reliable professional trustee rather than to try to retain control of the trust assets and administration of the trust through a letter of wishes or a protector.

Choice of jurisdiction

There are a number of factors which should be considered when deciding where to establish a trust. The main considerations are as follows:

Favourable Tax Environment

It is prudent to choose a jurisdiction for the trust which has a favourable tax environment. In general, the larger jurisdictions such as the United States, the United Kingdom, Australia, Canada and the Republic of Ireland do not have favourable tax jurisdictions although they do have excellent trust laws. In contrast, New Zealand has excellent trusts law with tax exemptions for the trust and the trustees provided that the settlor is not a New Zealand resident and the trust does not have New Zealand source income. If the beneficiaries are also not New Zealand residents there will be no New Zealand tax liability for them. A New Zealand trustee of a foreign trust has no reporting obligations in New Zealand and can claim the benefit of New Zealand's network of double taxation agreements for the beneficiaries.

Satisfactory Trust Law

It is most important to choose a jurisdiction with a satisfactory trust law. As the trust concept developed first in England as part of the law of equity, it is sensible to choose an equity law based jurisdiction. There are, however, some uncertain areas in English trust law which is one of the reasons why a number of offshore jurisdictions have introduced their own trust laws. These tend to consolidate many of the principles of English trust law while at the same time attempting to clarify areas of doubt and trying to deal with special problems such as those affecting settlors whose dispositions are subject to forced heirship rules. There are dangers in seeking to modify the traditional rules of equity in relation to trusts if a trust law goes beyond clarifying grey areas and seeks to change or repeal some of the fundamental principles of the law of trusts. In this regard the trust laws of some jurisdictions appear to be defective in that the trusts for which they provide do not always comply with what are traditionally regarded as fundamental requirements such as control and ownership of the trust assets vested in the trustees to the exclusion of the settlor.

This is particularly so in the case of those jurisdictions which have set out to attract so-called asset protection trusts by giving settlors wide powers of control over the trust assets which are inconsistent with the control that must be exercised by the trustee of a valid trust. It has also been suggested that a trust law can provide for a trustee to delegate all its discretion as well as its powers. If, however, a trustee were to delegate discretion the probable result is that the delegatee would become a new trustee because a trustee cannot, as a matter of equity, delegate all discretion and remain a trustee. There may also be problems for those jurisdictions like Jersey, Guernsey and Malta which are not equity based and whose trust laws, some have suggested, exist in a vacuum. The main difficulty appears to arise from the fact that a trust is a relationship between a trustee and a beneficiary which is recognised by and if necessary enforceable under the principles of equity. A trust is not “formed”, “incorporated” or “created by registration” like a company. Moreover, as a trust is a creature of the law of equity which has developed over more than 800 years, it is not clear that a trust that is recognised by statute in a jurisdiction which has never formally adopted the law and principles of equity, is necessarily governed by all the same principles and can be enforced by all the same remedies as a truly equity based trust. It should be said that although the law and principles of equity were first developed in England they are now followed and developed in many jurisdictions. It follows that where a jurisdiction has adopted the law and principles of equity it will have adopted world-wide equity principles and therefore can follow the latest developments which are not necessarily the current English version of equity (See Cusack & Cotter v Scroop Ltd (1997/98) 1 OFLR 68 and Cusack & Cotter v Pannell Kerr Forster & Crowe (1997/98) 1 OFLR 409).

A trust that is recognised by the Jersey or Guernsey trust law will be regarded as a trust for the purposes of those statutes in any legal proceedings brought in Jersey or Guernsey but such a trust might be regarded as something different from an equity based trust by the courts of an equity jurisdiction. Provided, however, that the basic principles of equity trust law have been followed there should be no problem. The lack of equitable remedies for the enforcement of trusts may also be a problem. While these concerns may be academic and it may be that in practice there is unlikely to be a problem, it has to be remembered that many trusts are coming under attack from disappointed relatives of settlors, creditors and tax authorities with the result that the trust laws of the world are coming under closer scrutiny than ever before. Moreover, the user-friendly trust laws of some jurisdictions which have tried to make trusts achieve objectives that are inconsistent with the essentials of a trust are causing some advisers to question the validity of trusts recognised under such laws. Jersey, Guernsey, and certain civil law jurisdictions like Malta, have not made the mistakes of some offshore jurisdictions in this regard but nevertheless their trust laws do raise the question of whether they necessarily create trusts which will always be recognised and enforced as trusts by other jurisdictions. On the other hand, it should be said that the Jersey and Guernsey trust laws expressly preserve whatever trust law existed previously unless inconsistent with their trust laws. There clearly was some trust jurisprudence in Jersey and Guernsey before the Islands enacted their trust laws (see e.g. the Guernsey Royal Court decisions in John Edward Lihou (10/6/1837); Priaulx Le Marchant & Co. V. Brehant (9/2/1839); and Ahier v. Le Mesurier and Le Cocq (17/6/1843). The main difficulty with the trust concept in Jersey and Guernsey is that the Islands' legal systems have not apparently developed a full range of equitable remedies for the enforcement of trusts. This could be important because ultimately trusts are about enforcement by beneficiaries using equitable remedies.

Good Judiciary

This is extremely important. There are occasions when trustees need to apply to the court for directions and it is essential that they can instruct competent counsel to appear before a judge who understands trusts and the principles involved. A further matter of importance is that from time to time there are disputes between trustees and beneficiaries, and others such as tax authorities, when again it is necessary that the judiciary can cope with what are sometimes very complicated legal proceedings. The older trust jurisdictions such as Jersey, Guernsey, the Isle of Man and Bermuda are all well able to cope, indeed much modern trust case law has been developed in these jurisdictions. There are, however, inevitable doubts concerning the judiciaries of some of the newer jurisdictions. In a few cases trust jurisdiction is in the hands of what are in reality lay magistrates without formal legal qualifications.

Good Professional Services

This is also essential. It takes many years to develop trust expertise within a jurisdiction which is backed up by adequate legal, accountancy and banking services. Again, the older jurisdictions are very well served in this regard but some of the newer jurisdictions less so.

Good Communications

Good communications are important where a trust is based in an offshore jurisdiction. If the settlor and beneficiaries are in other parts of the world, they must be able to communicate quickly and easily with the trustees. The settlor and beneficiaries may also wish to travel to the jurisdiction of the trust from time to time and therefore adequate telecommunications alone may not be sufficient: there should be adequate means of transport to and from the jurisdiction.

Political and Economic Stability

This has already been mentioned. It is of fundamental importance when putting together a structure involving a trust or trusts in offshore jurisdictions and the use of offshore asset holding companies.

Reputable and Prudent Supervision

Some of the older jurisdictions are well supervised and for that reason have long standing reputations for prudence and respectability. Jurisdictions such as Jersey, Guernsey, the Isle of Man and Bermuda are pre-eminent in this regard. Malta has also become a highly reputable and well regulated jurisdiction. Some of the newer jurisdictions, however, do not yet have reputations for thorough and prudent supervision of their users. Some are known for trying to attract business by being too user friendly at the expense of prudent supervision.

An Up-to-Date and User Friendly Company Law

Most trust structures involve the holding of assets in companies the shares of which are held by a trust. In choosing a jurisdiction for offshore property holding companies, it is important to select one that has an up-to-date and user friendly company law. There are now many jurisdictions which have modern company laws and in most cases the bureaucracy has been reduced to a minimum. Unfortunately, the trend has perhaps gone too far in some offshore .jurisdictions with too much emphasis on being user friendly and little or no emphasis on supervision or regulation. This can result in courts around the world disregarding the separate corporate existence of such companies. It should be added that proper regulation is costly and therefore results in higher incorporation and annual fees. It is not always prudent, however, to select a company law jurisdiction on the ground of low cost because in the long run incorporations which are cheap but unregulated can result in rejection by banks when loans are sought and investigations by tax and regulatory authorities.

Which Trustee to Choose?

The choice of the right trustee depends very much on the nature of the trust and the particular circumstances. Clearly, it is important to choose an individual or a corporate trustee in whom the settlor can place absolute confidence. For a small trust established for family purposes, such as a trust to provide for a member of the family who suffers from a disability, there are strong arguments for choosing a member of the family or perhaps a professional adviser who is well-known to the family. In the case of a trust which is set up for the benefit of a number of beneficiaries, perhaps a discretionary trust, there are good reasons for using a bank trustee company or some other large institutional trustee. Such a trustee will have the backing of a large organisation, a substantial (and one hopes) well trained and intelligent staff, and ultimately substantial financial resources that can provide compensation if anything goes seriously wrong.

When choosing a professionally qualified trustee or a trust corporation, it will be necessary to take careful account of the cost. A professional trustee such as a solicitor or accountant will normally charge by reference to the time involved. Very often, a firm of solicitors or accountants will provide a separate trust company but this is unlikely to affect the basis for charging. In the case of a trust corporation, such as a trust company which is part of a banking group, charges may be related to the value of the fund or consist of a fixed charge when the trust is established, an annual fixed charge and a charge by reference to time for work involved. An institutional trustee should normally be expected to provide a set of annual accounts in return for the basic annual charge. A few corporate trustees still charge an “exit charge” on retirement, a practice which is widely regarded as an unsatisfactory. It may be acceptable to charge for administrative expenses when a trustee retires but a fixed or ad valorem charge which is not related to the cost of any work involved might be seen as designed to discourage a change of trustee. If that is what is intended such an approach is inconsistent with the fiduciary obligations of a trustee even if apparently permitted by the trust instrument. Overcharging is a breach of trust. In general, most corporate trustees no longer charge fees on an ad valorem basis.

It is usually more satisfactory, and generally cheaper, if there is a fixed charge when the trust is set up together with an annual fixed charge and an additional charge for any special work done. The better corporate trustees will treat the fixed annual charges as covering their role as a trustee and the provision of annual accounts. Any additional work will normally be charged out on a time basis. Some large trust companies are prepared to quote a fixed annual fee without the addition of charges for time expended once they have considered the nature of the trust, the complexity of the administration and the amount of the funds involved.

The fees charged by corporate trustees vary a great deal, but it does not necessarily follow that those charging high fees always provide a better service. It is sometimes the case that large fees reflect the costs of a large and costly organisation together also with the additional compliance costs which can affect very large trustees whose aggregate trust assets require them to disclose their interests in listed companies because the trigger point for disclosure is passed. Smaller trust companies do not have the same overheads and compliance costs to pass on to their customers while they do often have excellent back offices capable of coping with the large quantities of paper work and computer records that trust administration can generate. When assessing the fees charged by a trustee company and making a final decision on the choice of a trustee, it is always important to ensure that it has a back office capable of coping with the proper administration of the trust. “Cubical” trust companies run by another entity may not be able to meet the administrative requirements of some trusts and will also be subcontracting the administration to another person. The fact that the chosen trustee is not actually administering the trust but has delegated this to another organisation is far from satisfactory and may, in itself, amount to a breach of trust.

In choosing a trustee, particularly a bank trust company, it is important to discover whether it is assumed by the banking group that other bank services such as general banking and investment management facilities will be used by the bank trustee company. Not all banking groups understand the nature of a trust and the fact that it involves a special relationship between the trustee and the beneficiaries. There have been cases where banks and other large institutions have “sold” trusts as though they were “products” with intention of charging additional fees for providing banking and investment management services. Unfortunately, the pressures of modern marketing techniques are often incompatible with the relationship which is required by law to exist between a trustee and the beneficiaries of a trust. A bank trustee company which uses other services within the banking group should always make this practice clear to the settlor and provide details of the charges involved before the trust is set up. If this is not done there may be a conflict of interest resulting in a breach of trust by the trust company which could be sued by the beneficiaries.

Where it is the practice of a bank trustee company is to use other services within the banking group, great care should be taken by the trustee to ensure that the fiduciary obligations owed to the beneficiaries take priority over the understandable loyalty that may exist to other companies within the banking group. If the trust company is run in disregard of the fiduciary obligations of a trustee, and regard is had only to commercial considerations, the likelihood is that sooner or later the bank trustee company will be sued for breach of trust. In recent years, there have been a number of successful actions brought against bank trustee companies (see, for example, Bartlett v. Barclays Bank Trust Co. Ltd. [1980] 1 All ER 139 and West v. Lazard Brothers Co. (Jersey) Ltd. (1993) Jersey Unreported Judgments 136 (18/10/93)).

B. OFFSHORE COMPANIES

There are now many offshore jurisdictions offering company incorporations. Some of these jurisdictions, in a frantic effort to obtain business copy each other and sometimes enact new laws with only the short term objective of marketing their companies in mind. At first sight, it is difficult for a professional adviser to decide how the choice of jurisdiction should be made although like sharks in a feeding frenzy most turn first to the British Virgin Islands for an international business company.

In general terms, it is possible to divide the jurisdictions offering offshore company incorporations into nine categories. These are as follows:

 

1.The Caribbean international business companies’ jurisdictions. The most active are the British Virgin Islands, the Bahamas, Barbados, Belize, St. Kitts, Anguilla, Cayman Islands, Nevis and the Turks & Caicos Islands. Of these, the British Virgin Islands is by far the most popular although some of the other Caribbean jurisdictions offer an equally good and sometimes cheaper products with, in some respects, more attractive legislation. It is, however, necessary to sound a warning note about the concept of the international business company, simple, quick and cheap as it may be. In essence, the concept involves a jurisdiction with two company laws, one for those who wish to carry on business within the particular jurisdiction which is subject to wide ranging disclosure requirements and the other designed for those who do not wish to carry on any business or do anything at all in the particular jurisdiction. Indeed, the basis of an international business company is, or seems to be, that the jurisdictions offering this product usually take no interest in who the beneficial owner of the company is going to be or the purpose for which the beneficial owner intends to use the company, provided that nothing is done within the jurisdiction itself!

For most traditional company lawyers, there is an uneasy feeling that this is not really what company law is all about. Indeed many are left wondering whether the House of Lords would have reached a different decision in the celebrated case of Salomon v. Salomon & Company [1897] AC 22 (which confirmed that a company run by one person was a separate legal entity and not a mere agent of the owner) had the case concerned an international business company. Given that in some of the Caribbean jurisdictions, there is very little attempt to control who owns international business companies and in none of the Caribbean jurisdictions is any attempt made by a regulatory authority to discover beneficial ownership as a condition for incorporation, it is probably only a matter of time before the larger jurisdictions, which make up the members of the International Fiscal Task Force, bring pressure to bear on those jurisdictions offering unregulated international business companies forcing them to introduce disclosure of beneficial ownership and other forms of regulation such as public registers of directors and shareholders.

2. The new Pacific and Indian Ocean international business company jurisdictions. The main jurisdictions are the Cook Islands, Samoa, Niue, Vanuatu, Labuan, The Marshall Islands and Mauritius. These jurisdictions are as yet largely without track records in relation to their international business companies.

3. The Channel Islands and Isle of Man tax exempt companies. Jersey, Guernsey, Alderney and the Isle of Man provide for a special category of tax exempt company which, although resident, is treated as non-resident in relation to offshore activities. A fixed annual fee of £500 is payable for this status although there has been discussion in Jersey of the abolition of this fee. The principal advantage is that an exempt company can be managed and controlled from each island and can still be treated as non-resident so that it is not necessary to arrange for directors' meetings to be held in some other jurisdiction in order to achieve non-resident status. The exempt company fee was introduced to discourage the use of Sark, another Channel Island, as a place for the holding of board meetings and the avoidance of Jersey and Guernsey income tax. While this ended the “Sark Lark” mark 1, the mark 2 version involves the use of Sark as a provider of directorships for Caribbean international business companies which operate in Jersey and Guernsey with little or no regulation. Alderney has power to regulate foreign companies operating in the Island and is expected to introduce rules requiring the filing of information by such companies.

4. The European international business company or international company. These are provided for by Jersey, Guernsey and Alderney, the Isle of Man and Gibraltar. These jurisdictions do not offer equivalents to Caribbean, Indian Ocean or Pacific Ocean international business companies. The European concept, which began in Jersey and Guernsey, is largely tax driven. Although the concept varies a little from jurisdiction to jurisdiction, the basic idea is that these jurisdictions offer variable tax rate companies. For example, in the case of an Alderney or Guernsey international company, it is possible to negotiate a tax rate with the Guernsey Tax Administrator of between something over 0% and and not more than 30%. This is then fixed for five years. These companies are useful for the purpose of tax treaty planning and for avoiding the effects of controlled foreign corporation legislation in the jurisdiction of a parent company. These companies can also be used for offshore treasury functions and captive insurance.

5. Jurisdictions catering for special purpose companies. This includes insurance or ship and aircraft registration companies. In the category of insurance, Guernsey is at present the fastest growing centre for captive insurance companies but the Isle of Man, Bermuda and the Republic of Ireland also have extensive insurance and captive insurance company business. Jurisdictions well-known for ship and aircraft registration include Bermuda, the Bahamas, Liberia, Malta, Panama, the Isle of Man, Guernsey and Jersey. Guernsey has very recently developed a new concept which allows a company to be divided into separate self-contained compartments or cells which operate independently of each other. The companies are particularly attractive to the fund management and insurance industries at whose request they have been provided. There may be other situations in which cell companies can be used but it is too early to judge what they might be. The essence of a cell company is that each cell is separated with its own cell assets. If a cell is wound up the liquidator and creditors have no rights as to the assets of other cells.

6. Jurisdictions offering guarantee companies and hybrid companies. These are used for tax planning purposes and as alternatives to trusts. The main jurisdictions include the Isle of Man, many of the Caribbean jurisdictions, Alderney and recently Guernsey. A hybrid company is a guarantee company with shareholders as well as guarantee members.

7. Jurisdictions offering limited duration or limited life companies. These are known in the US as limited liability companies. These corporate bodies are in substance a form of corporate partnership in which all members must be involved in the management. Despite corporate personality they are “transparent” for all tax purposes, that is to say all income, gains, expenses and credits are attributed to the individual members on a pro rata basis. These corporate entities effectively provide for a simple form of corporate entity with limited liability for domestic use by small traders or as a simple asset holding entity. They can be used in much the same way as the Caribbean and other international business companies and have great attractions for US persons because they avoid the heavy tax liabilities affecting conventional non-transparent offshore subsidiary companies. This form of incorporation is now possible in the Bahamas, the Cayman Islands, the Turks & Caicos Islands, Nevis and the Isle of Man.

8. Jurisdictions offering tax treaty benefits. Although most offshore jurisdictions do not offer tax treaty opportunities because of their low tax rates, there are a few which nevertheless are able to do so. Thus, Cyprus has an excellent double taxation treaty network with Eastern Europe, Madeira has advantages through its connections with Portugal and therefore the European Union as a whole, Malta has a wide range of useful tax treaties and Mauritius has useful double taxation treaties with China, India and South Africa.

9. Jurisdictions offering geographical advantages. Various offshore jurisdictions offer geographical advantages, e.g. Jersey, Guernsey, Alderney, Isle of Man and the Republic of Ireland (Europe), Cyprus (Eastern Europe), Bermuda, the Bahamas, the Cayman Islands, Panama (U.S.A.), Mauritius (India), Hong Kong, Singapore and the Philippines (S.E. Asia and in the case of Hong Kong, China).

Having considered the nine categories into which offshore company jurisdictions can be divided, the choice of a category will normally be indicated by the particular requirements of the client. These may involve political or image considerations, a particular business sector such as shipping, aircraft, captive insurance, or guarantee or hybrid companies or quantity and cost where a large number of companies are required as asset holding companies for a major international group structure. Usually once the requirements of a client are taken into account, it is relatively easy to arrive at the appropriate category from which to choose a jurisdiction.

Before making the choice from within a particular category, it is most important to exercise prudent judgment. Reservations concerning the future of the international business company concept have already been expressed. The main problem is that the enormous success of the British Virgin Islands international business company registry could well result in scandals in the absence of prudent regulation. Many British Virgin Islands international business companies have been set up for artificial tax planning purposes and this has given the jurisdiction a questionable reputation with many tax authorities. It is possible that some BVI IBCs have been set up as fronts for international criminal activities. This is particularly so because many have been incorporated with bearer shares so that tracing beneficial ownership is almost impossible. Without some control over the beneficial ownership of these companies, the risk of international business companies falling into the hands of undesirables is significant, bearing in mind that in 1996, for example, 32,000 BVI IBCs were incorporated (with in total 210,260 companies on the register at 31 December, 1996). It is only a matter of time before scandals involving BVI companies occur and the danger then will be that bona fide users of the jurisdiction could be tainted by association. One only has to look back at the flight of companies out of Panama in the 1980s to see what might happen in the absence of adequate supervision. The danger of taking BVI companies and those connected with them for granted without first making careful inquiries was illustrated in Shanghai International Capital Ltd. v. China Finance Trust and Investment Corporation 1995, No A994, a decision of the Hong Kong High Court. The case concerned a Mareva injunction to freeze the assets of the defendant, a company with assets of US$10 million. The solicitor acting for the plaintiff failed to make proper inquiries as to the bona fides of his client and obtained the injunction in the belief that the plaintiff company was a reputable merchant bank. In reality it was a BVI company with assets of HK$55 and US$180. The upshot, when the truth emerged, was that the plaintiff s solicitor was ordered to pay the whole of the defendant's costs as damages for the inconvenience caused.

There may be other serious problems that will emerge with time in relation to the use of international business companies. An example arose in 1991 in relation to a case decided by the Chief Justice of the Cook Islands Sir Clinton Roper. In Century Insurance Ltd. v. Credit Lyonnais Bank Nederland N.V. (1991) Plaint No. 4/91 (12/4/91) it was held that for technical constitutional law reasons a Cook Island’s international business company registered as an insurance company could not obtain leave of the Cook Island's court for service of legal proceedings outside the Islands.

Many judges are now prepared to disregard companies incorporated for tax planning purposes or for the purpose of avoiding liability to creditors where the use of a company is contrived and artificial. The English courts have shown that they will disregard the veil of incorporation and look through corporate personality to prevent incorporation being used unjustly. In the case of Re a Company [1985] BCLC 333 Cumming-Bruce L.J summarised the position in this way:

“In our view the cases before and after Wallersteiner v Moir [1974] 3 All ER 217, [1974] 1 WLR 991 show that the court will use its powers to pierce the corporate veil if it is necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration. As Lord Denning MR said ([1974] 3 All ER 217 at 238, [1974] 1 WLR 991 at 1013) the companies there identified were distinct legal entities and the principles of Salomon v Salomon & Co Ltd [1897] AC 22 prima facie applied. But only prima facie. On the facts of the Wallersteiner case, the companies danced to Dr Wallersteiner's bidding”.

This approach was followed in Private Trust Company v Grupo Torras SA (1997/98) 1 OFLR 443 where the Bahamas Court of Appeal was satisfied that a trust structure over which the principal beneficiary exercised substantial control should be pierced and the beneficiary treated as the beneficial owner. This approach has been followed independently by United States judges. For example in United States v. Reinhard P. Muller (U.S. Court of Appeals for Eleventh Circuit; 77 AFTR 2d Par 96 - 457, No. 94 - 3617), a case which involved tax evasion, the judge ignored the separate personalities of the individual (for whom the company had been incorporated) and the company which was held to be the alter ego of the individual. The judge commented that the “observance of the fiction of separate existence would ... promote fraud or injustice”.

In InverWorld Inc. v. CTC (Memo, 1996 301), another U.S. case, an aggressive tax avoidance scheme involving the use of a foreign company to separate foreign from domestic activities so as to restrict US tax liability to income from domestic activities was successfully challenged by the IRS. This was achieved largely by challenging the scheme as artificial.

It should not be assumed that attacks on the artificial use of companies is confined to the United Kingdom, the United States and the Bahamas. In Hong Kong, a parent company and its wholly owned subsidiary were treated as one and the same in deciding the liability for profits tax of the parent company (see CIR v. Magna Industrial Ltd) [1996] HKRC 90-078). This decision was reversed on appeal ([1997] HKLRD 173) without reference to the United Kingdom, United States or Bahamian authorities. Nevertheless, the danger of a judicial attack on the artificial use of companies remains a real one. It appears that in cases involving tax avoidance or evasion, and in cases involving fraud on creditors, the courts of several jurisdictions are prepared to lift the corporate veil or apply the “alter ego” theory. In jurisdictions such as Australia, Canada, New Zealand and Hong Kong where general tax avoidance legislation allows the reconstruction of transactions it may well be that this can extend to lifting the veil of incorporation. There is little doubt that the next decade will see a large number of court decisions in which corporate veils will be lifted.

Another area of concern which involves the use of offshore companies is the increasing danger of a criminal prosecution of both the taxpayer and his advisers where the tax authorities of the taxpayer’s home jurisdiction allege fraud or the common law offence of cheating the Revenue and conspiracy where more than one person is involved (see for example R v Charlton and others [1996] STC 1418 CA and R v Chipping and R v Allen both of which cases were heard in 1997 and are subject to appeal. They are at the time of writing, May 1998, unreported). What these cases emphasise is the importance of giving substance to offshore companies and not simply running them from onshore without any attempt to ensure that control is exercised fully and properly in some other jurisdiction, preferably that of the place of incorporation. In an interesting article “Foreign companies and the Danger of Criminal Liability” Vol 8 Issue 1 of the Offshore Taxation Review, Stephen Brandon Q.C. highlights the dangers for professional advisers who do not ensure proper use of offshore companies either because they work for large firms and are not sufficiently in touch with what is actually happening or because they and their clients “suspend disbelief” when considering where an offshore company is resident for tax purposes.

In addition to the particular requirements of a client, there are, of course, standard criteria which are relevant in selecting an offshore jurisdiction for incorporation of a company. Thus in choosing a jurisdiction for the incorporation of a company, one will need to take account of such things as political and geographical considerations, time zones, the availability of professional expertise, judicial expertise, reputation and the likelihood of scandals. There are also matters which relate specifically to company law such as disclosure requirements. The attitudes to disclosure vary a good deal among offshore jurisdictions. Some require disclosure of registered shareholders, some require disclosure of beneficial ownership to a licensed agent, some require disclosure of directors, some, such as the Channel Islands and Malta, require confidential disclosure of beneficial ownership to a regulator and others require no disclosure of any kind.

Where no disclosure is required, an offshore company jurisdiction may have sown the seeds of its own destruction. In contrast, although confidential disclosure of beneficial ownership as required in the Channel Islands (Alderney, Guernsey and Jersey) has not proved good for business from South East Asia, it is interesting to note that a recent survey of European independent financial advisers rated Jersey and Guernsey (together with Alderney) as the second and third most confidential of offshore jurisdictions. There are many in South East Asia who have been unhappy with the prospect of having to disclose beneficial ownership, even confidentially, to a faceless regulator on the other side of the globe and have therefore rejected the Channel Islands and incorporated their companies in places such as the British Virgin Islands. However, it should be stressed that confidential disclosure of beneficial ownership is precisely what it is stated to be, confidential. Confidential disclosure of beneficial ownership is, therefore, no problem for an honest person, indeed it is a hallmark of respectability to be accepted as a suitable beneficial owner of a Jersey, Guernsey or Alderney company. All that is involved is disclosure of the name or names of the beneficial owners to, in the case of Jersey, the Registrar of Companies and in the case of Alderney and Guernsey, the Financial Services Commission, in order that the names can be run through a computer data base and checked for any record of dishonest or criminal activities. Ironically the reputable and well regulated offshore company jurisdictions are, because they are reputable and well regulated, favourite targets for money laundering and organised criminals.

Another matter to be considered when choosing an offshore jurisdiction is administrative regulation. Matters such as the making of annual returns and returns of other information for inclusion on public or private registers can be time consuming and expensive. Most offshore jurisdictions now realise that much of the information which formerly had to be returned for small companies was of no real use and can result in serious storage problems for the registry. In consequence many filing requirements have either been removed altogether or greatly relaxed. The lack of a public register of charges to protect the priority of a lender’s interest is, however, a disadvantage because banks are reluctant to lend to companies incorporated in jurisdictions which do not provide for formal registration and protection of creditors interests. This is a weakness with some of the international business company jurisdictions which have tried to oversimplify their legislation.

It will also be necessary to consider the flexibility of the constitution permitted for a company incorporated in an offshore jurisdiction. Again, most offshore jurisdictions have taken this into account. For example, most provide for single member companies, have a requirement that only one director is necessary, provide for no par value shares, allow share purchase and redemption, provide for flexibility as to names (together with a procedure for reservation of names) and have abolished the ultra vires rule. Many allow names in another language and some allow the memorandum to be in any of a number of specified foreign languages.

Not all offshore jurisdictions permit bearer shares. The advantages of bearer shares have been greatly exaggerated, particularly in South East Asia, with little or no attention being paid to the dangers. Bearer shares can create serious problems. If lost or stolen, the control of the company can pass to third parties. But most important of all to professional advisers, it is not possible to comply with due diligence obligations where bearer shares are issued unless the bearer share certificates are retained by the adviser on safe deposit. In general, many of the advantages of bearer shares, without the disadvantages, can be achieved by using nominee shareholders or by using guarantee or hybrid companies.

Another matter which is regarded as important is corporate mobility or migration which is often misleadingly called redomiciliation. This has become fashionable and most international business company jurisdictions provide for it, as does the New Zealand Companies Act 1993. Some jurisdictions also provide for merger provisions which enable a company in one offshore jurisdiction to leave and merge with a company in another. It should be said that not all the problems which these concepts create have been solved. In the case of a merger of, for example, a Panamanian company into a British Virgin Island company, there can be problems where shares are held by the Panamanian company in a Hong Kong company. How does the Hong Kong company register the change of shareholding? Have the shares been transferred or have they passed from one company to the other by transmission? This is important for Hong Kong stamp duty purposes and also for the purpose of completing the entries in the register of members of the Hong Kong company. There is also the difficulty that some foreign courts might not recognise the concept of corporate mobility. For example, a French court might decide that a migrated company has in substance been put into liquidation in the jurisdiction of original registration and reincorporated in the jurisdiction of so-called immigration. This will be important where the assets, or some of them, are in France. There is also a view that a company which owes its existence to the fact that it is recorded on a register in a particular jurisdiction will cease to exist when it is removed from that register and therefore there is nothing to transfer to the other jurisdiction. It may be that this problem can be covered by an express legislative provision but until tested in the courts it is difficult to say for certain that migration is technically possible.

In conclusion, something should be said about certain special types of companies. Reference has already been made to guarantee and to hybrid companies. Guarantee companies are companies which do not have limitation of liability by reference to shares but by reference to sums which the members have guaranteed to pay to meet the companies’ debts in the event of a winding up. Hybrid companies are companies with members whose liability is limited by shares and also with members whose liability is limited by guarantee. Although guarantee companies have been widely used for many years in several jurisdictions for charities, university colleges and clubs, until recently both ordinary guarantee companies and hybrid companies were thought to be of little other use.

Guarantee and hybrid companies have, however, become important recently in hitherto unexpected ways. Guarantee companies were thought to be useful in connection with capital gains tax planning in the United Kingdom and in other jurisdictions where taxes affecting companies have been drafted in such a way that they only apply to companies limited by shares. It may, therefore, be possible to avoid the effects of certain tax legislation by simply not having a share capital. This particular loophole was, however, closed in the United Kingdom by the Finance Act 1996.

Hybrid companies have a number of other uses not related to tax planning. The first concerns the use of a hybrid company to achieve many of the objects of a trust without establishing a formal trust which will be subject to the strict equitable rules requiring the control of assets by trustees and governing trustees in the way they exercise their fiduciary duties. For example, it is possible to establish a hybrid company in such a way that the shareholders effectively own and control the assets for the benefit of beneficiaries who are the guarantee or “beneficial” members. It is possible to draft the articles of association so that additional guarantee members (beneficiaries) are introduced from time to time and also to provide for a “protector” by giving one shareholder special powers. If necessary, the person who is the effective “settlor” can be given a controlling shareholding or controlling directorship. This approach is useful where a settlor wishes to retain more control than the trust concept will permit or where the settlor is domiciled in a jurisdiction which either does not recognise trusts or has forced heirship rules. Since all jurisdictions normally recognise companies, wherever incorporated, the problems caused by a formal trust disappear. The Isle of Man, Alderney and Guernsey hybrid company legislation is particularly useful where an alternative “trust” structure is needed. Amendments are in hand which should make Alderney guarantee and hybrid companies even more useful.

Other advantages of hybrid companies include the achieving of confidentiality for beneficial ownership through guarantee membership which is not recorded on a register of shareholders (this has many of the advantages of bearer shares without the disadvantages), achieving transparency for U.S. tax purposes and exchange control planning because the creation of new guarantee members (i.e. new beneficiaries) does not involve the transfer of any cash or the use of a security.

C. CONCLUSION:

The uses of offshore trust and company jurisdictions are now complex and varied. As the wealth of individuals increases, there is an increasing tendency for the control of their wealth to move away from the larger jurisdictions. Some large countries may view this development with alarm and wish to take preventive action, but it is probably now too late for the process to be stopped altogether. While many countries have agreed on the need to control international activities involving money laundering and the more extreme forms of tax avoidance, and they may be successful in limiting such activities, the uses (and abuses) of offshore jurisdictions will continue to multiply. Nevertheless, as most offshore jurisdictions are small and unable to resist serious pressure from large and powerful countries, and some are potentially unstable, professional advisers would be wise to exercise caution in selecting a jurisdiction for a trust or company. The possibility that the trusts and corporate products of some underregulated offshore jurisdictions will be excluded from access to the international banking system and financial markets should not be overlooked.

© 1998

PETER G WILLOUGHBY

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