by Peter Hargreaves

Trusts can be useful in both tax and non-tax planning for private clients because they take assets out of the absolute ownership of wealthy families and individuals. Trusts are however essentially complex. Common law jurisdictions - specifically England, which created the trusts - and those jurisdictions whose laws are derived from England, including the US, Australia and Canada, have had to come up with complex rules to tax trusts whether they are established domestically eg, trustees, settlor and beneficiaries all resident in the UK, or established in offshore tax havens, eg, settlor and beneficiaries in the US, but trustees in Jersey.

The tax systems of European civil law jurisdictions (say all EU members excluding the UK and Ireland, but including Switzerland) encounter still greater difficulties in dealing with trusts. In particular, problems arise when dealing with the classical discretionary trust in which the trust beneficiaries are defined but the quantum and timing of benefit paid to any particular beneficiary is left to the trustees' discretion. For example...

There are no domestic trusts (although there may be trust analogues).

Even with the extension of the Hague convention on the recognition of trusts, the trust concept fits poorly with civil law legal systems, in particular their concept of undivided ownership.

There can therefore be a mismatch between the trust as a legal construct and the tax systems of European jurisdictions in which trust settlors and beneficiaries are resident

This mismatch provides planning opportunities. It can also produce pitfalls, uncertainties and unexpected outcomes where fools rush in where angels fear to tread.

Each stage in the trust relationship should be considered in turn in order to assess how civil law jurisdictions may tax offshore trusts and therefore whether, and to what extent, there are tax planning opportunities from the use of offshore trusts for European residents.

Dealing with each stage in turn:-

The settlor transfers assets to trustees

A settlement of assets by a settlor is a gift in trust for the beneficiaries. Most European jurisdictions tax gifts during lifetime at the same rates as they tax inheritances on death. These rates vary depending on the proximity of the relationship between donor and donee - the lowest rates generally being on transfers to spouses or children. As an example of the usual European "donor" base for gift taxes, France taxes lifetime gifts of French property by individuals wherever resident and of the property of French residents wherever situate.

The question is then whether gift tax applies to settlements made by individuals resident in civil law jurisdictions on offshore trusts.

There are two possible answers - sophisticated and unsophisticated.

The unsophisticated answer is that a transfer to trustees by a civil law resident would be considered a complete gift and therefore potentially subject to gift tax at the highest rates as a gift between unrelated persons, the settlor and trustees. Switzerland provides an example where transfers by Swiss residents to irrevocable trusts are considered to give rise to an immediate cantonal gift tax liability.

Spain similarly seems to consider a transfer in trust as a complete gift. There are nonetheless opportunities for the establishment of trusts by Spanish residents free of Spanish gift tax since Spain does not conform to the general European basis for gift taxes; rather it adopts a "donee" basis for taxing gifts of Spanish property to individuals wherever resident and the receipt of gifts of non-Spanish property by Spanish residents. Therefore the settlement of non-Spanish property on offshore trustees by Spanish residents should be free of gift tax.

The sophisticated answer, which has been confirmed by court cases in the Netherlands, is that gift tax does not apply on the original settlement on the trustees who are not enriched thereby. Instead tax is deferred until benefit is provided by the trustees to the ultimate beneficiaries. A similar principle was confirmed in German tax cases relating to will trusts (those created by will) where inheritance tax was deferred until the ultimate transfer to beneficiaries of the will trust. This clearly provides planning opportunities for at least the deferral of gift tax, and in Germany inheritance tax. Any subsequent transfer from the trust created by a Dutch or German resident is likely to crystallise the original liability to gift or inheritance tax, regardless of the jurisdiction of residence of the ultimate recipient at the time of the eventual transfer.

A possible liability to income or capital gains taxes should also be considered where assets pregnant with gains (appreciated assets) are settled on offshore trusts by a civil law resident.

Civil law jurisdictions are generally less likely to tax private gains than are for example the UK, US and Canada. Thus in Germany, gains on disposals of shares by individuals are tax free if held more than six months or unless the individual has held a shareholding in excess of 25% in the past five years. Gains on real property are outside the scope of tax if held more than two years.

In France gifts (presumably including gifts in trust) potentially subject to gift tax are not also subject to income tax on any deemed gains on gifts of appreciated property.

By contrast, as well as giving rise to a potential liability to gift tax, a lifetime gift may result in a liability to Spanish income tax on a deemed capital gain based on a gift being treated for tax purposes as a sale at market value. The basis for such taxation differs from that described above for Spanish gift tax and instead is "donor" based applying on gains on transfers of Spanish property by individuals wherever resident and of the worldwide assets of Spanish residents.

The potential tax liabilities and uncertainties about whether a liability may apply as a result of the settlement of assets on offshore trusts by settlors resident in civil law jurisdictions means that individuals moving to such countries should consider creating what are known as "drop-off trusts" before they become resident in their new jurisdiction. In doing so, careful attention needs to be paid to the tax legislation of the jurisdiction which they are leaving. Some jurisdictions, including Germany and the Netherlands, have so called "tail-off" rules which in certain circumstances can continue to tax former residents after they have ceased to be tax resident.

The trustees hold trust assets

This stage highlights the tax advantages of an offshore trust established by a settlor who is (or subsequently becomes) resident in a civil law jurisdiction - and of the essential quality of the trust which gives rise to all its planning advantages, whether for tax or other purposes, which is that it represents a pool of assets held in an estate outside the direct ownership of an individual.

For example, compare an irrevocable Jersey discretionary trust holding non-French assets settled by a French resident with a French resident individual holding the same assets personally.

Assets held by Jersey Trust         Assets held by French Resident

No French wealth tax (ISF)          Wealth tax is payable annually

No French income tax on             Income and gains subject to 
trustees' income or gains           French income tax
on sale of investments

No inheritance tax on the           Inheritance tax applies to the
death of the settlor                value of the assets at the time
                                    of the individual's death

Equivalent income and wealth tax advantages may apply where the settlor or other beneficiaries of the offshore trust are residents of other European jurisdictions, but probably not Germany. Germany has an extensive anti-avoidance code, the Aussensteuergesetz, which includes a provision to tax the German beneficiaries of a foreign family foundation to income and wealth taxes on an arising basis ie, regardless of whether any distribution is paid to the beneficiaries. The provision was aimed at the use of Liechtenstein family foundations by German residents, but a court case in 1992 applied the provision to a Jersey discretionary trust where the trust beneficiaries were members of the settlor's family.

Following this ruling, the German resident settlor of an offshore family trust will be taxable on an arising basis to both income and wealth taxes as if he held the trust assets personally. Where the settlor is not German resident, German resident beneficiaries are liable to be taxed to income and wealth taxes according to their respective interests in the trust.

The trustees provide benefit to beneficiaries

The greatest difficulties are encountered in planning to benefit civil law residents whilst minimising the resulting tax charge.

Trustees and advisers in common law jurisdictions traditionally make a distinction between the tax treatment of income and capital receipts by trust beneficiaries. Income receipts are where trust income, eg, bank interest, dividends, rents, less income expenses are paid out of income assets to beneficiaries. Capital receipts are payments of original trust corpus, reinvested capital gains and any undistributed income accumulated and added to capital. Whilst Anglo Saxon jurisdictions may make a distinction between the tax treatment of income and capital payments, it is doubtful that civil law tax authorities would do so.

Clearly there must be a risk that if regular payments from a trust are made to a civil law resident, they would be taxable to income tax at progressive rates. The Netherlands, for example, taxes individuals to income tax on periodic receipts and therefore may tax income receipts from an offshore trust accordingly.

Such treatment, however, runs up against a fundamental difficulty that civil law jurisdictions have with trusts, their concept of undivided ownership. The fact that trust income may be paid to a trust beneficiary who has no entitlement to the underlying assets giving rights to that income may be difficult for civil law tax authorities to comprehend.

One possibility is that payment may be treated as if it were a usufruit interest. Civil law follows the concept of ownership being divided between the usufruitier who enjoys the fruits, and the nue proprietier who has an interest in capital, in which he will enjoy the whole ownership (plein propriete) on termination of the usufruit, usually on the death of the usufruitier.

Treating trust income as a usufruit right is probably unhelpful to the trust beneficiary, because the trust and the usufruit are not analogues, the usufruit being a form of joint ownership between the usufruitier and nue proprietier and also because it could be disadvantageous for tax purposes. For instance, in France and the Netherlands a usufruitier is liable to be treated as the owner of the undivided assets and therefore subject to annual wealth tax on their capital value.

It may be more helpful if payments from trusts are not treated as of an income nature and instead treated as equivalent to a capital gift. Capital payments from offshore trusts would thus be equated to gifts or legacies from a foreign donor or estate, which may be tax free in the hands of the recipient resident in a civil law jurisdiction. Switzerland, for instance, adopts this approach.

Treatment of a receipt from an offshore trust as if it were a foreign gift or legacy would be unhelpful if the recipient was either Spanish or German resident. As explained above, Spain taxes Spanish resident donees in receipt of gifts or legacies regardless of the residence of the donor or deceased. So does Germany, which also taxes the worldwide estate of German resident donors.

The French tax code causes particular difficulties as it has a specific provision to tax to French income tax all receipts by a French resident from an overseas trust. It remains unclear as to whether this is limited to receipts of an income nature or extends also to receipts of trust capital. The prudent view must be to assume that the provision extends to all receipts including trust capital by French resident beneficiaries.

An alternative to absolute income or capital payments to beneficiaries is for the trustees to loan funds to civil law resident beneficiaries. Another route which can be useful in planning for a number of jurisdictions is where a trust is partly funded by way of loan from the settlor, who is then able to receive funds in his country of residence by calling for repayment of the debt. Meanwhile any growth in value of the trust fund accrues to trust corpus and therefore the wider class beneficiaries. Another possibility is where the trust is funded in part in consideration of the right of a civil law resident to receive an annuity, receipt of part of which may be treated as a tax free return of capital.


Trusts certainly provide planning opportunities for wealthy families resident in civil law jurisdictions, particularly in the increasingly frequent circumstances where wealthy families are made up of husband and wife from different nationalities and who move between jurisdictions during the course of their careers and marriage. Such circumstances provide opportunities, but are full of pitfalls which require careful planning and replanning in the light of changing family circumstances and all-too-frequent changes to tax laws and their interpretation both by the courts and tax administration.

The optimal use of trusts in planning for civil law residents and domiciliaries may be where trusts hold assets, for instance "friendly" shareholdings in family companies which represent reserve funds to be held for the long term benefit of the family, but which are in excess of the cash flow needed to meet immediate living expenses and which may be accessed when one or other members of the family are resident in an appropriately friendly tax jurisdiction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

For further information please contact:

Veronica Tonge
Ernst & Young Trust Company (Jersey) Limited
PO Box 621
Le Gallais Chambers
54 Bath Street
St Helier
Channel Islands

Tel No: 01534 501000
Fax No: 01534 23265
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