By Andrew Rogerson
Turquoise seas, pristine coral, endless, near deserted white sand beaches with iconic palm trees — a holiday dream for trust lawyers and their clients?
In the past, trusts established in these jurisdictions were often intended for use as a means of avoiding or evading tax, sometimes legally and sometimes illegally. That approach has fallen into disrepute following the disclosures contained in the “Panama Papers” and the “Paradise Papers,” and government responses to such activities.
Canadian tax laws have been amended to require Canadians to pay tax on income that they earn in foreign trusts located in tax havens. Most of the legally available tax benefits of offshore trusts have been eliminated for Canadian residents, though there may still be some for those who receive inheritances or gifts from wealthy foreign relatives.
Foreign bank secrecy is disappearing. As of 2020, 91 foreign jurisdictions have agreed to regularly report information to the Canada Revenue Agency about accounts held by Canadians. That list now includes most of the countries that were previously known as tax havens, such as Bermuda, the Cayman Islands, the Cook Islands, Turks and Caicos, and Jersey. Under this treaty, known as the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, the information is automatically reported to Canada Revenue on all accounts held by or for the benefit of Canadians in that jurisdiction.
That does not mean that the opportunities offered by foreign diversification should be disregarded. Tax savings never were the only reason for establishing an offshore trust. One of the best reasons has always been asset protection and the benefits that diversification of location and holdings provides for high net worth individuals.
That consideration may not have loomed as large in the past for residents of politically stable countries such as Canada and the United States. Unfortunately, the new experience of the 2020s, with pandemics and other turmoil, demonstrates that no country is completely safe. The suspension of normal civil rights, and the associated weakening of property rights, is being contemplated in countries where these were previously sacrosanct. Since no country is completely safe, the best strategy you can adopt is the time-tested one of not putting all your eggs in one basket.
Jurisdictions
There are many offshore jurisdictions in which a trust may be established. Some are extremely successful. The fact that their economies depend so heavily on financial services means that the government will try very hard to enforce laws that maintain the integrity of the system.
For example, Cayman relies on financial services for more than 40 percent of its GDP, and has branches of most of the world’s 50 largest banks. The British Virgin Islands (“BVI”) are home to more than 400,000 offshore companies, and financial and legal services in connection with these are one of its major sources of employment. At the same time, the BVI government is committed to transparency with respect to beneficial ownership.
Bermuda reports the world’s fourth highest per capita GDP in the world, over US$100,000, if one takes into account the revenues of offshore corporations passing through that country. The Turks and Caicos Islands, whilst smaller, is a niche jurisdiction, offering friendly and efficient boutique services against a backdrop of wonderful beaches and fine hotels. Many Offshore Finance Centres are current or former British Colonies and / or associated states located in the Caribbean, North Atlantic and the Channel Islands. They are characterised by the following:
- A legal system based on English common law with a generally independent and non-corrupt judiciary;
- Strict regime of supervision by financial services authorities, generally headed by people with international financial experience (which require trust companies and banks to maintain heavy insurance cover).
Most of the offshore jurisdictions provide similarly attractive regimes, so the decision as to which one to use will, to a degree, depend on personal preference. Skilled and efficient trustee and corporate services are available in most of them. One important factor in selecting a jurisdiction is the ease with which you can travel there. In the modern telecommunications era, it is not essential to ever set foot in the jurisdiction. However, there is much to be gained by making at least an initial visit to familiarise yourself with the jurisdiction in general and the trustees in particular. This consideration may make the North American investor select the Turks and Caicos Island or the Bahamas over, say Lichtenstein or the Cook Islands. Ease of communication with regard to time zones may also be an important factor to consider.
Asset Protection
Historically, trusts evolved in medieval England as a means of protecting assets. This was achieved by having another trusted person hold legal title to assets on behalf of (or in trust for) another. The donor would put assets into trust on behalf of minors or mentally incapable dependents.
The “spendthrift trust” can provide support for a dependent who cannot be relied on to take proper care of his money. If a person is of such a character, rather than leaving him a lump some of money in a will, a discretionary trust can be established to provide support as needed. The terms of a trust can include a provision that no money may be paid to a beneficiary who is bankrupt.
People of substantial means who are, or may be, at risk in the future from unwelcome litigation should give consideration to establishing a trust. This can include people in professions with a risk of liability that might exceed the amount of their insurance. People in business are often sued for the debts of a failed business. Sometimes personal liability is imposed even if their business was operated through a corporation. While we like to think of our legal system as fair, court awards of damages can be unpredictable, and large damage awards against a defendant are sometimes as much a matter of bad luck as of objective culpability. On occasion, even people who were reasonably careful and prudent in their business and professional dealings can find themselves hit with immense and crippling damage awards that could ruin them financially. Reversals of fortune that lead a person from riches to rags are the stuff of soap operas, but it can sometimes happen in real life.
Once assets are transferred into the name of the trustees then, after a prescribed period, creditors are no longer able to execute against such assets. This is because the Settlor has divested himself of legal ownership. Asset protection may be obtained by establishing trusts both in your home country and offshore. The advantage of establishing a trust in one of the offshore finance centres is their prevalent debtor friendly regimes. These shorten the period of time in which a creditor may bring proceedings to attack the establishment of the trust or settlement of specific assets into the trust. The jurisdictions range geographically from the Bahamas to the Cook Islands. Trusts established in the debtor friendly jurisdictions are typically referred to as Asset Protection Trusts.
The Cook Islands provides particularly large hurdles for a creditor to overcome. First, he must seek the leave of the court in Rarotonga to bring the action. Secondly, if leave is granted, he must prove beyond reasonable doubt (the criminal standard) that the transfer into the trust was made with the intention of defrauding a creditor. No action may be brought in respect of any transfer that took place before, or more than two years, after the cause of action arose. If the settlement takes place within the two-year window, then the creditor must bring an action in the Settlor’s home jurisdiction within 12 months of the transfer of assets to the Cook Island trust alleging some sort of debt or damages. He must then commence a further action in the Cook Islands’ courts within two year of the transfer of assets into the trust. If the creditor does not comply with both of these limitation periods, then the claim will be statute barred.
The Cook Islands marks the high-water mark of protection against creditors. Caribbean jurisdictions such as the Turks and Caicos Islands have similar regimes but are slightly more neutral.
In the Bahamas, The Fraudulent Dispositions Act establishes a 2-year limitation period for creditors’ attacks on asset protection trusts; the attacker has to prove fraud by the settlor.
Even if fraud is proven, beneficiaries who have received benefits from the trust are permitted to retain what has been distributed to them unless they themselves acted in bad faith. In Barbados, creditors have three years to apply to set aside the terms of a trust. An intention to defraud, on the part of the debtor, must be established. A successful creditor can only set aside such parts of the trust as have caused him prejudice, not the balance.
Once a trust is established, legal title rests with the trustees and not the settlor. His family may become beneficiaries and entitled to receive discretionary distributions, but, with a properly established trust, there is no right on the part of the beneficiaries to require payments to satisfy their creditors. Accordingly, execution against such a beneficiary could prove fruitless.
Some of the advantages of utilising offshore trust for asset protection purposes include the following:
- The geographic distance between your home country and the offshore centre makes an action against the trust more difficult to pursue. To use an extreme example, the distance, as the crow flies, between Calgary, Alberta and Rarotonga, Cook Islands is 11,670km. To fly there from Calgary takes a minimum of 24 hours in the air changing planes in Los Angeles and Papeete, French Polynesia.
- Foreign judgements normally are not recognised in offshore jurisdictions. A plaintiff will therefore have to litigate the entire action afresh in the offshore court, always assuming that the offshore court agrees to accept jurisdiction, which it may not.
- Should the action be permitted, then substantial costs will be incurred in prosecuting the action offshore.
- Time zone differences make it difficult to speak to lawyers by telephone. Distances preclude satisfactory conferences and briefing of witnesses ahead of travel to the offshore jurisdiction. Lawyers’ hourly rates may be substantially higher, owing to the difficulty of attracting lawyers willing to practice in such locations.
- It will be logistically difficult and expensive to transport witnesses to give evidence.
Laws governing the trust will be those of the offshore jurisdiction. The laws of the offshore jurisdiction are likely to be much more favourable to the debtor than the creditor. Generally, the self-interest of an offshore finance centre is best served by a legal regime that upholds the sanctity of a trust under attack from disgruntled creditors of the settlor. In most offshore finance centres, a high proportion of the population is employed in the trust and banking sector. Allowing trusts to easily collapse ultimately leads to the destruction of an important industry. Overseas investors will be unwilling to have their trust administered in a jurisdiction that allows the interests of overseas creditors to prevail.
The net result is to discourage frivolous lawsuits and to encourage reasonable settlement offers from more legitimate complainants.
Freedom from probate (impost and confidentiality)
Upon death, details of assets that have to be probated become a matter of public record. There is no requirement to make public details of assets that one settles into trust prior to one’s death. Probate fees (however described) are charged in most cases on the value of assets probated on death. These charges cannot be levied if the assets are already settled into an inter vivos trust, as the assets no longer form part of the deceased’s estate.
Many of these benefits can currently also be achieved in Canada by using a domestic trust to avoid probate. However, there is a risk that in the future the pressure of government deficits will lead to the diminution of such protection through domestic trusts. Whether such future changes in Canadian laws could reach an offshore trust remains an open question. In an uncertain world, risk can be mitigated through diversification.
Ease of Administration of Assets and Continuity
One problem that manifests itself, particularly in the context of family businesses, is that of ownership of shares in the holding corporation by siblings, irrespective of their knowledge of the business and involvement in its day-to-day activities. For example, one child may have dutifully entered the family business upon completion of his education. Another may have pursued a career as a musician. It is unlikely that the latter sibling will be able to make the same contribution to business discussions as the former.
Also, health or psychiatric problems may hinder family members, who have the best intentions, from properly exercising their rights as shareholders. Family disputes and lack of capacity can frequently bring down a family business. An offshore discretionary family trust can be used to overcome these problems. Ownership of shareholding is vested in the trust. The trustees decide who shall sit on the board of directors. The trust receives dividends paid by the company. The trustees then distribute income received by the trust from the company according to the need of the beneficiaries, having regard to their duties as trustees, which require them to act in an even- handed manner. Further, upon the death of any family member, there is no issue pertaining to transfer of ownership of shares. The interest of the deceased in the trust is transferred on, according to the provisions of the trust deed.
Perpetuity Period
In some countries, there are remnants of what is known as the Rule against Perpetuities. A complex rule that serves to limit the duration of a trust, by requiring that an interest thereunder vest within the period of a life in being at the date of settlement plus 21 years. Although modified by statute, the rule can lead to a lack of certainty and a shorter dura-tion for the life of a trust than is desired. Most offshore jurisdictions have codified their trust law to provide for a fixed term for trusts, typically, 80 years. In 2004, the Bahamas extended their perpetuity period from 80 to 150 years. In 2006, Jersey amended its trust law to provide for trusts of unlimited duration.
Political stability
Many North Americans have fears as to the complexion of future governments and prefer the prospect of having assets held in a trust based in, say, The Isle of Man, which is politically stable and conservative. The legislature of this country, The Tynewald, is 1,000 years old, making it the oldest parliament in the world. The “offshore” world now is accepted as including Switzerland, whose political confederation dates back to 1201. It has also enjoyed legislated neutrality in international conflicts since 1815. The trust industry is prominent in both countries.
Tax Savings
The primary reason for setting up an offshore trust should be asset protection. In most cases, offshore trusts will not be of assistance in providing any legal saving of income tax.
In the past, if a trust was managed by trustees who resided in the foreign jurisdiction, income earned within the trust would be exempt from Canadian income tax. In the high profile 2012 Supreme Court of Canada decision in the Fundy Settlement case, trusts were set up in St. Vincent in the Caribbean, which held shares of a Canadian auto parts manufacturing company. The shares were sold for a capital gain of several hundred million dollars. The intention of the owners was that the gains would be exempt from Canadian income tax. In this case, the trusts failed to protect the income from Canadian taxation, because it was found that they were not genuinely resident in the Caribbean. Canadians retained effective management and control, and therefore the trusts were deemed to be residents of Canada.
More recently, the law has been changed so that there would not be any tax savings even if money is placed in trusts that are genuinely resident in an offshore location. As of 2013, section 94 of the Income Tax Act was amended by Parliament. The result is that if a foreign trust receives contributions from a Canadian, or pays its income to a Canadian beneficiary, it will be taxed as if the income was earned in Canada. Canadians who receive income from an offshore trust are required to file a Form T1142, “Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust.” These rules apply even for an extended period after a person emigrates from Canada. E.g., a contribution made by a former Canadian for up to five years after emigrating will be captured.
There is, however, one significant situation where the offshore trust can still provide tax benefits. This may apply to Canadians who are immigrants and who have wealthy parents or grandparents in foreign countries who were never residents of Canada. Such trusts are sometimes referred to as “granny trusts,” as something that might be provided by a rich foreign grandmother to a Canadian grandchild. A trust set up by such a person in a tax haven can earn income at the low tax rates that exist in the haven. Subsequently, the trust can make distributions from its capital for the benefit of the Canadian resident free of tax.
This is a more tax-efficient way for the Canadian resident to receive an inheritance from a foreign country, rather than having all the capital delivered to Canada immediately. It also means that the Canadian resident cannot have any role in deciding how the money held in trust is invested, which may be a good or bad thing depending on the investing acumen of the individual concerned. A large portion of Canada’s population consists of immigrants, and therefore this can be a significant consideration for many Canadians.
Asset Protection within Canada
As a preliminary point, it should be said that prior to considering any form of offshore structure, one should always look first at structuring for greatest safety within your own country.
Domestic structures may be appropriate in terms of ease of establishment and cost. Since asset protection and tax structuring may be available onshore, you should always look, initially, at means of achieving your ambitions within the domestic context. One means of doing this, which also provides tax benefits, is to make sure to maximize contributions to Retirement Savings Plans (“RRSPs”).
In Canada, section 67 of the Bankruptcy and Insolvency Act (“BIA”) exempts RRSPs and Registered and Registered Retirement Income Funds (“RRIFs”) from forfeiture (except for deposits made within the 12 months prior to bankruptcy).
In addition, section 67 of the BIA exempts any funds held in trust by the bankrupt debtor for another person. A trust allows the donor to retain control over investment decisions and have discretion over the distribution of the funds, even though he is no longer the beneficial owner of those funds once they have been donated to the trust. Therefore, if a person establishes a trust, e.g., donating assets to the trust for the benefit of his spouse, children or grandchildren, the assets in that trust would in principle be exempt from seizure. However, section 96 of the BIA can by used to attack such donations. Any such donations made up to five years before the bankruptcy could potentially be subject to seizure if it can be proven that the donation was made with the intention of frustrating the claims of creditors. As noted above, some of the offshore jurisdictions have a much shorter limitation period than Canada for this purpose.
Section 67 of the BIA also exempts from seizure “any property that as against the bankrupt is exempt from execution or seizure under any laws applicable in the province within which the property is situated and within which the bankrupt resides.” This varies from province to province, but usually includes insurance policies and assets in registered pension plans.
In that regard, it is important to note a distinction between provincially regulated registered pension plans
Therefore, while some significant asset protection is available under domestic Canadian law, it still falls well short of what can be achieved in offshore jurisdictions.
Which Jurisdiction is Best for You?
Make a shortlist of jurisdictions that have the asset protection regime and professional services you and your adviser feel comfortable with. Go and have a look. Find out which jurisdiction leaves you with a good feeling. Sample the beaches, hotels and restaurants in the context of an easy plane ride from your country of residence. Then choose a place that you enjoy going to, so that meetings with trustees and bankers are a pleasurable experience.
Andrew Rogerson is Toronto lawyer with many years experience in offshore asset protection. He is a Fellow of the Society of Trust and Estate Practitioners (STEP). His practice encompasses Estate Planning and Asset Protection. This article was originally Chapter 59 in T.A.S.K., published by Lexis Nexis, https://www.rogersonlaw.com/wp-content/uploads/2019/02/Chapter59.pdf. It has been updated with the assistance of Peter Spiro.
This article is provided for general information, and is not intended as legal advice for your personal situation.