Recognition of foreign trusts
Many wealthy Latin American families turn to foreign trusts to protect their assets and to achieve efficient tax and estate planning. Which are the key points to consider when dealing with Latin Americans using trusts outside their home jurisdiction?
I will briefly address the three most important topics to answer that question: a) recognition of foreign trusts by Latin American countries, b) relevance of forced heirship rules and c) tax requirements for efficient tax planning. I will finish with the scarce relevant case law on these subjects.
Recognition of foreign trusts
Although Argentina, Brazil, Chile, Ecuador, Mexico, Panama, Paraguay, Peru, Uruguay and Venezuela are all members of the Hague Conference on Private International Law, none of them, nor any other Latin American country, ratified the Convention of 1 July 1985, on the Law Applicable to Trusts and on their Recognition, which entered into force on 1 January 1992.
Undoubtedly, ratification would be helpful to avoid the current concerns. However, considering the existence of domestic trust regulations in: Argentina, Bolivia, Brazil, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Panama, Paraguay, Peru, Uruguay and Venezuela, and even regulations on taxation of foreign trusts benefits in several of these countries, it is reasonable to assume that foreign trusts would be recognised. In fact, as explained below, case law related to foreign trusts has recognised them expressly or implicitly.
As mentioned in a previous article (STEP Journal – January 2010), trusts are used in Latin America mainly as business trusts (ie for real estate developments, commodities production or forestry developments) and guarantee trusts. Why is there little use of trusts for wealth protection or estate planning with trustees in Latin America? Arguably, Latin American wealthy clients look for foreign jurisdictions for political risk protection and avoidance of forced heirship (in essence, a restriction to the freedom to draft a will that gives the surviving spouse, children and/or other relatives fixed shares of the estate).
In short, estate planning could only be achieved by a Latin American settlor if the trustee and the trust assets are located in a jurisdiction that would reject an order of a judge of the last domicile of the settlor.
The exception in Latin America is Panama, where not only is there no forced heirship but also Panamanian private-interest foundation law specifically addresses forced heirship rules of the founder’s jurisdiction, stating that the Panamanian judge would not consider such rules applicable to the foundation.
Many Latin American wealthy people create trusts and not only transfer formal ownership, but also actual control over the assets transferred to the trust. Therefore, they reduce their wealth tax basis and exclude any income arising from such property from their income tax. Nevertheless, in certain cases, these trusts have been challenged by the tax authorities. Which are the characteristics that a trust must have in order to avoid (or successfully overcome) such a challenge? A list based on experience and case law can be drafted as follows:
- 1Independent trustee: the first and most obvious requirement to consider in order to ensure that the settlor does not retain sole control over the trust assets is to ensure that the trustee is independent from him or her.
- Clear proof of the date on which the creation of the trust and the transfer of property took place: this point includes the notarisation of the trust deed, the notarisation of the instrument of the transfer of property (ie the transfer of shares of a company) and copy of any necessary notification (ie to a debtor if the asset transferred is a credit or to the company that issued the shares), and if the settlor is executing the deed through a power of attorney, the notarisation of such document.
- Irrevocable trust: if the trust is revocable, the tax authorities would consider it a mere investment mandate.
- Actual transfer of property and control from a substantial point of view: this is one of the most delicate requirements because the desire of the settlor to give instructions to the trustee must be balanced with the necessary actual loss of control over the assets. On the other hand, purely discretionary trusts have been challenged by tax authorities as ‘unbelievable trusts.’ In other words, it was considered unbelievable that a wealthy person should transfer a substantial portion of his or her assets to an independent trustee with no instructions at all.
- One of the most frequently asked questions by the tax authorities is: ‘if you are not in charge of the investment of the assets, who is?’ The trust deed must provide a crystal clear answer to this question and if the person in charge of administration is not the trustee (ie a financial advisor hired by the trustee), the trust deed must have a replacement procedure to avoid any doubt, which states that the settlor cannot be appointed as financial advisor nor can any related party to the settlor.
- Beneficiaries cannot be replaced by the settlor: at least, it must be established in the trust deed that the settlor, or any company controlled by him or her, cannot be appointed as trustee.
- Acceptance by the beneficiary: under several Latin American jurisdictions, donation must be accepted and ‘contracts in favour of third parties’ must be accepted by such third parties to became binding. If they are not accepted, they can be revoked. A trust scheme was challenged based on the fact that as the beneficiaries did not accept the benefits emerging from the trust deed, it was not an irrevocable trust. However debatable, this is a requirement that must be carefully evaluated.
- Independent protector: although a protector is someone close to the settlor that has his or her confidence, and it is of the essence of that appointment to appoint a related party, in certain cases the tax authorities considered that the existence of such a protector with wide powers is proof of the actual control of the settlor over the trust assets.
Relevant case law
Foreign trusts were the subject of discussion in the following cases:
Vogelius (Buenos Aires City’s Civil Chamber of Appeals, 2005)
Mr Vogelius transferred to a trust the rights over the basement, garage and first floor of 149 Abbey Road, Camden, London and appointed two of his sons (out of a total of five) as beneficiaries of such trust. The widow and other sons of Mr Vogelius (that were not appointed as beneficiaries of the said trust) started the probate procedure in Buenos Aires (last domicile of Mr Vogelius) and requested that the beneficiaries of the trust be considered as receiving a prepayment of the estate to be distributed. Therefore, the other assets of Mr Vogelius had to be distributed in greater proportion to those that were not beneficiaries of the trust, to compensate such benefit.
It follows from experience and case law that foreign trusts would be recognised by Latin American countries that have domestic regulation of this legal scheme
The key part of this court decision is that the Court ruled that: ‘trust is not a legal scheme unknown to our law and therefore section 14 of the Civil Code is not applicable.’ The said section 14 of the Civil Code provides the cases in which foreign law is not applicable in the country. In short, the Court clearly recognised the foreign trust as a valid legal scheme.
Moreno (Buenos Aires City’s Administrative Litigation Chamber of Appeals, 2007)
The Court, although not in the holding, sustained that foreign trust form and validity of foreign instruments (including trust deeds) are ruled by the law of the place of creation and no challenge to its recognition should be made.
Eurnekian (Buenos Aires City’s Criminal Court of Appeals, 2004)
This is a tax case in which the tax authorities argued that the settlor was still in control of the assets of the trust and that such assets should have been included in his Personal Wealth Tax return. The Courts rejected the tax authority’s position. It must be stressed that the tax authorities’ unsuccessful challenge was based on a substance-over-form rule, and the validity of a foreign trust was never in question.
Deutsh (Buenos Aires City’s Criminal Court of Appeals, No final decision yet)
This is also a tax case. Tax authorities started a criminal action against a renowned businessman, arguing that the foreign trust he had created was a sham trust with the sole purpose of avoiding taxation (translated using ‘Cadbury’ ECJ decision terms, a wholly artificial arrangement intended to escape tax).
Although Latin America comprises several countries and any rule about the area must be considered a generalisation that may have exceptions, it follows from experience and case law that foreign trusts would be recognised by Latin American countries that have domestic regulation of this legal scheme. Nevertheless, this does not mean that any foreign trust would prove efficient for tax and estate planning if key conditions are not met.
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