Balancing act

Tuesday, 01 May 2012
The equal challenges of understanding trusts and foundations.

Although our Society carries ‘trust’ prominently in its name, from the viewpoint of many civil-law jurisdictions, the trust is an outrageous concept. For a civil-law practitioner, it is hard to understand that ownership in strict law may rest with the trustees while ownership in equity rests with the beneficiaries. The concept becomes even more mind-twisting when it comes to the trust fund. It may be variously invested without altering ownership right. This illustrates a concept of ownership most civil-law jurisdictions are unfamiliar with. Not surprisingly, German lawyer Otto von Gierke said, when speaking to F W Maitland about the concept: ‘I do not understand your trust.’1

As the uses of trusts are manifold, it does not have one single civil-law equivalent. However, the foundation has similarities with a trust, such as having its roots in medieval times. Godly founders would spare monies primarily for charitable purposes or to secure their own participation in paradise, e.g. by paying the church for continuous prayers for their souls. For example, the Bürgerspitalstiftung (citizens’ infirmary foundation) in Wemding, Bavaria, was founded as early as the 10th century to finance an infirmary. This foundation is still active. Today, foundations play an important role in many civil-law jurisdictions, such as Austria, Germany, the Netherlands and Switzerland. In others, such as France, where foundations were forbidden between 1791 and 1983 (Loi Le Chapelier), foundations have only slowly and recently regained importance.

Most jurisdictions allow foundations to be structured either as legal persons (corporations) or as separate estates without legal personality. In the latter case, ownership of the foundation’s assets is held by an administrative body, e.g. a corporate foundation, which is contractually obliged to administer the assets in pursuance of the foundation’s aims, bringing such dependent foundations close to the structure of a trust. Usually, foundations are represented by a board of directors who are, in turn, controlled by a supervisory body, usually a council.

In many jurisdictions, e.g. Austria, France, Germany or Malta, foundations are not restricted to charities but may pursue purposes that are solely private, like the support of the founder’s family. All this should appear familiar to common-law practitioners, but what makes them difficult to understand is the issue of ownership. There is no owner, or, to put it another way, the foundation belongs to itself. This is quite extraordinary. The Bürgerspitalstiftung in Wemding has existed for more than 1,100 years without anybody ever owning it!

‘Trusts are rarely appropriate for reducing the level of tax for settlors or beneficiaries in civil-law jurisdictions’

Like trusts in common-law jurisdictions, in many civil-law jurisdictions foundations have become important structures for estate and tax planning and asset protection. In cross-border estate planning, however, the use of trusts and foundations may still be regarded as underdeveloped. Only a few civil-law jurisdictions have enacted comprehensive rules on taxing trusts. Malta and Switzerland are two of the few positive examples. The others more or less rely on a case-by-case assessment on the basis of a comparison between the individual trust and the legal structures the respective jurisdiction is familiar with.

In general, I think it is fair to say that trusts are rarely appropriate for reducing the level of tax for settlors or beneficiaries resident in civil-law jurisdictions. Under German tax law, for instance, gift tax is levied not only on the funding of a trust, but also on distributions. Distributions may also be subject to income tax and, subject to the German controlled foreign corporation rules, trust income may be attributed to German resident beneficiaries, making trusts widely unattractive for German taxpayers.

But you must not overgeneralise. If a trust is settled by a foreign resident settlor, no German gift tax applies to its funding. This makes a trust a perfect means of inheritance and gift tax deferral because no gift or inheritance tax is triggered when the settlor passes away. Gift tax only applies to distributions. From a tax viewpoint, a trust offers the opportunity to park the ownership of the trust assets in a gift-tax nirvana, potentially making the trust a savings box for years.

It is only fair, isn’t it? While civil-law practitioners have to understand split ownership of trust assets, common-law practitioners have to cope with the idea of non-owned foundations. The tough question is: will the tax collector always keep pace?

This column will run every issue, written by authors from different civil-law jurisdictions. Those interested in contributing should email [email protected]

  • 1. Maitland: State, Trust and Corporation, by F W Maitland, edited by David Runciman and Magnus Ryan, Cambridge University Press 2003.
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Dr Daniel Lehmann

Dr Daniel Lehmann TEP is a Partner at RölfsPartner in Munich.

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