Families’ personal situations, as well as their investments, are becoming multi-jurisdictional. In parallel, tax and reporting requirements are becoming more complex. Safe and efficient tax and wealth structuring require, more than ever, flexible solutions and multi-dimensional attention. Wealthy families increasingly consider trusts to meet the complexity of their multi-faceted connections and cross-border activities. However, due to the special features of the trust, it’s not without its challenges. It’s important to understand what the risks are and where they are present. It starts with understanding trusts. We will explore the trust concept from 5 different perspectives, with a special look at Switzerland and its project to introduce a Swiss trust.
What is a trust? Understanding them from every perspective.
A brief history
The trust is, in accordance with its name, based on trust. It goes back to the 12th century and the time of the crusades under the King of England. When a landowner left England to fight in the Crusades he conveyed ownership of his land to a trusted person to hold and manage the estate for the benefit of his family.
From a conceptual perspective
A trust is not a legal entity. It’s a contractual arrangement where assets are transferred by “the Settlor” to “the Trustee” to hold and manage the assets for the benefit of others, “the Beneficiaries” according to specific objectives or for a specific purpose.
By the settlement, the settlor surrenders his ownership of the assets. The Trustee has a fiduciary duty to act in the best interests of both current and future beneficiaries and can be held personally liable for any breach of that duty.
There are a variety of different types of trusts. An essential feature to determine is whether the trust is revocable or irrevocable, i.e. whether the Settlor can claim back the assets or not. Equally important is whether the trust comes with a “fixed interest” or if it is a “discretionary trust”. In the latter case, the beneficiaries have only an expected right to the trust assets until the Trustee executes his discretionary powers to decide if, when and how a distribution shall be made.
The legal perspective
One of the main reasons why a trust can be misunderstood relates to the principle of separation of legal and economic ownership. This is a feature of common law, the legal system found principally in Anglo-Saxon countries. The trustee is said to have an ownership in law, whereas the beneficiary has ownership in equity. In civil law, the legal system developed from Roman law, ownership cannot be divided. It can only provide limited beneficial rights such as usufruct or supervisory rights, such as guardianship. Civil law also knows the concept of “fiducie”, but the fiduciary never owns the assets. When the two legal systems are confronted, uncertainty arises.
As an example, when a settlor transfers assets to a trust; considering that the trust is not a legal entity, the trustee is not the economic owner of the assets, and if no beneficiary has received a definite right, then who receives the assets from a civil law perspective? Or, when a beneficiary in a civil law country receives a distribution from a trust; from whom is the distribution received? From the trust, the trustee or the settlor?
From a tax perspective
The tax treatment of the parties to a trust and the related transactions differs widely between countries and, while trusts can offer important benefits, they can also imply disastrous drawbacks if organised or managed poorly.
The fact that the trust is not a legal entity often implies that tax liability is attributed to either the settlor or the beneficiaries. If the settlor has retained certain control, if the assets can be revoked or if the trustee is not acting sufficiently independently, the settlor can be considered still being the owner. Sometimes the trust can even be considered as a sham and treated as void.
The tax treatment will also depend on whether the beneficiaries have received absolute rights (“fixed interest”) to the assets or thereto related income, in which case tax liability can be triggered even if the assets remain with the trustee and nothing has been distributed.
In some countries, a trust is treated as a tax subject despite not being a legal person. It is also important to understand the responsibility the Trustee has for paying taxes relating to the ownership of the trust assets.
Understanding trusts from a Swiss perspective
Although Switzerland has been working with trusts for centuries, there has never been such thing as a Swiss trust. However, through the ratification of the Hague Trust Convention in 2007, Switzerland formally recognise the trust as an institution of its own kind. Swiss tax law also lacks reference to trusts but a “tax circular” serves as a basis to standardise the tax treatment among the federal and cantonal tax authorities. According to the Circular, the tax liability is placed either on the settlor or the beneficiaries, depending on the character of the trust and the tax residence of the parties. From a Swiss tax perspective, trusts are today especially attractive for pre-immigration planning.
Switzerland already has specific land registration rules for trusts holding real estate and financial laws were enacted in 2020, regulating the trust business for Swiss-based trustees. Now the final step, that of a proper Swiss trust, is on the doorstep. The draft law was published on 12 January 2022 and is in consultation until the end of April 2022.
One of the arguments for the parliamentary initiative is that a Swiss trust would offer Swiss residents a flexible succession planning and wealth structuring instrument, more accessible and easier to understand than a foreign trust. The objective is also to offer trusts in the context of commercial transactions. Integrating the trust in its own legal system offers undeniably higher legal certainty.
The proposal is however not without its challenges. Academics and professionals debate whether the trust is necessary besides the already existing instruments such as family foundations, usufruct and fiduciary contracts. There is also a conceptual challenge as to the choice of legal model and how it can relate to other known civil law concepts and principles.
Forced heirship rules, an important principle in civil law, is another challenge surrounding trusts. Trusts are typically used for flexible succession planning and to protect parties such as unmarried or same-sex partners, those generally not covered by the ordinary legal system. Switzerland will continue to apply forced heirship rules, which nevertheless will be modified as from 2023, according to already enacted laws.
The wealth planning industry has placed high expectations on a Swiss trust, which would provide new possibilities and increase the understanding, recognition and appreciation of trusts overall.
The trust to accompany the family’s long-term success
One of the principal advantages of a trust is the flexibility it offers through the possibility to adapt to unexpected situations and changing circumstances. The trustee’s duty to act in the best interest of all the beneficiaries requires both an agile and holistic approach, where both the individual and the family’s needs are considered.
If organised according to the family values and visions and accompanied by professional tax advice and management, a trust can be an excellent tool for efficient wealth structuring and safe generational wealth transfer. It can also serve well for consolidated commercial investments and asset protection.
Understanding the features and advantages of trusts open interesting opportunities. Understanding the challenges is equally important. With the proper attention, the trust can be well worth considering for responding to a family’s long-term visions and goals. Perhaps your next trust will be Swiss?