Asset Protection

9.1.1 INTRODUCTION:  At simplest, a Trust can be used by itself.  It will be formed in an Offshore low-tax jurisdiction, outside the United States, with an independent Trust Company appointed as Trustee.

9.1.2 The Trust will be irrevocable and discretionary.  The Settlor will be capable of benefiting from the Trust Fund at some future time when liability to creditors is no longer an issue: this can be achieved in either of two ways:

• Either by the Settlor receiving assets as a distribution to him/her as a beneficiary;
• Or by the Trust becoming revocable after a certain period and the Settlor then exercising his/her power to revoke it.

9.1.4 The Settlor may retain the power of appointing new/successor Trustees, but he/she will be excluded from being so appointed.  As a further refinement, this power can be vested in a Protector, or a Committee of Protectors.

9.2 UNDERLYING COMPANIES:  In addition, the Trust may incorporate a new Offshore Company to act as its underlying investment holding company.  This wholly-owned subsidiary of the Trust would open bank and brokerage accounts, and thus hold the Trust Fund indirectly for the Trustees.  See also 9.3.4 below.

9.3.1 UNITED STATES INCOME TAX ISSUES:  The United States Income Tax treatment of the Trust is of ethical importance.  In general, the Trust should be Tax neutral.

 There are two alternatives:

• Either the Trust can be configured as an Offshore Grantor Trust for United States Income Tax purposes under IRC S.671 - 679, in which case the Settlor remains liable for all reporting and taxation issues; or
• The Trust can have two or more co-Trustees who are United States residents or Citizens, in which case the Trust is classified as a "United States Trust", and is taxable in the United States on its income and gains.

9.3.3 If the second alternative is used, the Trust must contain "anti duress" provisions, enabling the Offshore co-Trustee to fire the United States co-Trustees in the event the latter become subject to Court Orders in the home country directing them to take particular action with regard to Trust assets.  The Trust will thereby become "wholly Offshore", so the same result is achieved in the end.  The purpose of an anti-duress Clause is of course to protect the Settlor against coercion by their Courts of his/her jurisdiction, and consequent exposure to perjury charges for failure to comply therewith.

9.3.4 Also in relation to the second alternative, if a United States Trust is used, it might have a wholly-owned subsidiary incorporated in Delaware.  The Delaware Holding Company would elect taxation in the United States as a Sub-Chapter S Corporation.  See also 9.2 above.

9.3.5 Reportings and Filings are discussed at 10.3.2 below.

9.4 FEDERAL ESTATE AND GIFT TAX ISSUES:  In order to avoid the Gift Tax provisions of Code Section 2501 and 2511, the Transferor/Settlor should make an incomplete gift.  This can be accomplished by the Settlor reserving a power in the Trust Agreement such as the power to add or delete persons as Beneficiaries, with the consent of the Trustees.  Also, to remove and appoint Trustees.  The Settlor should also file a Gift Tax return in respect of the incomplete gift, disclosing all relevant facts including a copy of the Trust Agreement (Treasury Regulations on Gift Tax S.25.2511 and 25.6019).

9.5 FEDERAL EXCISE TAX:  Code Section 1491 Excise Tax does not apply on a Transfer of appreciated assets to an Offshore Trust if the Trust is configured as a Grantor Trust (see Revenue Ruling 87-6l).

9.6.1 TYPES OF ASSETS:  In theory, the Settlor is free to Transfer to the Trust any and all assets that he/she wishes to have protected by the Trust.

9.6.2 In practice, Offshore Trustees prefer to receive, and may insist on only receiving financial assets, such as bank deposits and cash-equivalents.  These will be transferred to newly-opened accounts in one or more Offshore banks, in the name of the Trustee.  Investment portfolios and brokerage accounts are as generally acceptable, and are subject to the same procedure.

9.6.3 Offshore Trustees have more difficulty in accepting shares of stock in privately-held United States corporations; and must be even more circumspect about accepting title to Real Estate assets in the United States.  Why?  Because these categories of assets are by definition "United States situs" assets, and as such remain within the jurisdiction of the United States courts.  They therefore remain liable to attachment by Order of a United States Court, on successful suit by a Creditor claimant.  This involves consideration of jurisdictional issues, both in relation to the Trust Fund, and to the Trustee itself (see 9.7 below).

9.6.4 Depending on the State of the Settlor, a range of assets are not attachable in a bankruptcy (e.g. the homestead).  Florida and Texas place no limits on the value of the home. Pennsylvania excludes insurance policies in favor of the spouse or children.  Normally in Creditor Protection Trusts, these 'exempt' assets are not among those transferred to the Trust.

9.7.1 JURISDICTIONAL ISSUES:  In relation to jurisdiction over Trust Assets, the Trustee must be mindful of extra-territorial jurisdictional aspects in relation to opening accounts for the Trust with banks or brokers within the United States.

9.7.2 Effectively it is open to a Judge in the Onshore proceedings to disregard the structure created by the Settlor vis-à-vis assets remaining in the United States, and Order direct attachment of the United States assets.

9.7.3 Some United States Advisors recommend against the CPT holding United States Dollar deposits, as by their very nature, these are always (ultimately) Onshore United States assets.

9.7.4 It is possible for United States situs property such as Real Estate, Sec. 144 stock, or accounts receivable to be sold, or mortgaged for cash, and the resulting liquid assets transferred to the Offshore Trustees.

9.7.5 In relation to jurisdictions over the Trustee itself, if the Offshore Trustee is a subsidiary of an Onshore Parent, then Creditors may try to "short circuit" enforcement against the Offshore structure by a direct attack against the Onshore Parent.  This further jurisdictional aspect of the Trustee itself having a United States branch, subsidiary or presence is also critically important, but a detailed consideration of this is beyond the scope of this Paper.

9.7.6 It should be noted that most United States Banks/Trust Companies do not accept United States persons as clients of their International Private Banking Divisions, which generally include their Offshore Trust Companies.

9.8.1 LIMITED PARTNERSHIPS:  There are other more sophisticated structures, involving the use of United States Limited Partnerships.  In these, the Settlor becomes the General Partner of the Partnership, and the Offshore Trust is the Limited Partner the Settlor, as General Partner, usually has a 5% or less interest in the assets of the Partnership, and the Offshore Trust has a 95% or more interest.  The Settlor transfers his/her assets to the Limited Partnership, and continues to manage them.

9.8.2 This type of planning takes advantage of the provisions of Article 7 of the Uniform Limited Partnership Act 1976 (as amended) relating to the nature of a partnership interest, assignment thereof, and rights of creditors.

9.8.3 If a Creditor obtains an 'onshore' judgment against the Limited Partnership, he/she cannot under present law force the Limited Partnership to make cash distributions or to sell the assets of the Partnership to satisfy the judgment.  The creditor's claim is thus satisfied by a charging order, the effect of which is normally held in suspense, although this principle may be being eroded.

Centurion Corporation v. Crocker National Bank, 255 Cal Rep. 794 [1989].

9.8.4 Meanwhile, the creditor becomes a substituted Limited Partner for United States Income Tax purposes, and must report and pay tax on the phantom income of the partnership.  The Creditor is thus responsible in Law for Income Tax on the asset of which he/she is not yet the legal owner.  There is thus a deterrent effect on the creditor.

9.8.5 The Offshore Trust remains in a back up role, until such time as the Partnership is wound up, at which point the assets are owned direct by the Offshore Trust.  An Offshore Trust can of course own interests in a series of Limited Partnerships, each of which would have different types of underlying assets.

9.9 INSURANCE:  The Trustee should also check with its own Insurers that its normal policy will remain effective in relation to CPTs.  Trustees may end up declining certain types of CPT business for this reason, which may in turn become a limiting factor in the growth of this market.