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Session Reporter

Lars Glaeser

Schindler Attorneys, Vienna

lars.glaeser@schindlerattorneys.com

 

New Era of Taxation, Toronto, 7–8 November 2019

Session Co-Chairs

Valeria D’Alessandro GSHR – Goldemberg Saladino Hermida Rolado & Asociados, Buenos Aires

Victor Alexander Jaramillo Caplin & Drysdale, Washington DC

Speakers

Fabiola Diaz Prado Anaya Abogados, Mexico City

Guadalupe Diaz Sunico Lener, Barcelona

Sunita Doobay Blaney McMurtry, Toronto

Eva Stadler Wolf Theiss, Vienna

Claudia Suter Homburger, Zurich

Fabio Wagner KPMG Brazil, São Paulo

 

Introduction

Co-Chair Valeria D’Alessandro opened the session by emphasising that, although the topic is quite new for some jurisdictions, structures including trusts and foundations are considered to be very attractive and there has been an increase in respective tax planning over the past few years. However, tax-efficient wealth management planning has faced fundamental changes within the last decade due to exchange of information policies, the trend to establish or increase inheritance and wealth taxes, G20/Organisation for Economic Cooperation and Development (OECD) initiatives and, especially, amnesty regimes. Within this new scenario, trusts and foundations have gained special relevance within wealth structuring.

Purpose of a trust

Co-Chair Victor Alexander Jaramillo began by giving an overview on several legitimate non-tax reasons for the establishment of a trust, including the preservation of family wealth, succession planning, asset protection and controlling wealth. However, from his perspective, tax issues are of major relevance in all these structures, especially if United States taxed persons are involved.

Co-Chair Valeria D’Alessandro emphasised that many jurisdictions have already identified the use of trusts as tax planning tools. Under consideration of the general aim to avoid aggressive tax planning, tax administrations may have different tools to tackle such tax planning. It may be questionable whether such structures are considered an abuse of law subject to the application of general anti-abuse rules (GAARs). For instance, in Argentina, a decisive criterion for determining whether or not a structure is considered abusive is if the trust is revocable or not and who is exercising control over the assets. In contrast, Spain, according to Guadalupe Diaz Sunico, would not typically apply GAARs in order to tackle these structures since there are several other tools available. In any event, the main driver for the establishment of trusts is not necessarily tax related but rather asset protection/estate planning.

Taxation of trusts

In most countries, trusts are not considered legal entities. Therefore, the question as to who is considered a taxpayer arises. In a lively discussion, the panellists gave an overview of the main aspects regarding the taxation of trusts, settlors and beneficiaries in their jurisdictions, which can be summarised as follows:

Mexico

In Mexico, according to Fabiola Diaz Prado, only the settlors or the beneficiaries can be considered taxpayers, depending on the specific characteristics of the trust. Almost all revocable trusts are considered owned by the settlor, who in turn is then considered a taxpayer.

However, the Mexican Congress is currently discussing amendments pursuant to which foreign trusts themselves may be considered as taxpayers in future. Although congress justifies the initiative of the amendments by BEPS Action 2 (base erosion and profit sharing), it is questionable if their effects would be in accordance with the final recommendations of this action or if, on the contrary, their implementation may produce new mismatches for reverse hybrid entities. Furthermore, it is uncertain how such amendments would affect applicable tax treaties and how other countries would categorise the Mexican trust and trust income. For instance, Mexico may only recognise trusts under tax treaties if they explicitly refer to the entitlement of transparent entities, as in the Mexico-US treaty. Taking into account that most Mexican tax treaties do not refer to transparent entities, provisions of the tax treaties may not be applicable.

Canada

From a Canadian common law perspective, according to Sunita Doobay, a trust is not a legal entity, yet it is treated as a separate entity from an income tax perspective. Tax treatment is determined by who settled the trust, who contributed to the trust and who controls the trust. If the trust is not controlled by the contributor, the income can stay within the trust and is generally taxed at the highest marginal tax rate or can be distributed to beneficiaries (at potentially lower tax rates). While a Canadian trust may not be very attractive from an income tax perspective, it may be very attractive from a capital gains perspective by allowing beneficiaries the ability to multiply the life-time capital gains exemption on the sale of shares of a corporation which qualifies as a small business corporation, as defined in the Income Tax Act.

If a settlor moves to Canada and has created a trust within five years before moving, the trust will be deemed to be a Canadian trust. Also, if somebody moves from Canada and establishes a trust within five years of moving, Canada will still try to get jurisdiction over the trust if beneficiaries are resident in Canada. If a settlor leaves Canada and dies within 18 months, the estate will be deemed a Canadian trust.

Austria

According to Eva Stadler, Austria does not recognise trusts as legal entities since Austria is not a signatory to the Hague Trust Convention. However, from a tax perspective a trust can either be transparent or non-transparent. If the income of the trust cannot be attributed to any other person based on the trust deed and factual circumstances, the trust itself is seen as a taxpayer subject to corporate income tax.

If the trust is considered non-transparent, there are generally three levels of taxation. First, the transfer of assets to the trust may trigger a transfer tax amounting to 25 per cent, which factually results in Austrian residents never being settlors of trusts. Second, the trust itself is generally taxed on its income at a corporate income tax rate of 25 per cent if the place of effective management is in Austria. Third, distributions to Austrian resident beneficiaries are subject to tax at progressive income tax rates in case they qualify as ‘recurring income’. However, in case of a one-off (non-recurring) distribution, such distribution may be non-taxable.

If a trust is considered transparent, the transfer of assets to the trust is considered tax neutral. The trust itself would not be subject to corporate income tax, but rather the person to whom income is attributed would be taxable on such income. Distributions to beneficiaries will be considered as gifts from the settlor to the beneficiary if the trust’s assets and income are attributable to the settlor. Although Austria does not levy gift tax, a gift notification would generally have to be filed.

Switzerland

Switzerland on the other hand, according to Claudia Suter, is one of the few countries that signed the Hague Convention and recognises trusts. As for taxation, control and power over distributions, respectively, are the decisive factors. Similarly to Austria, a distinction is made between transparent trusts where income is only attributable to the settlor or the beneficiaries and opaque trusts recognising personality for tax purposes. If a trust is considered opaque, it will not be considered subject to wealth tax. Such distinction is, generally speaking, also relevant from a tax treaty perspective. If a transparent trust would receive a dividend, such dividend would be directly attributable to the person(s) to whom the trust is considered transparent. Such person(s) may claim application of the tax treaty.

If a trust is treated as opaque, it may be very useful as a tax planning instrument in order to avoid attribution of assets to the individual. In case of distributions, the amount that is considered a trust fund or capital, needs to be determined. These may be distributed to the settlor without triggering taxes. This is of particular interest for individuals relocating to Switzerland.

Currently, the Federal Council is assessing whether Switzerland should introduce its own trust law. This project is very controversial and it remains unclear whether it will be finally introduced.

Spain

According to Guadalupe Diaz Sunico, Spain differentiates between private foundations, which have a legal personality, and trusts, which do not have legal personality. Regarding trusts, Spain does not differentiate between transparent or non-transparent trusts but simply disregards them as a general rule. Therefore, neither the trust nor the trustee would be considered as taxpayer but rather the settlor or the beneficiary. Historically, as long as the settlor was still alive, it would be fair to say that income was always attributed to the settlor. However, this rule is not so clear today as there is a more case-by-case approach based on the particular trust documents. As a consequence of disregarding the trust, the contribution of the settlor is disregarded and distributions of the trust are considered as direct gifts from the settlor to the beneficiaries and, therefore, subject to gift taxation under consideration of the kinship, which continues to be recognised. Equally, if the settlor passes away, the heir is taxed through an inheritance tax under consideration of the kinship.

Issues typically arise if non-Spanish trusts get a Spanish component. A settlor moving to Spain would be an example of this. In such a scenario, the settlor is still considered the recipient of income and owner of the assets, thus potentially subject to wealth tax. In this respect, so-called ‘blocker structures’, involving companies sometimes in black-listed countries, generally do not work but rather increase tax issues, as controlled foreign company (CFC) rules may have to be considered as well.

In order to determine the taxpayer, Spain follows general criteria. In cross-border scenarios, only few tax treaties refer to trusts, such as, for example, the tax treaties between Spain and the UK or Spain and the United States. Furthermore, it must be differentiated between income and inheritance tax. Mismatches may arise if the estate is considered as taxpayer in some jurisdictions and the heir wants to credit those taxes paid abroad in Spain. This has been accepted in binding rulings.

Brazil

As for Brazil, Fabio Wagner explained that trusts are generally not mentioned in the legislation. There is only general guidance on the determination of the taxpayer for some specific cases. One of the main criteria is whether the trust is revocable or irrevocable, which may also trigger different disclosure obligations. In the case of a revocable trust, it is the common view that the settlor should disclose it. In the case of an irrevocable trust, beneficiaries may be subject to disclosure. If beneficiaries live abroad, arguably no one may be obligated to disclose. Please note that, as a consequence of a tax amnesty in 2016, several Brazilian resident families decided to relocate abroad.

In the case of irrevocable trusts and private foundations, there is no clear guidance. The contribution of the trust should be considered as subject to gift tax at a maximum rate of eight per cent. If assets were already transferred to a trust outside of Brazil, there should be no income taxation in Brazil. Distributions to beneficiaries could be either subject to individual income tax at a rate of 27.5 per cent as asset increase or, a more likely scenario according to Fabio Wagner, subject to the maximum eight per cent gift tax rate as a donation. However, there is currently a discussion in Brazil about whether gift tax may be applied on assets located abroad.

In case of revocable trusts, the assets could be considered as remaining with the settlor. No gift tax is applicable if assets are contributed at cost, which they typically are. Income and capital gains generated by the assets are most likely subject to tax at individual progressive rates from 15 to 22.5 per cent. Earnings would be subject to the individual income tax rate of the settlor at a rate of 27.5 per cent. As for distributions from revocable trusts, the same tax treatment as for distributions of irrevocable trusts should apply.

Disclosure obligation

As an introduction, Victor Alexander Jaramillo emphasised the relevance of reporting and disclosure obligations. Particularly in the US, penalties for failure are huge and affect the statute of limitations.

Spain

In Spain, the settlor has to report the assets. The trustee reports only when he or she has certain authority over the assets. Beneficiaries only have reporting obligations when they have an actual right over the assets. Penalties can reach 150 per cent.

Canada

In Canada, beneficiaries of a foreign trust must report the receipt of distributions on Canada Revenue Agency (CRA) form T1142. If distributions are received by an estate, it should be reported.

Mexico

Mexico has reporting obligations under the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS). Mexican tax residents are obligated to report their participation in transparent trusts to the Mexican tax authorities, even if they receive no income or distributions. Income tax returns must be filed by the settlor or by beneficiaries if income is attributed to them. It is likely that such reporting obligations will be extended in the course of the upcoming tax reform, including the introduction of criminal consequences and penalties for tax advisers in case of non-compliance.

Austria

In Austria, there is generally a filing obligation if a tax is triggered. Gifts are subject to notification obligations. In addition, as in other European countries, there is an ultimate beneficial owner (UBO) register that should only apply to trusts if the trust is administered from Austria, which is a very rare case.

Brazil

In Brazil, there are reporting obligations with the tax authorities and with the Central Bank authorities. Non-disclosure to the Central Bank authorities could be considered a crime. In cases of irrevocable trusts, the settlor will not disclose anything. However, under a conservative approach taken by the Central Bank authorities, the beneficiary may be obligated to report, in some cases without even knowing that they are beneficiaries and subject to reporting requirements.

Switzerland

In Switzerland, most tax rulings are obtained in respect of the tax treatment of the trust. Therefore, tax reporting obligations should be quite clear. However, there are specific anti-money laundering (AML) forms for trust structures and foundations.

Private foundations

From a practical perspective, Victor Alexander Jaramillo takes the view that there seems to be little distinction between trusts and foundations. Somebody has assets, ceasing control over such assets to independent people operating the assets for beneficiaries.

In Spain, legal personality is the key concept. Although Spain does not have private foundations, transfer of assets to and from private foundations are recognised as capital gains-triggering events (unless the private foundation is challenged under GAAR). Even if a non-Spanish private foundation receives Spanish assets, Spanish non-resident taxation is triggered. However, recognition may be good if assets are transferred to a private foundation before the donor relocates to Spain. In such a case, the assets are actually owned by the foundation without income tax or wealth tax in Spain. However, kinship is then lost and distributions by the foundation to beneficiaries are taxed at the highest rates.

Similarly, in Mexico, legal personality is decisive. In case of transactions between settlors and beneficiaries, for tax purposes, the transaction can keep the nature that they want, only using the trust as a vehicle. However, in case of private foundations, there is always a third party. This may be important if one considers that Mexican tax residents are generally exempt from income tax in inheritance and similar cases. Such exemptions may not be applicable or easy to apply in cases of private foundations.

Private foundations in Austria have a legal personality and are taxed similarly to corporations, also enjoying treaty protection. Again, three levels of taxation apply. Gratuitous transfers of assets to the private foundation are generally subject to a transfer tax of 2.5 per cent. The private foundation itself is subject to corporate income taxation at a rate of 25 per cent. The so-called interim taxation regime applies partially, under which corporate income tax may be refunded later, in connection with taxable distributions. Distributions to beneficiaries are taxed at a flat rate of 27.5 per cent. However, under applicable double taxation treaties, distributions to non-Austrian beneficiaries mostly qualify as ‘other income’, preventing Austria from taxing such distributions. Non-Austrian foundations are treated similarly to trusts.

In Switzerland, the nature of the foundation needs to be determined first (charitable, family foundation, corporate foundation), whereby the place of its incorporation is also relevant. Once such assessment is made, the tax treatment differs significantly. However, when it comes to foreign family foundations, it may be said that they are generally treated in a similar way to trusts.

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