The New Zealand "Foreign Trust" regime vs the USA "Foreign Trust" Regime
Contributed by US Trust Advisory Services LLC
30 May, 2017
When it comes to trusts, New Zealand (NZ) and the United States of America (US) are remarkably similar, as they appear to be the only OECD countries, with recognizable "foreign trust" regimes, and both seem to have been created by amendments to tax laws rather than by specific intention. Although I stand to be corrected on this point.
Even their domestic trusts bear similarities, as a domestic trust, in either country, must file for a taxpayer identification number, at initiation, and should file a tax return, which may result in a tax payment obligation.
An NZ "foreign trust" (NZFT) must have either a NZ resident individual trustee or an NZ corporate trustee, (with at least one NZ resident director), and must file a form 607 with the New Zealand Internal Revenue Department (IRD) to be recognized as a NZFT. The NZFT is then exempt from NZ income taxes so long as there is no NZ source income. (It should be noted that NZ does not have capital gains taxes or inheritance taxes although certain types of capital gain can be classified as income under NZ tax rules).
Under US tax laws, a trust is deemed to be a "United States Person", and thus domestic, if it satisfies BOTH the "court" and the "control" test, which simply put are as follows:
i) a US court can exercise primary supervision over trust administration (the "court test"); and
ii) US persons control all substantial trust decisions (the "control test").
That means that all other trusts are deemed to be "foreign trusts", for US tax reporting purposes, including a US state law trust with a US trustee if it does not pass both tests. A foreign trust with a US Trustee is usually called a "Hybrid Trust" by US trust lawyers.
Converting a US domestic trust into a US Hybrid Trust can be as easy as replacing a US protector with a foreign protector (FP) if that FP has certain "control powers" such as being able to remove and appoint trustees. Although many US states have adopted delegated and directed powers provisions so the FP can have much wider powers if the Settlor and Trustee agree to same.
An FP can also be appointed on the trust establishment date so as the trust is a Hybrid Trust from its initiation date. In such case, we recommend that the FP is a non-US corporate entity, rather than a foreign individual, as individuals have been known to have become inadvertently US tax resident. (That happened to a friend of mine only last year).
In contrast to NZ, it should be noted that there is no requirement for the Hybrid Trust to register with the US Internal Revenue Service (IRS), as a "foreign trust", nor to file a US tax return unless the trust itself has US source income. It is automatically a foreign trust if it fails either of the mentioned tests and an FP that has control powers would certainly cause a Hybrid Trust to fail the "control" test.
A Hybrid Trust would not be subject to US taxes, because it has no requirement to file a tax return with the IRS, assuming it has no US source income. In the case, where US source income is likely to arise, then we recommend the inclusion of a US corporation, or an LLC, into the trust structure, so it is that entity which has the tax filing requirement rather than the Hybrid Trust itself.
We anticipate that most Hybrid Trusts will not have US source income, as they are likely to be established for the benefit of non-US persons. Indeed, a US person will likely derive more tax benefits from a domestic trust than a Hybrid Trust, as accumulation rules will penalize US beneficiaries of foreign trusts upon the decease of the Grantor (aka the Settlor). These accumulation rules do not apply to domestic trusts. In that respect, it is also simple to convert a Hybrid Trust into an US domestic trust, by replacing the FP with a domestic protector, which can be a recommended course of action if there are US beneficiaries after Grantor decease.
It should also be noted that the foreign person does not have to be a protector. Even a foreign advisor will suffice to classify an US trust as a Hybrid Trust, so long as the foreign advisor has sufficient control powers to defeat the "control" test.
In recent years, NZFTs have been incredibly popular, with emerging market clients, mainly because it has been the case that NZ is an OECD country and is therefore unlikely to be "black listed" as many offshore trust jurisdictions are. (Indeed, NZ is even "white listed" by the Italians as is the US btw). Plus, trust clients were promised relative anonymity as minimal information was required to be filed with the Form 607. (Usually just the name of the trust and the name of the trustee plus it's registered office address). This popularity has continued until very recently even though NZ trust laws are relatively archaic. (The NZ Trustee Act has not been amended since 1956 and NZ is remarkable for being the only currently popular trust jurisdiction that still retains an 80-year perpetuity period).
It is regrettable, therefore, to report that the previously benign information requirements are now coming to an end, with effect from 1st April 2017, as trustees of existing NZFTs must reapply for registration, by 30th June 2017, and pay a registration fee (not previously required). For new trusts, please be advised that the registration deadline is 30 days from the trust being established. The additional information requirements are as follows:
- The name of the trust;
- A copy of the trust deed;
- The date and details of each settlement on the trust;
- The name, email address, residential address, country of tax residence and tax identification number of each trustee, settlor, appointor, protector, controller and beneficiary (or class of beneficiaries in the case of a discretionary trust);
- The Trustee(s) must also notify the IRD within 30 days where any of the above information changes.
Alert readers should have noticed that none of this information is required for a US Hybrid Trust.
The draconian information requirements do not cease there, as each NZ FT will now be required to file an Annual Return and pay an annual filing fee, with the first annual returns being due by 30 June 2018. Information to be included in the annual return is detailed below:
- The financial statements for the trust for the previous year;
- The date and amount of each distribution made by the trust during that year with the name, email address, residential address, country of tax residence and tax identification number of each beneficiary to whom a distribution is made;
- The date and nature of each settlement made on the trust during that year with the name, email address, residential address, country of tax residence and tax identification number of each settlor making the settlement;
- Any changes during the year to the information included in the original registration.
We cannot believe that these changes will sit well with settlors and beneficiaries of NZFTs. In fact, some astute observers believe that these information requirements will prove to be the death knell of the NZFT, as its biggest competitor, the US Hybrid Trust, has no such information requirements.
Although we have discussed US Trusts, there is in fact no such thing as a US Trust, per se, as each US state has its own trust laws and US Trustees are licensed by state banking commissions. Our preferred states, for US Hybrid Trusts, are South Dakota and Delaware although Nevada, Wyoming and Alaska also deserve mention, as does Florida if the trust will own Florida real estate. (I have a soft spot for Florida because I own a house there).
Focusing on South Dakota (SD) trust law specifically it should be noted that SD trust law has:
- No perpetuity period so dynastic trusts are possible;
- It has an asset protection provision, (similar to a few offshore jurisdictions), that provides a 2 year "look back" statute of limitation for creditors to attack the gifting of assets to the trust;
- Directed trust statute which permits separation of trust administration and asset management;
- Delegated powers where a trustee can delegate control powers to protectors, advisors or other connected persons;
- SD law also provides for the establishment of non-charitable purpose trusts;
- SD is also considered to have the best trust privacy laws in the US;
- SD trusts are not subject to any state income taxes.
None of these trust law features are available to NZFTs apart from some limited delegation of powers by NZFT Trustees. In fact, I recently explained the benefits of US Hybrid Trusts, to a BVI lawyer, and his comment was "Why would a client use any other trust jurisdiction?", even though he understands BVI trusts have also proven to be very popular particularly in Asia.
It should also be noted that a US Hybrid Trust is likely to have minimal, (or even no), FATCA or CRS reporting requirements if all financial assets are invested through US financial institutions. Non-US assets can also be held through a Hybrid Trust but most US Trustees will require "foreign assets" to be held though an underlying corporate entity, which can also be foreign. (It should be noted that if those "foreign assets" include non-US bank or investment accounts then CRS reporting by the foreign financial institutions may still be required).
One other extremely interesting feature of US Trusts is that there is no "Sham Trust" concept under US laws. Thus, if a US Trustee "slavishly" follows the instructions of a Settlor then that will not invalidate a US trust, while an NZ FT could possibly be set aside, as a Sham, in similar circumstances. Nevertheless, even if legally possible, potential trust Settlors should be aware that absolute control can cause them a tax problem in their home countries.
To know more about US Trusts and US Hybrid Trusts then please visit our website address http://ustrustadvisory.com/index.html or should you wish to receive valuable advice, concerning the restructuring of your NZFT, then please send an email to email@example.com.
For and on behalf of US Trust Advisory Services LLC
Ed Rogers TEP, Chief Executive Officer
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