Financial Transparency Coalition

It is a fact that the trust laws of some tax havens openly promote illegality. The reality that some tax havens will not enforce foreign laws (e.g. ensuring non-recognition of foreign laws and judgements that favoured legitimate heirs and former spouses) is even publicly advertised by some offshore service providers, not on the deep web like drugs and illegal weapons, but on the internet, accessed by a simple google search on tax or estate planning.

Despite this, there has been some reluctance from governments to take on the issue of trusts, and some difficulties posed for governments that have attempted to deal with some of their more problematic features. Today, a new paper called Trusts – Weapons of Mass Injustice from the Tax Justice Network, and funded by the Financial Transparency Coalition, attempts to reopen the debate on trusts, and argues that there is urgent need for effective measures to curtail their activities.

A controversial issue

Trusts create a lot of controversy. While many of them are taxable at the trust level, they may hold assets or engage in business just like companies, and not everybody fully agrees with the idea of registering all trusts, including some transparency campaigners. That’s either because of their complexity or because they believe in “cheaper” options, such as targeting only tax haven trusts.

We looked at some of these issues in a paper we published in November 2015, which made the case for trust registration. The paper describes trust’s secrecy risks and explains why available technology applied to registers of companies means that registering trusts’ beneficial owners is just as simple. Another crucial point is that incorporation of trusts (requiring them to incorporate or register in order for them to legally exist) is the only way to enforce trust registration. This idea currently applies to companies and other legal entities similar to trusts in their effects, like foundations.

Taking on the trusts

In May 2015 the European Union approved the 4^th Anti-Money Laundering Directive, establishing central registries of beneficial owners[1] for companies and legal persons (in Art. 30) but leaving glaring loopholes when dealing with the beneficial owners of trusts (in Art. 31).

In response to this, we published a paper suggesting amendments both to the EU Directive but also to the FATF[2]Recommendations’ definitions of beneficial owners of trusts. In contrast to some countries’ regulations (e.g. the UK and the U.S.) that limit the definition of the beneficial owner of a trust to the trustee and anyone with control, we favour a definition that encompasses all related persons of the trust as beneficial owners (all settlors, protectors, trustees, beneficiaries, classes of beneficiaries, and any other person mentioned in the trust deed with control over the trust). This ought not be controversial: the OECD’s Common Reporting Standard (CRS) for automatic exchange of information already requires financial institutions in more than 100 countries to take this approach when identifying the beneficial owners of their trust clients.

In a set back for transparency, in July of 2016, the French Constitutional Court banned the newly introduced French public registry of trusts on the basis of an individual’s right to privacy. Our arguments, which can be found here, rely on a very basic principle: trusts should not be considered a private matter if they can be used and abused to commit financial crimes (e.g. tax evasion, money laundering) and also to defraud legitimate creditors. In essence, we propose a basic principle of responsibility: if you want your trust provisions to be binding on third persons (e.g. a personal creditor to whom you owe money), then a trust must be registered and its beneficial owners publicly disclosed. You don’t need to register anything else that can have no effect on people not related to the trust arrangement.

But, back to the beginning: the problem with trusts goes way beyond their sophisticated secrecy that allows so many crimes to be committed. This new paper explores trusts as creatures of history. While they had good reasons to exist centuries ago (e.g. to protect the family of knights joining the crusades in the Middle Ages), trusts have been used across time to evade and avoid taxes and restrictions placed on asset ownership or transfer by governments.

More recently, new types of trusts and provisions, such as spendthrift provisions and discretionary trusts (available not only in traditional tax havens but some of them also in the U.S. or the UK), allow trusts to be used as asset protection vehicles. This effectively shields assets from legitimate creditors of settlors and beneficiaries, such as tax authorities, former spouses or victims of damages (e.g. mala praxis). Such schemes are being offered instead of an insurance (after all, why pay an insurance premium as a medical doctor if your personal wealth can be protected by placing it in an asset protection trust?).

The results for society can be devastating: in the case of malpractice by a doctor, the claimant will be unable to reach the doctor’s assets for compensation even after trial, while the doctor can avoid liability and financial responsibility for (gross) negligence. Trusts also allow wealth to be accumulated for centuries (reducing or avoiding inheritance tax in the meantime), and inequality inevitably deepens.

To make matters worse, traditional trust rules that did ensure a certain level of good governance are being eroded, such as the rule against perpetuities (to limit the duration of trusts), limits to the settlor having control over the trust or being “a” or “the only” beneficiary of the trust, the requirement for trusts to have beneficiaries (e.g. purpose trusts) and even the very control and management by the trustee (e.g. the BVI Vista Trust).

Often, trusts’ asset protection (and secrecy) is justified by the need to protect vulnerable persons. Yet nothing in trust law requires trust beneficiaries to be vulnerable or minors. And – as our paper shows – specific exemptions could accommodate such concerns easily without creating uncontrollable risks or loopholes.

Trusts offer even more asset protection than an ordinary company. While both trusts and companies may achieve a similar separation of assets and limit liability, corporate shareholder’s personal creditors have one last resort if the shareholder doesn’t pay back: claim the shareholdings (and eventually reach corporate assets). Trusts, in contrast, have no shareholdings. Therefore, if the trust is structured so that beneficiaries have no vested interest (e.g. in a discretionary trust), personal creditors of the settlor and beneficiary have no access to trust assets.

For decades trust law has evolved without democratic scrutiny, and is frequently abused for nefarious purposes. We frankly doubt whether trust law would look as it does if society were aware of the potential harm that trusts can cause.

This paper thus tries to start a new, more critical debate on trusts. Not only on the secrecy that they enjoy (and the fallacious arguments that prolong it), but a more profound discussion on whether society still needs all the current provisions available for trusts, given their huge potential for abuse.

[1] The natural persons who ultimately own, control or benefit from a company, trust or any type of entity or arrangement.

[2] Intergovernmental body in charge of setting up and reviewing Anti Money Laundering Recommendations

You can read the paper we’re releasing today Trusts – Weapons of Mass Injustice here.