Jurisdictional Selection In International Trust Structuring: A Design Led Process

Offshore V Onshore

An offshore jurisdiction typically refers to a country or territory that offers tax benefits, privacy, and regulatory advantages to non-resident users of the financial services offered within the jurisdiction. These jurisdictions often have low or zero tax rates on trust and corporate profits, capital gains, and income, as well as enhanced confidentiality for business/asset owners and investors.

Offshore financial centres are used for setting up companies, trusts, foundations, and other legal structures for tax planning, protecting assets, and facilitating international transactions. Examples of offshore jurisdictions include British Virgin Islands, Cayman Islands, Bermuda, Luxembourg, Isle of Man, Bahamas, Jersey, Guernsey, Panama, Liechtenstein, Cook Islands, Nevis, and Gibraltar.

Using an offshore jurisdiction can offer several potential benefits, including tax optimisation and avoiding double taxation. It may also provide enhanced privacy and asset protection, safeguarding assets from threats in one’s home country. Offshore jurisdictions can facilitate foreign direct investment and international trade, with simplified reporting requirements and regulatory environments designed to attract, pool, and deploy capital. Additionally, they can offer political and economic stability to capital from more volatile regions.

Some risks and disadvantages of using an offshore jurisdiction include potential legal and reputational risks associated with perceptions of tax evasion, fraudulent conveyances, or unethical financial practices. There can be increased scrutiny from tax authorities and international regulatory bodies, leading to complex compliance requirements and customer due diligence. Offshore jurisdictions might also face political or economic instability, affecting the safety of assets. Additionally, less transparency and regulatory oversight can increase the risk of fraud and financial crime.

An onshore jurisdiction typically refers to countries that impose high tax rates on business profits, income, and capital gains, and have stringent regulatory and compliance frameworks to protect against a broad range of risks. These jurisdictions are known for their transparency, adherence to international financial regulations, and robust legal systems. Onshore jurisdictions may offer less privacy in financial matters but provide greater stability and recognition in the global financial system, making them more suitable for operating and/or regulated businesses, and individuals seeking to maintain a transparent and reputable financial presence. Examples of onshore jurisdictions include the United States, the United Kingdom, Germany, France, Australia, Canada, Japan, and South Korea.

Global Efforts To Level The Regulatory Playing Field

Arguably, the distinction between onshore and offshore jurisdictions has always been blurred and is becoming less relevant. For decades, many onshore jurisdictions (like the City of London) have offered offshore type features and services to attract capital and stimulate economic activity. More recently, global efforts towards financial transparency, anti-money laundering (AML) and counter-financing of terrorism (CFT) regulations have levelled the playing field.

Anti-Money Laundering and Counter Terrorism Financing laws (AML/CTF), the Financial Account Tax Compliance Act (FATCA), the Common Reporting Standard (CRS), the Base Erosion and Profit Shifting (BEPS) project, and Registers of Beneficial Ownership, have pushed jurisdictions traditionally considered ‘offshore’ to adopt standards similar to those of ‘onshore’ jurisdictions. Consequently, the global financial landscape has evolved towards a more uniform regulatory and compliance framework, diminishing the obvious contrasts previously seen between offshore and onshore finance centres.

Despite global efforts to level the regulatory playing field, there remains an illogical and often unwarranted stigma associated with some offshore jurisdictions. This prejudice often translates into practical challenges, particularly when entities established in these jurisdictions engage with regulated counterparts like banks. Financial institutions, which, under pressure to comply with international AML/CFT standards, often exercise heightened scrutiny or even reluctance in dealing with trusts and companies from offshore jurisdictions perceived as less transparent. This cautious approach can complicate banking relationships and financial transactions, impacting the operational efficiency of entities based in offshore jurisdictions.

The Emergence Of The Midshore Jurisdiction

A midshore jurisdiction is a less commonly used descriptor, but it has evolved as a term to describe a jurisdiction that combines the legal and financial advantages of offshore financial centres with the stability and regulatory framework of onshore jurisdictions. A midshore jurisdiction offers a balanced approach, providing tax efficiency and privacy for international business and investment, while adhering to international standards and transparency requirements, and having the capacity to provide economic substance, where needed. These features are attractive for families, businesses, and investors seeking to hold their wealth or optimise their operations within a legal and regulatory environment that is globally recognised and respected, bridging the gap between the traditional offshore and onshore models.

Examples of midshore jurisdictions include Hong Kong, Singapore, Ireland, Malta, the Netherlands, Luxembourg, the United Arab Emirates (particularly Dubai), and New Zealand.

Choice Of Law

The law governing a trust does not necessarily need to be that of the jurisdiction in which the trustee (or indeed the settlor or beneficiaries) is located.

Under the 1985 Hague Convention on the Law Applicable to Trusts and on their Recognition (Hague Convention) it is generally possible to select the law of a foreign jurisdiction to govern a trust in another jurisdiction. Whilst the Hague Convention has only been ratified by 14 countries (including Australia, parts of Canada, Hong Kong, Switzerland and the United Kingdom plus 12 of its dependent territories/crown dependencies), the common law of most countries will have the same permissive effect, subject to public policy considerations.

This gives the flexibility to choose a governing law for a trust that provides the features that a settlor values most in a structuring strategy. For example, a settlor might want to select a jurisdiction that provides:

• ‘Firewall legislation’ designed to insulate trusts against foreign claims against the trust, dispositions of property into the trust, or the capacity of the settlor.
• Wide powers of variation without the consent of beneficiaries.
• Statutory provisions that permit certain decisions taken by trustees to be unwound where they had unintended (often tax) consequences.
• Protection to settlors from creditor’s claims seeking to claw back transfers into trust.
• Protection to third parties dealing with the trust in good faith.
• Reserved powers legislation that confirms the express reservation of certain powers will not invalidate the trust.
• Mechanisms for trustees to hold shares in operating companies more expediently than under an orthodox discretionary trust.
• For trusts to be set up for non-charitable purposes and hybrid (purposes and persons) trusts.
• For trusts to exist in perpetuity or otherwise longer than traditionally permitted.
• Alternative dispute resolution (eg mediation and arbitration) procedures for the resolution of internal disputes.
• Flexibility in relation to the required disclosure of information about the trust to beneficiaries.

It is important to consider both the advantages and the disadvantages of a particular jurisdiction’s trust laws before proceeding. No one jurisdiction provides a perfect solution.

Courts

While a robust legal framework is essential, the quality of a jurisdiction’s court system is equally critical. The court is the ultimate supervisor of a trust, and several factors must be considered:

• Credibility of the jurisdiction: any perception of bias, corruption, or incompetence within the judiciary can undermine the trust jurisdiction’s credibility. A compromised judiciary erodes trust and confidence in the legal system, potentially jeopardising the very purpose of establishing a trust.
• Protection of beneficiaries: the ability of the courts to scrutinise trustees on behalf of settlors and beneficiaries is necessary to ensure that trust assets are protected from internal as well as external risks to the trust.
• Ability to apply the law: settlors, trustees, and beneficiaries must be able to rely on the courts to interpret and apply the law correctly. The court’s experience in making sound legal decisions in trust-related matters is an important factor in the efficacy of a jurisdiction.

Service Providers

The capabilities and experience of trustee companies within the chosen jurisdiction are vital to the effective administration of trusts:

• Trustee’s litigation history: a trustee’s track record in navigating challenging litigation is a critical factor in assessing the trustee’s reliability in adverse legal scenarios. The ability to weather legal storms and protect assets is indicative of a trustee’s competence and dependability.
• Network of legal contacts: a trustee’s network of legal contacts is a strategic asset. The ability to tap into diverse legal expertise around the world ensures the trustee can adeptly handle a spectrum of legal challenges, enhancing the efficacy of the trust structure. A well-connected trustee is better equipped to navigate complex issues.
• Experience in issue identification: identifying crucial issues is a skill that comes with experience. Trustees with a proven ability to navigate legal complexities and obtain accurate advice instil confidence in clients regarding the proper management of trust affairs. The capacity to identify and address potential legal challenges before they escalate is a hallmark of a proactive and capable trustee.
• Competence: selecting a jurisdiction with a sophisticated, competitive, and competent trustee industry will go a long way towards mitigating the risk of a legal claim against the trust and resolving issues. Trustees who do not follow international best practice are more likely to face issues in relation to their administration and governance of the trust.

Regulation And Supervision Of Trustees

The regulatory environment plays a pivotal role in maintaining the integrity of a trust jurisdiction:

• Licensing and regulatory framework: a robust licensing and regulatory regime ensures that trustees undergo thorough due diligence checks by independent regulators. Scrutiny of ownership, personnel, fund protection policies, and other crucial factors are essential for upholding international standards. A well-regulated jurisdiction offers an added layer of confidence that trustees are subject to rigorous oversight, reducing the risk of malfeasance or mismanagement.
• Variability in regulatory regimes: not all jurisdictions are created equal in terms of regulatory stringency. While some jurisdictions lack licensing requirements, others may have straightforward processes with limited supervisory mechanisms. Understanding these variations is critical for evaluating the reliability of trustees. A jurisdiction with a comprehensive and effective regulatory framework helps to ensure the trustee is accountable.

A Design Led Process

Nowadays, contemporary wealth structuring requires sophistication and independence to avoid (at best) knowledge gaps and limiting biases, and (at worst) conflicts of interest. This has led to the emergence of the role of the independent consultant who is jurisdictionally neutral and agnostic to fiduciary service providers and financial institutions involved in trust management.

Such a consultant doesn’t replace the trusted advisors or jurisdiction experts and third-party service providers, but becomes the architect of a design for an optimised platform to govern and administer the trust. Once the design is finished, the specific componentry is then procured and assembled from the local/incumbent lawyers, tax advisors, trustees, wealth managers, etc.

The choices made regarding legislation, court systems, historical context, trustee capabilities, and regulatory environments, collectively shape the trust’s efficiency, effectiveness, and longevity. A holistic approach to evaluating the factors discussed in this article, coupled with expert independent consultation, is required to navigate the complexities of choosing a jurisdiction and setting up a trust.