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Offshore Trust

Offshore Trust
A variety of sophisticated features can be added to the strategies we have discussed by taking advantage of laws designed to encourage asset protection and privacy goals. In this section, we will discuss a popular planning option known as the Asset Protection Trust (APT) or the Offshore Trust, and show you the opportunities for enhancing the structure of your overall plan.

A recent report by the U.S. Department of the Treasury stated that in response to concerns about litigation the market for Offshore Trusts are “exploding.” The Treasury Department estimates that assets worth “tens of billions of dollars” are currently in these types of trusts with the number and amount growing rapidly each year. An article in the American Bar Association Journal stated, ironically, that lawyers are seeking protection from the hazards of their profession by setting up Offshore Trusts for themselves. As one attorney quoted in the article put it, “I don’t want someone doing to me what I do to them all day in court.”

The reason for the popularity of this technique is that it acts as an ultimate safety valve—providing an additional layer of protection for plans designed to avoid frivolous “deep pocket” litigation. Many individuals, wary of the potential for abusive lawsuits and frustrated by widespread violations of personal privacy, view the Offshore Trust as an important component of a sound financial plan.

Features of APT or Offshore Trust
In many ways an Offshore Trust looks like a standard domestic trust. The settlor is the person who transfers the assets to the trust. The trustee is generally a trust company, whose business is operated outside of the United States. The arrangement differs from Privacy Trust–Plan #1 and Privacy Trust–Plan #2 because, in this case, the trust company is located in a foreign country—outside the jurisdiction of U.S. courts. The Offshore Trust takes advantage of favorable asset protection and privacy laws which exist in other parts of the world.

In a typical trust, the trustees are given discretion to accumulate or distribute income among a specified class of beneficiaries. The settlor may be one of the named beneficiaries, together with his spouse, children, or grandchildren. One unique feature of this kind of a trust is the role of the Protector. The Protector is a person, designated by the settlor, whose consent is necessary for certain activity by the trustees. The term of the trust may be limited to a period of years, or it may continue after the settlor’s death.

Moving Property Overseas
One way to use an Offshore Trust is to transfer cash, securities, or other liquid assets to an account established under the name of the trust at a bank of your choice in a foreign jurisdiction. The Protector then advises the trustees on the manner in which the funds are to be held or invested. Income can be distributed to the beneficiaries or accumulated in the trust.

This arrangement provides excellent privacy and asset protection. As we will discuss, assets held in an overseas trust account—in a country with strict bank secrecy laws—can be a legitimate and powerful legal strategy for sophisticated individuals who are willing to tolerate some degree of inconvenience and additional expense in order to achieve a particular result.

Keeping Property in the U.S.
Most of our clients want the option to transfer funds into an overseas account—but are reluctant to do so immediately. The solution is to use a domestic entity such as a Family Limited Partnership or Limited Liability Company to maintain property in the United States.

Under this arrangement, husband and wife are the general partners or members with complete management and control over the company. Only the membership or partnership interests are transferred to the Offshore Trust. The strategy is similar to Privacy Trust–Plan #2—but the trust uses a foreign rather than a domestic trust company.

The trustee has no right to interfere in the management of the assets of the partnership or the LLC. Control is maintained by husband and wife as general partners or managers. Even though the trust holds the ownership interests, all of the assets remain physically located in the United States under the direct control and supervision of husband and wife.

This arrangement can provide a high level of asset protection benefits. Property is legally insulated within the FLP or LLC. The Offshore Trust owns and protects the interests in those entities. Liquid assets can be moved into the overseas trust account for additional protection or investment purposes.

The Offshore Trust is a trust established under the laws of a country which are more favorable to asset protection and privacy objectives than the laws in the United States. For example, the laws in some countries provide for a statute of limitations on fraudulent conveyances which can be as short as one year and the standard of proof required for a fraudulent conveyance is the difficult “beyond a reasonable doubt” rather than the lesser civil standard of a “preponderance of the evidence.” The courts in these countries will not enforce a judgment rendered in the United States, or an order of a U.S. Bankruptcy Court. To prosecute a claim against the trust, the creditor would have to go to that country and retry the underlying case, an almost impossible requirement.

A further advantage of the Offshore Trust is that a greater degree of flexibility can be achieved in the way in which the trust is established. The settlor of the trust can serve as beneficiary, and the trust will still be valid under local law. This allows the settlor to retain a substantially greater degree of enjoyment over trust assets than would be permitted under U.S. law with a domestic trust.

Of equal importance, an Offshore Trust allows a great deal of practical flexibility because the option is always available to move the assets into an account established in the foreign jurisdiction—subject to the protective features of local law. To reach those funds, the creditor would have to commence an action in the foreign jurisdiction and would have to overcome significant obstacles under the law of that jurisdiction.

The problem for a creditor with a judgment is that a U.S. court has no capacity to exercise its authority over a foreign trustee. Simply stated, a foreign person or company with no presence or assets in the United States cannot be compelled to act by a U.S. court. If a U.S. court ordered a foreign trustee to return assets, the foreign trustee, under a duty to preserve trust property, would refuse to comply with the order.

If a foreign person or entity has assets in the United States, a court can exercise leverage by threatening or attempting to seize those assets for failure to comply with the order of the court. For example, on occasion the U.S. Government seeks information about foreign bank deposits in matters concerning criminal tax evasion, drug charges, or securities law violations. Because of its local secrecy laws, the foreign bank usually fails to comply with the government’s request for information. However, when the foreign bank has assets, such as deposits or branches in the United States, the government may threaten to seize the assets if the bank does not comply with the court order. Generally, this threat is successful and the bank will reveal the sought-after information.

Precisely for this reason, most foreign based trust companies do not conduct business or have assets in the United States. Any foreign trustee which is selected must have no local business activity in order to avoid the financial leverage which might then be applied by a U.S. court.

Since the creditor cannot obtain satisfaction by obtaining a U.S. court order against a foreign trustee, the only method for compelling the trustee to act is to file a lawsuit in the jurisdiction in which the trustee is located. Whether or not the creditor can be successful in this forum will depend upon the particular laws in effect in that country.

Contempt Orders Against Debtor
Can you, a U.S. resident and a settlor of the Offshore Trust, be ordered by a court to return assets transferred to the offshore account? A judgment creditor would certainly like to obtain such an order from the local court and whether he can do so depends upon the terms of the trust.

Clearly, if you have the right to retrieve the assets, a judge will order you to do so. Judges back up these orders with the power to hold a person in contempt of court for refusing to comply. The sole issue then is your legal ability to return transferred property pursuant to a court order.

This issue is resolved, in a properly drafted trust, by not giving the settlor any such power to revoke the trust or reacquire the assets without the consent of the trustee. Although the trustee typically will comply with the wishes of the settlor, the trust agreement requires the trustee to disregard any communications issued by the settlor under duress. That is, if the settlor is ordered by a court to communicate with the trustee, the trustee is required by the terms of the trust to ignore such requests for action.

As a result of this structure, the settlor has no legal right to revoke the trust and reacquire trust assets. A court cannot logically compel an action that an individual has no power to perform, and the foreign trustee will not respond to orders from a court outside of its jurisdiction. The conclusion is that the assets of the trust are protected, and the settlor should not be in contempt for failing to achieve a return of the property.

The result may be different when the Offshore Trust is used as a scheme to defraud creditors or the IRS, or to protect the proceeds of criminal or fraudulent activities. In these cases, where the defendant is perceived as a “bad guy,” the judge may ignore the provisions of the trust document and apply the leverage of a civil contempt order. (See FTC v. Affordable Media, LLC.) The Offshore Trust is not designed to allow individuals to defraud others or engage in tax evasion or criminal conduct. If the trust is used for an illegitimate purpose, significant legal pressure—including contempt sanctions—may be brought to bear on the offender.

The Cook Islands
The Cook Islands was the first jurisdiction to enact legislation encouraging the formation of Offshore Trusts. All trust companies are licensed and regulated by the government of the Cook Islands with the strictest qualification and capitalization standards.

Since the enactment of the International Trusts Amendment Act of 1989, the Cook Islands have been the jurisdiction of choice for the creation of Offshore Trusts. The law provides the highest degree of protection, flexibility, and privacy. The trust companies in the Cook Islands are experienced and knowledgeable with an unblemished record of competency, thoroughness, and integrity unmatched by any other country in the world.

Popular Misconception
It is difficult to imagine an issue that is so clear yet produces as much confusion as the proper U.S. tax treatment of the Offshore Trust. Despite thousands of Web sites on the Internet promoting offshore trusts as legitimate strategies for avoiding income taxes—this is not the case. The Offshore Trust does not provide any income tax advantage. All of the income of the trust is included on the tax return of the U.S. settlor of the trust. The trust is treated in the same manner as a revocable living trust. This rule applies whether the assets of the trust are located in the U.S. or in an overseas account. It also applies regardless of whether the source of the income is from the U.S. or from another country. All income of the trust is taxable on the return of the settlor in the year it is earned. It doesn’t matter when the funds are distributed or returned to the U.S. There is no strategy or technique which will alter this result without causing you to commit perjury or tax fraud.

This treatment is beneficial from an asset protection standpoint because it allows you to transfer property to and from an Offshore Trust without creating any tax consequences. No gain or loss is recognized, and no taxable income is produced by a contribution or distribution.

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