Undisciplined clients: what to do when families make personal decisions that do not accord with their structure?

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Rinse Elsermans

Cazimir, Belgium

rinse.elsermans@cazimir.be

Report on IBA Private Client Tax Committee session at the 25th International Private Client Conference

Tuesday 3 March 2020

Session chair

Clare Elizabeth Archer  Penningtons Manches Cooper, London

Philip van Hilten AKD, Amsterdam

Speakers

Patricia Guerra Meyerlustenberger Lachenal, Zürich

Marie-Lorraine Henry Fidal, Paris

Richard Joynt Ocorian, St Helier, Jersey

José Blasi Navés Blasi Spanish Tax Advice, Barcelona

Elspeth Talbot Rice QC XXIV Old Buildings, London

The main focus of this session was undisciplined clients, the impact of their choices and the changing circumstances in their lives on estate planning, and how to anticipate this in our advisory practices. During this session, the panel thoroughly discussed what the specific role and goal of a private client adviser is when being confronted with clients who live their lives with little or no regard for the legal consequences of their actions on their estate planning.

Clare Elizabeth Archer pointed out that the panel would guide the audience through a checklist of things to consider when advising clients, with reference to specific examples to showcase the relevance to practices.

What is an undisciplined client?

An undisciplined client is not a client that deliberately makes choices that go against their trust deed or their estate planner’s advice. An ‘undisciplined client’ is someone who makes choices that have an impact on the structure that is set up or the wealth planning that took place (eg changing jurisdictions), without first consulting their private client adviser or even without informing them afterwards.

As confirmed almost unanimously by the attending IBA members at the 25th conference, undisciplined clients are a widespread phenomenon.

A speaker pointed out that, when working for private clients, you have to try to be as alert as possible to all the changes that modern times have brought about. The times when families live in one place and all their descendants live in the same area are long gone. Families nowadays are much more globalised: children live or work abroad, and grandchildren move from a common law country with a trust background to a civil law country (or the other way around) with considerable implications for their estate planning.

The panel has started a project called ‘the checklist’. When drafting documents, a private client adviser should always try to identify the plausible or possible changes that could occur in the life of their client that could have an impact on estate planning or wealth structuring. This gives the adviser the opportunity to incorporate appropriate measures when drafting these documents. The checklist is a tool that can help advisers by providing a list of events that should always be considered when advising clients.

The ‘safe and sound’ family checklist

A speaker pointed out that the first thing you have to figure out is the family situationof the client. One of the first and most important questions you have to ask the client when setting up a trust is: ‘Who is it for?’

Far too often, a generic beneficial class (like ‘the settlor and his issue’ or ‘me and my descendants’) is incorporated in the trust deed. Not enough thought is put into what this means. At first glance it seems obvious what it means, but in practice it frequently is not. When the generic beneficial class is defined as ‘me and my descendants’, does this include descendants born with assisted reproduction (ie a child born from a descendant, but not biologically related in any form of DNA)? When the trust deed says ‘legitimate issue’, does this include descendants born out of marriage? What about children adopted in a same sex marriage? And what about the definition of ‘family’? This can be different (both legally and culturally) for various international clients, where in some cultures family is defined very wide and in others much more limited.

The same goes for the definition of ‘spouses’. Does this include same-sex marriages? More and more jurisdictions have legislation in favour of same sex marriages. One speaker summed up some jurisdictions where they have already adopted such legislation: the Netherlands in 2001, England and Wales in 2014, and Northern Ireland most recently at the beginning of 2020. In Bermuda they are currently debating this topic.

Alternatively, you have jurisdictions where there is no such legislation, and where public opinion is against same sex marriages. The speaker gave a couple of examples: in Russia 7 per cent of the population are in favour of same sex marriage, 85 per cent is against it; in Bulgaria 16 per cent of the population is in favour, 74 per cent against; in Singapore 27 per cent of the population is in favour, 60 per cent against.

At the other end of the scale you have Sweden, where 92 per cent of the population is in favour of same sex marriage and only 6 per cent is against it. Those opinion polls, dating to 2019, show that public opinion is very divided about this topic in various jurisdictions. In some African countries, same-sex relationships are not only illegal, they are criminal and punishable with the death penalty.

The speaker linked this opinion poll back to trusts by giving the following example: your beneficial class includes the ‘spouse’, and your trust is governed by the law of Bermuda, where same sex marriage is (for the moment at least) illegal, but your beneficiary (whose spouse is included in the beneficial class) goes off and gets married to a same-sex partner in Northern Ireland. Is her spouse within the beneficial class or not? This could lead to discussion but could have been easily prevented if the settlor’s wishes regarding this topic had been included in the trust deed. The real question is not ‘Who is a spouse and who isn’t?’, the real question is ‘What did the settlor intend’?

Issue

The speaker further discussed this topic with regards to the definition of ‘issue’ and ‘legitimate issue’. An interesting point here is that, if the trust deed says ‘issue’, the initial common law position was that this does not include illegitimate children. Because of the European Convention of Human Rights, that common law position has been reversed in many jurisdictions by legislation. If the trust deed dates from after this legislation, illegitimate children will also be included.

Furthermore, the Human Rights Act states that the distinction between legitimate and illegitimate children based on date is discriminatory, so even if the trust deed dates from before the aforementioned legislation, the result would be the same. Once again, the intention of the settlor is what’s most important. The settlor can decide who is part of the beneficial class, and the discussions described above only arise if that intention wasn’t clear.

As advisers, it is your responsibility to ask these questions to the settlor and discuss different possibilities with the settlor as to describe the intentions of the settlor as clearly as possible in the trust deed. In doing so you can avoid potential litigation between the beneficiaries.

Location

Another speaker added another point to the checklist: the location of the family is also an important factor. Nowadays, with globalisation, families can move from one place to another very easily, whether it be for tax, cultural or other reasons. Moving jurisdictions could however have a big impact on the estate planning of our clients.

The chair expanded on that by pointing out that it is very important to keep in touch with your clients and to look at what happens after you set up a trust or foundation – new tax residencies in other jurisdictions, sales tax, capital gains tax and so forth. According to one of the speakers, these things should be carefully analysed from a tax perspective to determine whether or not those changes affect the tax scheme.

Another speaker demonstrated this point by giving an example where a couple had estates in three different jurisdictions. When the husband died, all three jurisdictions were of the opinion that the deceased was subject to inheritance tax in their own jurisdiction. In the absence of inheritance tax treaties, the family had to pay inheritance tax in these different jurisdictions. Had the clients discussed this situation with their advisers beforehand, the situation could have been remedied.

A speaker emphasised that the location of the assets is also an important factor to consider, definitely as far as litigation is concerned, but also as far as asset protection goes. Having assets in a structure that is airtight in, for example, the Cayman Islands – where there is strong firewall protection legislation protecting the structure against claims from third parties – only gets you so far. If the assets in that trust are located in a different jurisdiction, for example a house in Mayfair, then claims against this asset will be enforced in the jurisdiction the asset is located in without the need to go through the trust in the Cayman Islands. Where the assets are located is thus very critical to assess how much protection a specific structure provides.

Political instability

A speaker pointed out that political instability is another thing to take into consideration when advising clients. He demonstrated his point by referring to two real-life examples (one in Saudi Arabia, one in Russia) where an airtight structure for asset protection more than proved its usefulness. Because of these structures and their asset protection aspects, the assets of the clients in question were protected from their political rivals and could not be seized by the government. An important reminder regarding political instability is that the structure you use for asset protection should not be located in the same (politically unstable) jurisdiction where the settlor resides.

Undisciplined decisions

A speaker illustrated that ill-considered decisions can have far-reaching tax consequences by using two cases. In the first case, the speaker explained that the residence of the beneficiary of a trust is crucial information in analysing the tax consequences of that benefaction. If the beneficiary of a trust is tax resident in Spain (even under the so called ‘Beckham law’), a contribution to that trust is taxable in Spain. In another case, the speaker expanded on the fact that the tax residency of the donee of a gift can also be determinant for gift tax purposes.

The second case illustrated that moving from one jurisdiction to another can have serious tax consequences, especially if the client does not seek his tax adviser’s counsel beforehand. In this particular case, a woman moved from Spain to Switzerland. She owned a Spanish company from which she received a salary and dividends. Furthermore, she owned an apartment in Spain and rented it out to her sister after emigrating to Switzerland. The question then arose: where was this woman's tax residency: Spain or Switzerland? From a Spanish point of view, it is not only important where someone lives (in this case: Switzerland), but also where this person has her main economic interests. From a Swiss point of view, she was also a tax resident because she lived in Switzerland most of the time.

Since we face the problem of double tax residency, we have to look at the tax treaty between Spain and Switzerland and the tiebreaker rules that are established by this tax treaty.

• The first tiebreaker rule is related to the question whether a person has a permanent residence in the jurisdiction (in this case, only in Switzerland, but the Spanish authorities regard a residency rented out to a related party as a permanent residence of the landlord).

• The second tiebreaker rule is tied to the personal and economic centre of interests. In this case the personal (Switzerland) and economic (Spain) centre of interests were not in the same jurisdiction, so this second tiebreaker rule did not suffice.

• The third tiebreaker rule looks at the place a person actually lives: do they stay more than 183 days in one jurisdiction? However, even if a person stays less than 183 days in a certain jurisdiction, if they go there frequently this third tiebreaker cannot be used to determine tax residency.

• The fourth (and in this case deciding) tiebreaker looks at nationality. This person only has a Spanish nationality, so the tax authorities considered this person a Spanish tax resident, simply because she rented out her apartment to her sister.

This case could have been avoided altogether if the client had consulted her tax adviser, who could have told her not to rent out her apartment to a relative. In this case, the first tiebreaker rule would have worked in favour of a tax residency in Switzerland.

In a third and final case, it was explained that, according to the European Directive 650/2012 of 4 July 2012, assets will be inherited according to the law of the country where the deceased had their habitual residence at the time of death. The inheritance of a French national living in Spain will be inherited according to Spanish inheritance law, unless the testator makes a last will with a choice of law for the law of the country whose nationality he possesses.

Other key messages of this session

In the final part of this session, several speakers touched upon different takeaways that could be interesting to keep in mind when advising private clients.

It was noted that some clients want to stay in charge of their business as long as they live. They make sure they set up a structure to pass on this power to their successor after they die, but forget to make arrangements for when they are still alive but unable to look after their business anymore. An alternative to cover this situation is to work with a lasting power of attorney for the possibility that the client is still alive but unable to look after his business. It is important to note that the rules across the different jurisdictions about lasting powers of attorney can differ greatly.

The panel also addressed the issue of a settlor setting up a trust, thinking the assets are still his own assets, and regarding it as a beautifully wrapped-up parcel which has ‘asset protection’ and ‘succession planning’ written all over it. The oft-preferred structure is a private trust company (PTC), where the settlor or their family members are the directors so the settlor remains in control of ‘his’ assets. This works very well until the family falls out, then you have a deadlock situation and thus are unable to operate.

Expanding on the private trust companies, the speaker pointed out that these PTCs are commonly used as ‘purpose trusts’. This is a non-charitable trust without beneficiaries, but with a purpose. Most statutes require an ‘enforcer’ (ie some sort of protector figure) who has to supervise the trustees and make sure they are acting in the interests of the purpose. The legislation concerning purpose trusts often doesn't stipulate who can or can’t be an enforcer, so often the directors of the purpose trust and the enforcers of that same purpose trust are the same people – resulting in an unsupervised purpose trust.

It was pointed out that clients make decisions based on many different factors. Sometimes the client has made up his or her mind, regardless of the consequences, and you as an adviser are left to clean up the mess. In that case, you have to be creative and try to find a solution that negates as much of the negative consequences as possible, by taking advantage of certain treaties, making use of international foreign trusts and asking for tax rulings in the jurisdiction where the client has his tax residency.

To conclude, the speakers shared some key takeaways:

• Prepare, check and check again. Try to calculate in potential consequences and how to respond to those.

• Keep up with the life of your clients.

• Try to educate your clients and raise awareness in the family about the issues of moving jurisdictions.

• Be as clear as possible when defining the beneficiary class in your trust deed. Think about the future and anticipate on foreseeable changes or possible discussions.

• Make sure you have someone in the room that dares oppose the patriarch or matriarch when it is appropriate to do so.

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