„I cannot understand your trust“ one prominent German law professor of the 19th century said to his English counterpart. The English law tradition has two legal streaks, the original common law and the law of equity, originally each with its own branch of judicature. Trusts emanate from the law of equity. The German professor could be forgiven; looking at trusts and trust funds today, their whole point is not to be understood. Who actually owns and controls the assets in a trust is hidden behind terms like „duality of ownership“ or „split ownership“.
How it all started
For a thousand years, all land in England belonged to the crown. An ‚allodial‘ title, which meant that the land was free from delivery, service or other obligations, became few and far between otherwise. The next best thing, ‚Freehold’ was the all-encompassing form of tenement.
In much of central London, a third ‚estate‘ below the freehold, the leasehold, developed later. The lease was a private contract and left room for adjustment by the parties to meet their individual situations. In the Middle Ages and beyond, the holder of the freehold or ‚fee simple‘, however, had a problem: the protection of the freehold at common law did not allow for a spouse or issue of a knight to assume the role of a proprietor of land. Going on a crusade or into battle thus put the property – castle and land – at risk. A workaround of a leasehold for the spouse with the right to the land permanently mediated through (another) freeholder and not harnessed by a deed was not a proper remedy. However, a treaty-like ‚feoffment‘ was when such contract was (i) defined in time and (ii) had the trust as legal owner beholden to the knight as erstwhile freeholder. The trust would reverse to him or – should he not comeback alive – to his children capable of holding title.1 This reversionary interest is a hallmark of some but not all trusts and has found expression in the ‚estates’ in relation to real estate property between freeholder and leaseholder, in other words the freeholder’s protected interest to regain the full use of the property together with unfettered ownership.
Types of trusts
Under the law of equity developed in England, there are three types of trusts:
(1) express trusts; (2) trusts by operation of law and; (3) constructive trusts. Express trusts are intentionally created by the settlor. Besides this, there are some situations, normally around inheritance, where English law stipulates an implied trust. Finally, constructive trusts are adjacent but meant to mitigate the consequences of an unconscionable act on the side of either the deemed settlor/trustee or the deemed beneficiary. Purpose trusts come into existence mostly in the guise of express trusts. A purpose trust is not for the benefit of a person but for a specific purpose and is invalid under English law unless it is a charitable trust.2 A non-charitable purpose trust would lack a certain beneficiary and be in conflict with the English-law rule against perpetuities: the interest must vest no later than 21 years after the creation of the trust at which time a beneficiary must be alive or in gestation. Otherwise, the certainty of object could not be applied and the trust would fail. The only exception is the charitable trust which can satisfy the requirement of having any human beneficiary. The English 2011 Charities Act provides a conclusive enumeration of charitable purposes. Express trusts may run for a very long time and changes in the law – particularly tax law – may require a variation of the trust instrument. The English Variation of Trusts Act 1958 gives the power to the court to vary or revoke any term of the trust.3
Tax-driven trusts
In relation to tax-driven trusts, it is of paramount importance that creditors of the trustee have no right to the trust assets, not only in the event of a bare trust – one where the settlor may treat the trust assets as they were their own – but also for those with far-reaching discretionary powers for the trustee. The trust as an equitable concept (i.e. one derived from the laws of equity in England) is inherently flexible and it can be purposefully amended by legislation.
Non-charitable but economically strikingly successful examples of trusts can be found in the United States While federal jurisdiction and agencies have been harbingers of control and candour in the financial industry as well as in enforcing lawful taxation, the „Blue Sky laws“ of some states have opened a bountiful field for trusts.4
Trusts under the Blue Sky Laws
The British settlers had taken the trust idea with them to North America. Originally, perpetual or dynasty trusts permitting members of wealthy families to receive income from assets over many generations without legally owning them were not part of the legal basis for trusts, also not in the new world. The 350-year old rule of limitation against perpetual and dynasty trusts was jettisoned by twelve US states in the late 20th century in a bid to establish themselves as tax havens within a respected jurisdiction without the dark regulatory and political clouds hanging over may offshore places.5 South Dakota has embarked on its trust renaissance journey in 1983 and has added ever more features of convenience for wealthy individuals as clients. While trusts originally emanated from the distinction between a non-congruence of legal and equitable ownership, settlors of trusts in South Dakota may create a trust to benefit only themselves.6 In the league tables of tax havens maintained by the Tax Justice Network 7, the US have risen to second place after Switzerland and are ahead of the Cayman Islands, Hong Kong and Luxembourg. This is not the US on federal but on state level in those states which have become the most unusual of suspects.8 Still, federal legislation has played into their hands. The Foreign Accounts Tax Compliance Act (FATCA) 2010 as before it the Foreign Corrupt Practices Act has its focus solely outside the US, not within it. The trust practitioners in South Dakota and elsewhere have been creating perpetuity trusts for money from places like China, Venezuela, Mexico and many more.
Simply put, trusts are a blatantly convenient instrument to hide assets, and disassociate with such assets for tax purposes while retaining full economic control. The conflict between the individual’s desire to keep assets on the one hand and a righteous government’s desire to tax them on the other can foreseeably only be solved in the imperfect manner of a compromise and the Common Law trust concept could be an important tool for this. It would allow the recognition under tax rules of a platform for assets which would enable those assets to benefit their creators/trust settlors and those other beneficiaries which inheritance law allows while at the same time serving some public purpose in a duality of ways, e.g. by designating a share of the proceeds to a charitable or public purpose and by collecting at least some tax revenue in exchange for convenience and legal safety.
Beneficial owners of existing offshore and US state trusts are unlikely to flock to the idea soon but a population of trusts can also grow from the bottom up. A trust concept attractive to a much broader share of real and potential taxpayers can also serve as an instrument to a fairer effective tax regime. Property and hereditary rights enjoy legal protection and this is part of any capitalist order, however strong its overtone of social responsibility. A trust would still afford to the beneficiaries the protection which is fundamentally required and recognise the trustees as owners in a private-law sense. At the same time, assets could be transferred from one generation to another without taxes. Such taxes will either be regarded as baseless or disruptive if the trust assets mainly consist of a family business. Trust (tax) legislation could be designed to encourage larger numbers of beneficiaries, also for medium and even small asset values. Acceptance of some taxation, also, or perhaps even more so, if linked to the nature of the trust assets and their dedicated purposes, would probably rise. Note the plurality of purposes which could be distinguished. Not all of those need to be charitable; mixed and dual purpose trusts would be possible. Because the trust concept is inherently flexible, a variety of set-ups is possible, also within a civil-law setting. A democratisation of the trust concept in common and civil-law jurisdictions would not just be a side-effect but deliberate.
Effective taxation does not just rest on the assertion of formal claims but on making a credible offer.
Applying the idea of the Laffer curve 9 to the trust concept, a wider use of trusts at low costs and with measured taxation could respond to the desires of many citizens for their own assets as well as for their government’s relation to them. For the existing trusts of often larger sale, such credible offer would be a route to transition these assets to a trust structure. It need not trigger retroactive taxes but it would help achieve two purposes: (i) pave the way for some level of taxation being applied and (ii) make previously hidden assets visible and allow them to be put to a broader use more in line with public policy. A trust law following the example of the Societas Europea, applying EU-wide could be a useful tool to improve not just on fiscal but more importantly on political effectiveness aiming for a heightened degree of equality, real and perceived. Such policy would not be an equalising one by invasive means attempting to rectify the ills of freebooting capitalism but by providing a common field for trusts of various purposes and sizes to exist.
Trusts and housing policy
There is also a lesson for housing policy here: if the government did not sell land but granted a lease over it with reversionary interest after a specified period and made the character of a trust more prominent on top of this reversionary interest, a balancing of objectives appears feasible.
Strangely, England has not employed its long legal tradition of equity and trusts to this end, which is due to some extent to the historical make-up of British society but can be put down to a larger part to often misguided government policy serving a short-term political interest. A trust structure for an edifice on public land would allow private investors to operate with the certainty they need plus a fair bit, but not all of the economic freedom they desire – yet enough to make a project economically viable while being part of a government housing policy.
An interesting model of the cooperative segregation of the ownership and the operation of an asset is a structure found in a situation where real estate and business ownership coincide in the same place but not in the same hand. The „opco-propco-model“ is somewhat resembling of the trust scenario, where the landowning property company, „propco“ leases the land to the operating company, „opco“. Like a trust, this construction is driven by a purpose, albeit often exclusively one of tax-avoidance. A trust, however, would not involve different legal personalities but a set of mutual obligations engendering a constructive possession for a public-policy driven landowner with the developer controlling the operating entity. The government or another policy-bound owner would be the beneficiary-in-waiting while the developer would act as the trustee with a recognised, defined – and finite – commercial interest. A trust structure could make it easier to give due consideration to each party’s interests and make use of a trust’s inherent flexibility. The allocation of bargaining power in such trust structure would not be unduly skewed so that flexibility would not be a downside.10
1 This promise-based arrangement was over time recognised by the Courts of Chancery and the trusts over land formed the nucleus of the ‚uses‘ or ‚equitable rights’. Compare Leonie-Pascale Neu, Der Trust im italienischen Recht, Studien zum ausländischen und internationalen Privatrecht, Bd 405, Tübingen 2018, p. 17
2 see Leahy v Attorney-General for New South Wales (1959) AC 457 and Lord Evershed MR in Re Endacott (1959) EWCA Civ 5
3 Under the proviso in section 1(1) of the act the court may not approve of a term on behalf of the person unless it is for the benefit of that person. This clearly is statutory law at work in the realm of equity. The Courts of Chancery would likely not have concurred – another example for the“confluence“ observed by Lord Diplock
4 see fn 3 above
5 From the most deregulated upwards, these are South Dakota, Nevada, Tennessee, Arkansas, Wyoming, Rhode Island, Ohio, Delaware, Illinois, Montana, New Hampshire and Florida but in total 24 US states allow perpetual trusts
6 Sun Hongbin is the sole beneficiary of his own trust. He has transferred $ 4.5 billion of shoes in his Chinese real estate firms to his South Dakota trust, see Gerry W. Beyer, Law Professors Blogs Network, Wills, Trusts & Estates Prof Blog, 5 March 2019
7 see www.taxjustice.net
8 see fn 5 above
9 The Laffer Curve is a theory developed by supply-side economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments. The curve is used to illustrate Laffer’s argument that sometimes cutting tax rates can increase total tax revenue (investopedia)
10 REITS (real estate investment trusts) are treated like stock corporations in many countries, bound in form and purpose and not an instrument of public policy