This Trust Glossary is based on definitions contained in the Circular No. 30 on the Taxation of Trusts dated August 22, 2007 of the Federal Tax Conference. This (unofficial) English translation was made by the Society of Trust and Estate Practitioners, STEP.
The trust is a legal relationship which originated historically in England and consequently it has developed mainly in the common-law states (Great Britain, United States, Australia, Canada, South Africa, New Zealand). In addition, institutions similar to trusts can be found in other countries such as, for example, Japan, Panama, Liechtenstein, Mexico, Colombia, Israel and Argentina.
In practice, the trust has proved to be an extremely flexible instrument. It is frequently used in connection with estate planning and for so-called asset protection for individuals. In addition, trusts in the Anglo-Saxon legal world are among the most frequently used structure for charitable institutions, and employee pension plans and also to implement employee stock option plans for companies listed on the stock exchange. In view of the variety of possible forms of the trust, listing all types of trust would be an impossible undertaking and would also be of little use for determining their treatment for tax purposes. It is preferable to fix the principles of the tax treatment of trusts independently from the type of trust concerned.
The trust can either be set up by way of a legal act between living persons or by way of a testamentary instrument.
Even if its structure is similar to a Swiss foundation, the trust does not have separate legal personality. From a formal point of view, the trustee is the holder, on a fiduciary basis, of the trust assets. However, the trust is, on the other hand, not just a mere contract. Although the trust is originally set up by the settlor, it is, after its creation, essentially a legal relationship between the trustee and the beneficiaries which is principally governed by the trust deed and secondarily by the specific rules of the applicable legal system. In organising the trust, the settlor has a comparatively extensive freedom. Once the trust is set up, however, the settlor has only a limited degree of influence over the trust, as in the case of a founder of a Swiss foundation. After the trust is created, the trustee’s primary duty is to safeguard the interests of the beneficiaries and not those of the settlor. Another typical feature of a trust is the complex legal relationship which exists with respect to the trust assets. The trustee is the owner in civil law (common law: legal interest) of the trust assets, but he is required to administer the assets held on trust separately from his own assets and, in the event of death or bankruptcy of the trustee, the assets are not regarded as his own but are still subject to the law applicable to the trust and are held separately for the beneficiaries or the new trustee to be appointed.
The trust is not a (mere) contract. Although the trust is originally set up by the settlor, it is, after its creation, mainly a legal relationship between the trustee and the beneficiaries. After setting up the trust, the prime obligation of the trustee is to protect the interests of the beneficiaries and not those of the settlor.
The tax treatment of trusts is to be determined exclusively under Swiss tax law. Art. 19 of the Hague Convention provides expressly that the Convention does not prejudice the powers of States in fiscal matters. Ratification of the Hague Convention thus has no effect on the tax treatment of trusts.
The trustee is obliged to allow the beneficiaries (but not the settlor) and any protector, to have access to the records concerning the administration and management of the trust.
If the settlor establishes an irrevocable trust, he divests himself definitively of the trust assets, and in principle he basically has no more rights or duties in respect of those assets. Alternatively, the settlor can form a revocable trust. In general, there is no irrevocable divestment if the settlor has appointed himself as trustee or beneficiary. Furthermore, divestment is not recognised if the settlor retains any influence over the trust, in whatever form. The following factors (derived by way of example from the Federal Court’s practice concerning family foundations) allow the distinction to be made between revocable and irrevocable trusts.
Can the settlor
- benefit from capital distributions from the trust assets?
- benefit from distributions of income of the trust assets?
Does the settlor have the right
- to remove the trustee and to appoint another one?
- to appoint or cause the appointment of new beneficiaries?
- to replace the protector who in turn has powers comparable to those of a trustee?
- to amend the trust deed or cause it to be amended?
- to revoke the trust?
- to require liquidation of the trust?
- to exercise a veto over the trustee’s decisions with respect to the trust assets?
An affirmative reply to any one of the above questions will lead to the trust being treated as a revocable trust for tax purposes.
In the case of a revocable trust, the settlor reserves the right to revoke the trust at a future date and to recover the remaining assets or have them transferred to a third party. The settlor has therefore not definitively divested himself of his assets.
For tax purposes, it is not the designation in the trust deed which is conclusive but rather the economic reality. A trust designated as «irrevocable» may also fall into the category of a revocable trust if the divestment is not absolute.
Revocable trusts become irrevocable trusts following the death of the settlor unless the right of revocation is exercisable by another person or is transferred to someone else.
Irrevocable fixed interest trust
In the case of a fixed-interest trust, the provisions relating to the beneficiaries and their respective rights are to be found in the trust deed. With this type of trust the trustee thus has no freedom of discretion in the distribution of the income and/or capital of the trust. The trustee has neither the economic ownership of the trust assets nor does he have any independent freedom of disposition over the assets. In setting up an irrevocable fixed interest trust, the settlor has definitively divested himself of his assets.
In contrast to the discretionary trust in which case the rights of the beneficiary are merely in the nature of an expectancy, the beneficiary of a fixed interest trust has a legally enforceable actionable claim to the assets. Consequently, the beneficiary of a fixed interest trust can be considered by analogy to be an usufructary.
Irrevocable discretionary trust
In general, the trust deed of a discretionary trust only includes a broad class of beneficiaries. The decision as to whether who, ultimately, is to receive distributions from the trust is left to the trustee.
The settlor may in a letter of wishes indicate to the trustee his reasons for creating the trust and can suggest to him, in a way that is not legally binding, how he would wish the trustee to exercise his powers.
If the settlor places particular importance on certain specific issues, it can be provided in the deed that certain decisions of the trustee require the prior approval of a protector.
When a discretionary trust is created, there is no enrichment of the beneficiary as it is not yet certain which persons will receive a distribution, and of how much and at what time. The rights of the beneficiary are thus merely in the nature of an expectancy.