A difference has to be made between revocable and the irrevocable trusts. The latter are then divided into so-called discretionary and fixed interest trusts. It is essential for tax purposes to determine whether the settlor, on the creation of the trust, fully divests himself of his assets or whether he has reserved the right (legally or economically) to resort to the trust assets.
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.