Wealth structuresThe role of trust protectors – food for thought

The role of trust Protectors – food for thought (updated)

So what about tax and Protectors?

 

Article by Stephen Abletshauser. November 2019, updated July 2020 (https://bayernlegal.com/the-role-of-trust-Protectors-food-for-thought/) and May 2022

As the role of trustees is increasingly professionalised, the Protector is expected to meet the same fiduciary standards as that of the trustees. Decision making can become complex depending on the family dynamics and Protectors provide additional safeguards for carrying out the wishes of the trustees.

However, it must be emphasised that the appointment of Protectors could further complicate the tax residency of existing and future settlements of trusts. Existing trust deeds should be analysed and test checked at the earliest, so that the trust does not attract unforeseen taxes, in particular inheritance or corporation taxes. The Protector’s appointment might also complicate filing requirements of the trust.

Salt Trust is not biased towards any specific jurisdiction, and advocates that the appointment of Protectors and future settlements should be structured in such a way that the trust does not call for any unintended tax and reporting requirements.

With much experience as advising trustees, we can anticipate fiduciary duties to be carried out by the Protectors. We offer clients a hygiene check of their trusts, can provide a detailed outline of standard operating procedure for trustees and Protectors with a focus on taxation and filing considerations.

The Article is being updated following the decision of the Royal Court of Jersey in the case of In The Matter Of The Piedmont Trust & Riviera Trust, [2021] JRC 248 (”Piedmont and Riviera decision”). The Royal Court of Jersey discussed in detail the role of the trust Protectors and laid down central principles in relation to the trust Protector. 

 Tax considerations in relation to Protectors in a trust are often overlooked yet might potentially change the residence of the trust itself exposing it to unforeseen tax charges.

 

What does the decision of the Royal Court of Jersey say about the role of the trust Protector?

The Royal Court of Jersey has laid down the following principles in relation to the role of the trust Protector:

• Places a strong reliance on the decision of Ogier Trustee (Jersey) Limited v CI Law Trustees Limited [2006] JRC 158, which was primarily a decision on the role of outgoing trustee to that of the Protectors
• Places reliance on Holden on Trust Protector (see Para 7.68 to 7.73) to hold that when a Protector who has fiduciary powers should in principle, as an incident of those powers, prima facie be entitled to seek information and access to documents
• The trustees are to provide detailed reasons as to how they came to a particular decision to the Protector
• The Protector does not have a limited review function like the Court in a blessing application (see S v L E & Bedell Cristin Trustees Limited [2005] JRC 109 at [22])
• The Protector is not a trustee, that is, he is not to take decisions himself or to force the trustee to a decision, but the Protector and the Trustee are to enter into full and open discussion, with a view to finding something upon which they can both agree.

The decision of the Royal Court of Jersey evokes the principle laid down by the Court of Appeal of Louisiana, Third Circuit in the case of In re: Eleanor Pierce (Marshall) Stevens Living Trust, 159 So. 3d 1101 which held:

“By designing a trust Protector, the settlor’s interest in managing the assets for the benefit of the beneficiaries is better protected, as the trust Protector is someone whom the settlor has selected “to represent the settlor’s interest in making specified trust decisions that the settlor will be unable to make.” Sterk, Trust Protectors, Agency Costs and Fiduciary Duty, 27 Cardozo L. Rev 2761, 2777 (2006). It has been said that the trust Protector is “the living embodiment of the dead settlor, “that is, “a person whose primary function is to exercise judgement on behalf of the trust settlor”  

How does the Piedmont and Riviera decision affect the tax residency of the Trust?

The tax residency of a trust in the United States depends on the local laws and the kind of trusts, namely, whether a trust is a grantor trust or a non-grantor trust. For example, in the United States, in the State of Nevada the trust’s tax residence would depend on the beneficiaries’ residence. However, the North Carolina Superior Court issued its opinion in in Kaester 1992 Family Trust v. North Carolina, Docket No. 12 CVS 8740 (N.C. Super. Ct., April 23, 2015) and held that the trust is an entity distinct and separate from its beneficiaries and which did not establish contacts with North Carolina and the control of the trust remained with its trustees located outside the State and hence held that trust was not a tax resident of North Carolina. Many Superior Courts of various States have held that for tax residence the substantial nexus must be met under the Commerce Clause. In the US,  the decision in the case of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) set a four pronged test for giving a taxing right to a State under the Commerce Clause of the US Constitution (1) the taxpayer must have a substantial nexus to the taxing jurisdiction; (2) the tax must be fairly apportioned; (3) the tax being imposed upon the taxpayer must be fairly related to the benefits being conferred by the taxing jurisdiction; and (4) the tax may not discriminate against interstate commerce. In essence the first test, the taxpayer must have substantial nexus, must be met for taxing the trust in a particular State, at least from a United States perspective. (see Robert L. McNeil, Jr. Trust v. Commonwealth of Pennsylvania, No. 651 F.R. 2010 (Pa. Comm. Ct., May 24, 2013). Thus, the effective control of a trust, could attract the substantial nexus trust, thereby giving the State in which the trust is being controlled could seek taxation rights.  

It is also pertinent to note that the Canadian Supreme Court in the case of Fundy Settlement v. Canada, 2012 SCC 14, has held that a trust resides where its real business is carried on, which is where the central management and control of the trust really takes place.

Thus, when one is setting up a trust, the following aspects are important:

1. In which jurisdiction is the settlor establishing the trust?
2. Where are the beneficiaries residing at the time of setting up of the trust?
3. Where are the trustees residing and where are they making the decisions?

However, when a trust has a Protector, considering the Piedmont and Riviera decision, where specifically the Court has held that the trustees and the Protectors are to jointly to come to a consensus, the “commerce clause” in that case, may attract the tax laws of the country in which such decision is being taken, especially if being regularly taken in the manner prescribed in the Piedmont and Riviera decision.

 

Further considerations of Protector decisions?

Some further important considerations may be taken while appointing Protectors:

1. When the Protector has the power to amend the interests of the beneficiaries, since the Protector is acting in a fiduciary capacity and always for the interest of the beneficiaries, then such amendment would require beneficiary consent which could lead to taxability under the Federal Gift Tax (See PLR but also contra decision of Estate of Hazelton v. Commissioner, 29 T.C. 637)
2. Careful drafting of Substitution Power is required and one ought to avoid granting a Protector consent power, as that might lead to the trust being treated as a non-grantor trust (in the United States), which may affect the tax impact in relation to transactions between the settlor and the trust. (See Rev. Rul. 2004-64, 2004-02, C.B. 7 which had given various benefits under the federal gift tax provisions)

 

What could be the possible risk mitigation plan in relation to Piedmont and Riviera decision?

One of the major concerns flowing from the Piedmont and Riviera decision is that the control of the trust decides the tax residency of the trust. Some reasonable ways of mitigating this risk include:

1. Decentralising the control by appointment of a Protector Committee, where there are more than one Protector and the Protectors meet in a jurisdiction which is tax neutral;
2. Appointment of Protector Companies, where the intended Protector is a director of the company;
3. Risk mitigation in carefully choosing the clauses which are subject to Protector consent;
4. Appointment of professional Protectors, where the professional Protector co-ordinates all the discussions with the trustees, and the final decision is taken on the basis of the recommendation given by the Professional Protector;
5. Drawing up a proper procedure in the Letter of Wishes, where the fiduciary duties of the Protector are disapplied under certain circumstances (for example in the United States, see section 808 Uniform Trust Code, 2000 where the settlors have been given the power to eliminate the fiduciary duty of the trust Protector)

 

How could we help?

The role of the trust Protector must be considered from a tax planning perspective and one needs to select with care the kinds of powers afforded to the Protectors. The appointment of Protectors is to be planned in various stages:

1. Who is to be the Protector? The person’s tax residence becomes a key factor.
2. How to elect clauses which would be subject to Protector’s consent? Whether to give power of appointment to the Protector- tax residency of the trust would again be a vital consideration.
3. How to draft the Letter of Wishes and if one is to disapply fiduciary duties? This follows from 1 and 2 above and revolves in part around the taxation nexus.
4. Appointment of professional Protectors for providing end-to-end legal support to the Protector to facilitate effective Protector decisions and co-ordination with the trustees.