The evolving role of trusts in wealth planning

Trusts have traditionally been seen as a tax-efficient means to pass wealth between generations, but in recent decades government policymakers and tax authorities across Europe have increasingly taken steps to prevent trusts being used for tax avoidance. They still have a valuable role in wealth planning, especially in managing succession, preserving assets and effecting charitable donations.

Given the complicated structure of many modern families, which may include step-children and half-siblings spread across multiple countries or continents, and comprise members with different interests and needs, wills and/or national heirship rules are often inadequate to allocate complex estates that may comprise property, investment and business assets. Trusts are one tool among many that can help address this issue.

Trusts are a feature of the common law systems that prevail in the UK, US and many other Anglo-Saxon jurisdictions, as opposed to the civil law that prevails in Luxembourg and neighbouring countries including France (from which the grand duchy borrows much of its jurisprudence). However, the grand duchy’s vocation as an international financial centre and particularly as a hub for wealth management has resulted in the country emulating or at least recognising, some common law concepts and structures, including limited partnerships. Trusts are a more complicated matter.

Ongoing controversy over assets

Trusts give the settlor – the person who establishes the trust – control over assets at the outset, and, in some cases, on an ongoing basis. Settlors decide who should receive what assets held by the trust and when. They should be in a position to assess the personalities of the individuals involved and judge the appropriate point at which particular heirs should take possession of trust assets.

Trusts can give individuals the right to receive income from an asset, rather than ownership of it – for example, a portfolio of assets could be left to a child, with the surviving parent benefiting from a life interest. Trusts can also be a helpful means to head off lengthy wrangling between heirs over assets and to make the intentions of the settlor clear.

They can also have a protective function. At one extreme, this might relate to problems arising from countries’ political instability, but it can also protect wealth from being dissipated by a family breakdown; the settlor may wish to prevent a child’s spouse from receiving a significant share of their wealth in the event of a divorce.

Another purpose for trusts is charitable giving, since the settlor can give a sum of money or assets to the trust and provide the trustees with instructions on how they want the capital to be distributed to particular causes or organisations.

While the tax advantages of trusts in avoiding inheritance tax have diminished in recent decades, by controlling when and how an individual’s estate is distributed, it can still of help in managing rather than avoiding tax liabilities

While the tax advantages of trusts in avoiding inheritance tax have diminished in recent decades, by controlling when and how an individual’s estate is distributed, it can still of help in managing rather than avoiding tax liabilities – especially inheritance tax, although the benefits depend on the jurisdiction of the settlor and of the beneficiaries. Adopting the right strategy will require assistance from a qualified tax adviser. It is clear, however, that trusts cannot be used to circumvent compulsory heirship rules applicable in Luxembourg and other countries.

Operation of a trust

The settlor provides the capital for the trust and decides who should benefit, and when and how, but once it is established, they have surrendered its assets and no longer have any claim on them. At this point the responsibility for how the money is used or distributed lies with the trustees, who must manage it in accordance with the trust deed established by the settlor. Other individuals, starting with the beneficiaries, can challenge the trustees’ management of the trust if they believe they are not following the instructions set out in the deed.

The beneficiaries will also be named or defined in the trust deed. A key point is that they don’t have to exist. Capital can be set aside for the unborn children of existing people. History is replete with wealthy individuals that have used trusts to bypass their wayward children in favour of future grandchildren. The settlor can also add new beneficiaries to the deed if they so wish.

Establishing a trust is no more complex from an administrative perspective than establishing a company. The settlor is required to donate assets for the trust, whether in monetary or another form. The identities of the settlor, beneficiaries and trustees must all be recorded at the outset. The trust must have a specific name to ensure it cannot be confused with another legal entity or trust. The lifetime of the trust – up to a maximum of 100 years – must also be recorded when it is established.

Technically, the concept of a trust does not exist under Luxembourg law, although it recognises a concept that closely resembles it known as a fiducie – a fiduciary contract. As a result, where a foreign trust owns assets on behalf of an individual resident in Luxembourg, the proceeds are simply allocated to that individual for taxation purposes. The tax rules may be different for certain discretionary and irrevocable trusts, but this is a complex area that requires professional advice.

Trusts continue to play an important role in wealth planning, to ease the administration of complex estates and ensure that the right people get the right assets at the appropriate time. But professional expertise is vital to navigate the legal and tax issues, even more so in civil law countries such as Luxembourg.

Trusts in Luxembourg

Luxembourg law permits the creation of international trusts, which enables foreign citizens who are not ordinarily resident in the grand duchy to establish trusts there. Neither the settlor, beneficiaries nor trustees are required to be Luxembourg residents. The assets within the trust can be domiciled anywhere in the world.

Luxembourg’s parliament passed legislation in July 2020 establishing a register of fiduciaries and trusts, as part of a package of measures required by EU rules designed to prevent money laundering. The law means that all trusts must now be registered and trustees are required to keep detailed records of their beneficiaries. This creates new administrative obligations that largely fall on the trustees. Luxembourg companies that act as trustees must be authorised by the country’s financial regulator, the CSSF.

Even if the trust as conceived in common law does not exist in Luxembourg, some structures can be used in the same way. The most popular type of structure is one dedicated to family wealth, which is usually structured as a special limited partnership. As in Anglo-Saxon jurisdictions, the creator of the structure endows it with capital or assets and establishes how it is to be managed and used.

Trusts can give individuals the right to receive income from an asset, rather than ownership of it. Trusts can also be a helpful means to head off lengthy wrangling between heirs over assets and to make the intentions of the settlor clear.