Philippe Kenel

 

The trust: what is its usefulness within the context of Swiss law?

 

Philippe Kenel, Doctor of Law, Attorney in Lausanne, Geneva and Brussels, Python & Peter

 

Although Swiss law does not recognise the trust as such, this institution plays an essential role in Switzerland. Indeed, Swiss banks manage a considerable amount of assets held by trustees. Furthermore, Switzerland, more particularly Geneva, accommodates numerous companies whose key activity consists of fulfilling the role of trustee and/or administering trusts. Moreover, following the various attacks on Switzerland over the last months, the trust has been presented by some as the solution to all the problems faced by our country.

 

The purpose of this article is to summarise the situation of the trust within the context of Swiss law and to determine to what extent this institution would be an alternative, in the event of the elimination of banking secrecy.

 

The Hague Convention of 1 July 1985

 

Swiss law does not have internal legislation relating to trusts. Consequently, strictly speaking, no trusts exist under Swiss law. For many years, doctrine and the courts have developed many principles, tending to bring closer together the fiduciary trust, the foundation and the settlement for third parties. In order to ensure a certain amount of legal security for the economic players, the Swiss authorities, while abandoning the idea of creating a trust under Swiss law, decided to ratify the Hague Convention of 1 July 1985, on the law applicable to trusts and their recognition (hereafter “the Convention”). It came into effect in our country on 1 July 2007.

 

The Convention defines the trust as a legal relationship created by one person, the settlor – through an agreement between living individuals, or due to death – when assets have been placed under the control of a trustee in the interest of a beneficiary or for a specific purpose. The characteristic traits of a trust are thus the separation between the assets of the trust and of the trustee, the ownership of the assets in the name of the trustee and the obligation of the trustee to administer, manage or dispose of the assets according to the terms of the trust. The Convention, which is aimed only at voluntarily-created trusts, i.e., express trusts, in contrast to implied trusts, pursues two objectives. On the one hand, it determines the law applicable to the trust by favouring the law selected by the parties. If such is not the case, the trust will be governed by the law of the location with which the trust shows the closest ties. On the other hand, the Convention provides that a trust created in accordance with the determined law, according to the regulations above, will be recognised as a trust. Therefore, if the parties create a trust pursuant to the law of the British Virgin Islands, Switzerland will recognise that a trust is governed by the law of that State. Ratification of the Convention obviously has not resolved all of the questions that a trust may pose in civil law. Such is particularly the case concerning the viability of the legal agreement (gift or instrument not taking effect until death), by virtue of which the assets are transferred by the settlor to the trustee. Similarly, the Convention does not govern questions related to the reserved inheritance of heirs, which remains subject to the law of the government where the deceased was domiciled.

Consequently, if the succession of an individual domiciled on Swiss soil is initiated in Switzerland and the instructions given to the trustee prejudice the reserved inheritances of the heirs, this may represent a violation of Swiss law. The two single ways to avoid this risk are the inception of a pacte successoral [succession agreement] that was entered into between the late individual and the heirs, or the submission by the late foreign individual, prior to his death, of his estate to his national jurisdiction (professio juris) on the condition that this, like British law, does not recognise the concept of reserved inheritances.

 

The trust and Swiss tax law

 

For many years, the taxation of trusts was subject to practices that sometimes varied greatly according to the canton. For the sake of harmonisation, la Conférence suisse des impôts [the Swiss tax conference] published a Circular on 22 August 2007 (Swiss Tax Conference Circular number 30), which was subsequently also adopted by the Swiss Federal Tax Administration on 27 March 2008 (Swiss Federal Tax Administration Circular number 20). Consequently, it governs taxes at the cantonal as well as the federal level.

 

Without going into the details of this Circular (the reader will find a summary presentation of it appended to this article), it is nevertheless important to point out that its adoption has precipitated a certain amount of disappointment amongst the sectors affected. Indeed, while it was legitimate to think that the ratification of the Hague Convention, which contains no provision related to taxation, was going to pave the way towards a better utilisation of the trust as a tax and estate planning tool for Swiss residents, the adoption of the Circular by the Swiss Tax Conference crushed all hopes.

 

Three principal lessons can be learned from this document. On the one hand, this Circular has strengthened the Swiss trust industry by confirming the principal by virtue of which the trustee located in Switzerland is taxed neither on assets nor on revenues of the trust. On the other hand, it has eliminated any interest for a person domiciled in Switzerland to create a trust, since either this is not recognised or it falls to the settlor to pay the tax on gifts. Finally, this Circular recognises the viability of an irrevocable discretionary trust created by a person domiciled on foreign soil, even if he subsequently moves to Switzerland. Nevertheless, we draw the attention of the reader to the fact that the trust must not be created on the eve of the arrival of the settlor in Switzerland, as it may be considered as an abuse of law. Subject to this condition, it can nevertheless be attractive for a foreign national relocating to Switzerland with a view to benefit from the taxation based on expenditure, to create an irrevocable discretionary trust before coming to Switzerland, in order to find himself in a more favourable situation in the event that the lump sum tax were, hypothetically, to be eliminated.

 

The trust: an alternative in the event of the elimination of bank secrecy?

 

Contrary to what certain people maintain, the creation of a trust under Swiss law would in no case be an alternative in the event of the elimination of bank secrecy in Switzerland. Indeed, in the event of a legal structure opening an account, the question is not whether it involves a trust under Swiss or foreign law, but the information required by the bank on the economic beneficiary of the account. Therefore, the problem of competitiveness that Switzerland faces today with respect to specialised financial localities such as Jersey, Guernsey or the Cayman Islands is that the Swiss banks, when a bank account is opened by a trustee, require the identity of the settlor, of the beneficiary(ies), of the trustee and of the protector, which is not the case in the aforementioned countries. Consequently, the means that Switzerland has at its disposal and which it must use, is not to create a trust under Swiss law, but to put pressure on the OECD, so that the banks of all governments must require the same information as the Swiss banks. To conclude, we believe that the trust is an outstanding tax and estate planning tool, but that, in no case, within the current context, would it serve as an alternative in the event of the elimination of banking secrecy. Switzerland made a step in the right direction by ratifying the Hague Convention. Nevertheless, the Circular concerning tax matters should be modified in order for it to be a more attractive planning tool for persons domiciled in Switzerland.

 

 

Summary of the contents of Tax Guidelines No. 30 [Swiss Tax Conference] of 22 August 2007 on the taxation of trusts, as incorporated into AFC Circular No. 20 of 27 March 2008

 

 

1. Taxation of the trust

 

The trust is nether a Swiss legal entity, nor a foreign legal entity under Swiss tax law

 

2. Taxation of the trustee

 

A   Trustee outside Switzerland

The Swiss tax law is not concerned

 

B   Trustee in Switzerland

The trustee resident in Switzerland may not be liable to tax (income tax and net wealth tax) for any income generated out of the trust fund and for the trust fund itself. The trustee pays tax on his fees

 

3. Taxation of the Protector

 

A   Protector outside Switzerland

The Swiss tax law is not concerned

 

B   Protector in Switzerland

The Protector resident in Switzerland may not be liable to tax (income tax and net wealth tax) for any income generated out of the trust fund and for the trust fund itself. The protector pays tax on his fees

 

 

4. 1. Taxation of the settlor of revocable trust

 

A   Settlor outside Switzerland

The Swiss tax law is not concerned

 

B   Settlor in Switzerland

The ownership of the assets will not be considered to have been transferred to the trustee. Income and assets of the trust remain taxable in the hands of the settlor (income tax / net wealth tax / no capital gains tax)

 

 

4. 2. Taxation of the beneficiary of a revocable trust

 

A   Beneficiary outside Switzerland

If the settlor is in Switzerland, distributions to the beneficiary are gifts from the settlor to the beneficiary and the settlor has to pay the gift tax

 

B   Beneficiary in Switzerland

If the settlor is in Switzerland, distributions to the beneficiary are gifts from the settlor to the beneficiary and the settlor has to pay the gift tax

 

 

 

5. 1. Taxation of the settlor of an irrevocable discretionary trust

 

A    Settlor outside Switzerland

The Swiss tax law is not concerned even if the beneficiary is in Switzerland except if the beneficiary received distribution

 

 

B    Settlor in Switzerland

      1. The settlor pays income taxes

The Swiss tax administration does not recognize the trust. The settlor will pay income tax, wealth tax, but no capital gains tax. Any distribution is a gift and the settlor has to pay the gift tax

 

      2. The settlor pays taxes on the basis of expenses

The tax administration will recognize the trust and the settlor has to pay the gift tax

 

 

5. 2. Taxation of the beneficiary of an irrevocable discretionary trust

 

A   Beneficiary outside Switzerland

If the settlor is outside Switzerland, the tax Swiss law is not concerned

If the settlor is in Switzerland, he has to pay the gift tax for any distribution.

 

B   Beneficiary in Switzerland

      1. The settlor pays income taxes

The trust is not recognized and the settlor has to pay gift tax for       any distribution

      2. Settlor outside Switzerland or settlor paying taxes on the basis of expenses in Switzerland

The trust is recognized and the beneficiary pays income taxes on all distributions

The beneficiary can avoid the income taxes if he proves that the distribution is a part of the capital. However he has to pay tax even if he proves that the distribution is a capital gain

 

 

 

 

6. 1. Taxation of the settlor of an irrevocable fixed interest trust

 

A   Settlor outside Switzerland

The tax administration recognizes the trust. The tax Swiss law is not concerned

 

B   Settlor in Switzerland paying taxes on the basis of expenses or income taxes

The tax administration recognizes the trust. The settlor has to pay the gift tax at the moment of the creation of the trust.

 

 

 

6. 2. Taxation of the beneficiary of an irrevocable fixed interest trust

 

A   Beneficiary outside Switzerland

The Swiss tax law is not concerned

 

B   Beneficiary in Switzerland

The beneficiary has to pay income taxes on every distribution. However, he will avoid this tax if he can prove that the amount distributed is a part of the capital of the trust or capital gain. The tax administration considered that the income and the capital gains are distributed before the capital of the trust.

The beneficiary has also to pay the wealth tax