What's the difference between a foundation and a trust?
Since the introduction of the Foundations (Jersey) Law 2009, practitioners have contrived to analyse the practical implications for clients’ on the differences between foundations and trusts in order to decide which vehicle would best fit their clients’ needs.
Comparison - 01/02/2014
This Briefing by Director Michael Powell aims to give an overview of the main concepts of each and to summarise, compare and contrast the two structures in order to facilitate further discussion with clients or their advisers.
What is a Trust?
The trust concept has existed in common law jurisdictions from as early as the 12th century. The term ‘trust’ is used to describe the relationship which exists when a person (the trustee) holds assets on behalf of another person or group of people (the beneficiaries).
A trust is therefore not a separate entity, but a relationship. A trust begins when a person (the settlor) transfers assets (the trust fund) to a trustee or trustees, who will hold those assets and preserve or where appropriate enhance their value until such time as all or part of the trust fund is distributed to one or all of the chosen beneficiaries.
Whilst the legal title to the assets is held by the trustees, the beneficiaries have a beneficial interest in the trust fund. The trustees therefore hold the assets on behalf of the beneficiaries.
Although not strictly necessary, any trust which Hawksford administers will be governed by a formal written trust deed setting out the administrative and dispositive powers of the trustees, the terms of which are agreed with the settlor and his or her adviser.
There are various types of trust - for example, the settlor may wish for the trustees to pay income to one person during their lifetime, or they may wish to give the trustees discretion to make decisions on paying out income and capital (usually with guidance from the settlor on how they should exercise that discretion in the terms of a letter of wishes).
Trusts have formed the basis of succession planning for families for many years, allowing trusted professionals to administer wealth after the lifetime of a settlor and thereby ensure that his or her family continue to be looked after long after they have passed away.
A trust can therefore delay the time at which children become entitled to family wealth – it can prevent significant wealth passing to children or indeed adults before they are responsible enough to use the money wisely.
Separating assets from an individual’s personal wealth may also provide advantages in terms of protection from personal debts and other threats, and can in some cases provide tax savings depending on the laws of the settlor’s resident jurisdiction.
For most, the trust concept increasingly appeals for the reasons trusts were initially created: asset protection, succession and estate planning.
What is a Foundation?
A foundation is a relatively new concept to common law jurisdictions, which have traditionally used trusts for asset holding and succession planning. However, foundations have also been used for the same purpose in civil law jurisdictions since the Middle Ages.
A foundation is an incorporated legal entity which can be used to hold assets and will have a number of uses in wealth structuring and succession planning. As a concept it is neither a company nor a trust, although it has features of both.
As there are no shareholders or ‘owners’ and there is no requirement to have beneficiaries, Hawksford has experienced a growing trend to use a foundation as an ultimate holding vehicle which separates underlying assets from an individual’s personal wealth and therefore falls outside his/her estate for inheritance tax purposes.
Foundations are effectively orphan structures and are likely to be of particular use where charitable trusts, purpose trusts or companies limited by guarantee would have been considered. They can equally be used for charitable or non-charitable purposes, such as succession planning for wealthy families to divest assets which the foundation can hold for the benefit of its beneficiaries.
What type of assets can Foundations hold and who are best placed to use them?
Foundations can hold all types of assets from a single asset to a range of different assets and there are no restrictions on what can be owned by a foundation, other than immovable property situated in Jersey.
Features of Foundations and Trusts
The following information clarifies the major differences between foundations and trusts established under Jersey law:
- A foundation is a separate legal entity (similar to a company).
- A foundation can contract and hold assets in its own name.
- A foundation can sue and be sued in its own name.
- The foundation holds the legal and beneficial title to the assets.
- A trust is not a separate legal entity.
- The legal rights and obligations sit with the trustees rather than the trust itself and the trustee therefore contracts in his/her or its own name on behalf of the trust.
- Legal ownership of the trust fund sits with the trustees and beneficial ownership with the beneficiaries.
- The trustees would sue and be sued in their own name, as opposed to action being taken by or against the trust.
- A foundation must be formally registered with the Registrar at the Jersey Financial Services Commission.
- Registration will be conclusive evidence that the foundation has been incorporated and has met the requirements of the law.
- The foundation document (the charter) will be a public document. In practice, most of the information is contained in the regulations of the foundation which is a private document and very little information is included in the charter, which does not publically reveal the identity of the guardian, founder or beneficiaries.
- There are three basic requirements to establish a trust, stemming from English case law. In order for a trust to be valid it must:
- Demonstrate that at the time of creation there was an intention by the settlor to create a trust;
- Identify the trust fund and the beneficiaries.
- A trust does not need to be registered and no trust documentation needs to be made public.
- The existence of a trust can therefore remain confidential.
- A foundation does not need to have any beneficiaries.
- Beneficiaries of foundations have very limited rights unless the founder wishes to provide for rights to be granted under the foundation’s regulations.
- Beneficiaries of foundations do not usually have rights to information about the foundation.
- Beneficiaries of a foundation do not have any beneficial interest in a foundation unless the foundation council or the regulations confer some entitlement on them (such as a right to receive income).
- In order to be valid a trust must have beneficiaries.
- The only exception to this is a purpose trust, where there are no beneficiaries but an enforcer is appointed to ensure that the trustees run the trust in accordance with stated purposes.
- Beneficiaries of a trust have a beneficial interest in the assets, and therefore have legal rights which can go as far as forcing the trustees to take an action through the court or expressing their collaborative wish for an action to be taken which would be difficult for a trustee to refuse unless there were compelling reasons to do so (such as adverse tax consequences etc.)
- Beneficiaries also have rights to certain information about the trust. They are not entitled to disclosure of information as of right, but have a legitimate expectation of disclosure. A beneficiary’s rights to information are based on the fiduciary duty of the trustees to keep the beneficiaries informed and to provide accounts.
- A foundation can be established without any initial funds.
- The founder does not need to advance funds to the foundation, which comes into existence on registration.
- The settlor of a trust must pass some initial trust assets to the trustees in order to form the trust. Further assets can of course be added albeit generally with professional advice.
Running the structure
- A foundation has a council to run its affairs.
- Jersey law states that at least one member of the council must be a trust company service provider based in Jersey and registered with the Jersey Financial Services Commission.
- There is no maximum number of members that are allowed on the foundation council, but a maximum number can be set in the regulations.
- A council member must be at least 18 years old, must have mental capacity, and must not be disqualified from acting as a council member or director of a company
- The trustees of a trust are responsible for the decision making and managing the trust fund.
- The trustee can be an individual or corporate trustee.
- There can be more than one trustee but where there are two or more trustees, they must only perform actions where all of the trustees are in agreement (the trust deed may be amended to allow for decisions to be taken by a majority decision).
- The council has similar duties and functions to the board of directors of a company. The members of the council of a foundation must:
- act honestly and in good faith with a view to the best interests of the foundation;
- exercise the care, diligence and skill that reasonably prudent persons would exercise in comparable circumstances.
- The foundation council has no duty akin to a fiduciary duty towards the beneficiaries
- Trustees have far wider duties which on the one hand ensure the protection of the beneficiaries, but on the other may prohibit the actions that a trustee may take, or in some instances assets they may hold.
- A trustee must act with due diligence, as would a prudent person, to the best of the trustee’s ability and skill and observe the utmost good faith.
- Subject to the terms of the trust, a trustee has a duty to preserve and enhance the value of the trust fund, meaning that a trustee could come under criticism for holding wasting assets which devalue over time.
- Some of the duties of trustees can be delegated to appropriate parties such as where investment managers are appointed. However, there is still a duty to oversee their performance.
Enforcing the structure
- All foundations require a guardian as a matter of law. The guardian is repsonsible for ensuring that the council acts in accordance with the regulations and they act in accordance with their duties and if necessary take action to ensure that the actions required of the foundation council are carried out.
- The guardian can be the founder, a trusted friend or relative of the founder, or could be a professionally engaged firm to oversee the council.
- They may be granted powers of veto to approve certain actions of the foundation council and they may even give their approval to an action which is not allowed under the regulations provided it is in the best interests of the foundation to do so.
- A beneficiary can also take action against a foundation council but their rights are somewhat limited under the law.
- Protectors may have a power of veto in respect of certain actions so their consent is required to add/remove beneficiaries or make a distribution for example from the trust.
Assets the structures can hold
- Foundations are able to hold any assets other than immoveable property based in Jersey.
- Trustees may hold any type of property in trust except Jersey realty.
Rights of the founder/settlor
- The regulations of a foundation give rights to the founder.
- The founder can be a council member and also a guardian of the foundation and so have a direct role in the running of the foundation.
- Alternatively the Founder can have certain rights conferred on him/her under the regulations, such as the right to veto certain actions of the council.
- The settlor of a trust can reserve some rights to him/herself, but careful structuring is necessary to avoid any potential legal or tax issues.
- The trustees may confer with the settlor for his/her views on a proposed action but the settlor must not exert too much control over the decision making of the trustees as there is a danger of a sham argument that the trust is invalid.
- Alternatively, a settlor can appoint a protector to whom certain rights may be granted, such as a right of veto over the actions of the trustees.
- There is a registration fee payable to the Registrar which is currently £200 to establish a foundation (or £400 to be incorporated on the same day).
- A foundation is also required to pay an annual return fee to the Registrar (currently £150) and an International Service Entity (“ISE”) fee (currently £200) which is a flat fee to exempt it from goods and services tax in Jersey.
- As a trust is not registered with the Registrar, no registration fee is payable.
- There are no annual fees payable to the Registrar and a trust does not have to pay an ISE fee.
- Foundations are taxed as zero rated entities under the Jersey Zero-Ten legislation, which means that they will pay tax at 0% on any income and gains arising outside the Island.
- There may be a tax on the founder when endowing the foundation, or taxes on distributions from the foundation, dependent upon the recipient’s tax position.
- Specific tax advice should always be taken.
- There is no Jersey tax to pay for trusts provided there are no Jersey resident beneficiaries and no income arising from Jersey assets (there is an exception for interest earned on funds held in a Jersey bank account).
- The taxation of a trust will be dependent on the residence and domicile of the settlor and beneficiaries.
- Specific tax advice should always be taken.
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