Domestic and foreign financial institutions located in the United States in the international private banking business provide products and services to a select international clientele, usually comprised of high net-worth individuals, their families and businesses. Attentive, personal service is characteristic of such private banking services.
International private banking clients often maintain significant assets with one or more private banking operations based in the US, and ordinarily are provided with access to a diverse and often confusing array of options for holding and managing these assets. Each one of these options may have a significant impact on their personal investment, tax, estate planning, and other financial objectives, as well as their ability to keep their personal financial information confidential.
To assist the private banking client in making the most of available private banking services, we will describe two vehicles for holding and managing wealth that are commonly recommended by private bankers to their clients – the offshore personal investment company and the offshore trust. It should be noted at the outset that these vehicles generally are unsuitable for use by US citizens or residents. Consequently, this article focuses on options available to the non-resident private banking client.
Offshore Personal Investment Companies
An offshore personal investment company, commonly known as a PIC, is a corporation organized by the private banking client, often with the assistance of his or her private banker and legal and tax advisors, in an offshore jurisdiction. All of the shares of the PIC ordinarily will be beneficially held by the client and, if the client wishes, by members of his or her family. Most financial institutions will act as registered agent for, and provide management services to, any PIC established by a private banking client, upon the client’s request.
Assets of the private banking client who elects to establish a PIC are transferred to the PIC, and subsequent investments can be made through the PIC. A broad range of assets may be held by the client through the PIC, including passive US investment assets such as certificates of deposit, bank accounts, and stocks and bonds.
There are several potential benefits of an offshore PIC. First, by holding assets in the name of the PIC, the client is generally insulated from US estate taxes, that is, taxes imposed upon the estate of a non-resident alien decedent. US estate taxes can be quite significant. For example, the marginal estate tax rate on certain US situs assets in excess of $3,000,000 is 55%.
Use of a PIC also may enable private banking clients to better safeguard their privacy and that of their family because the PIC, rather than the client, generally will be the bank’s customer for legal purposes. In this regard, tax documents and other records required to be maintained by the bank may be prepared in the name of the PIC, although disclosure of the PIC’s beneficial owners to the bank – and its supervising regulators upon their request – also will ordinarily be required.
Owning assets through a corporation such as a PIC, in contrast to personal ownership of assets, also may provide a range of benefits to the private banking client associated with the use of the corporate form, which include limiting the client’s personal liability with respect to any US businesses, maximizing the client’s ability to sell or transfer US assets with minimum US tax, and centralizing administration and bookkeeping relating to the client’s assets.
The main disadvantage of a PIC is the expense associated with organizing and maintaining a foreign corporation. This expense can range up to several thousand dollars per year, depending on the jurisdiction of incorporation. Furthermore, an effective mechanism must be constructed for the distribution of a PIC’s assets upon the death of its shareholders. Care must also be taken in designating individuals who may issue instructions on behalf of the PIC, and in setting forth an appropriate range of powers for the PIC in its articles of association.
It is generally recommended that PICs be organized in a tax haven country, such as the Bahamas, Cayman Islands, Panama, or the British Virgin Islands, because these countries do not impose income taxes on corporations organized there.
Another vehicle available to the international private banking client for wealth management is the offshore trust. Generally, a trust is a legal obligation that binds an individual, or the trustee, to manage and administer property, or trust property, for the benefit of designated persons known as beneficiaries. More specifically, the grantor, also known as the settlor of a trust, creates the trust by transferring property to the trustee. This transfer may occur either during the grantor’s lifetime, creating a so-called ‘inter vivos’ or living trust, or after the grantor’s death in accordance with his or her will, creating a so-called testamentary trust. The grantor may be the trustee or a beneficiary of the trust.
Trustee is the trust company or individual to whom the grantor entrusts the care and management of the trust property. In the case of the international private banking client, the trustee often may be the grantor’s financial institution. The trustee is responsible for carrying out the instructions contained in the trust instrument.
The beneficiaries of a trust are those persons for whose benefit the trustee holds the property in accordance with the directions of the grantor. Trusts generally have two classes of beneficiaries: income beneficiaries to whom the trust income is paid and remainder beneficiaries to whom trust property is distributed, either upon termination of the trust or otherwise in accordance with the specific terms of the trust.
A trust is usually created by a written document that, among other things, sets forth the manner in which the trustee is required to manage trust property. Any act, or failure to act, by the trustee that is not authorized by the terms of the documents governing the trust may constitute a breach of the trustee’s fiduciary obligations to the trust beneficiaries, who ordinarily may enforce, in a court of law, any obligation imposed upon the trustee under the governing trust documents.
A trust may be revocable or irrevocable. A revocable trust may be amended or terminated by the grantor or some other person. An irrevocable trust is a trust not subject to a power of revocation.
If a private banking client has established a PIC, shares of the PIC may be transferred to, and held by, an offshore trust. Although it is generally recommended that the offshore trust be revocable, in some cases there may be tax or other reasons for the client to relinquish the right to amend or revoke the trust.
While the documentation establishing an offshore trust usually contains specific instructions to the trustee for distributing assets to the beneficiaries, the trust instrument may, if the private banking client wishes, grant complete discretion to the trustee concerning distribution of the trust assets among a group of beneficiaries. This type of trust, referred to as a discretionary trust, is normally accompanied by a memorandum of wishes, in which the grantor provides informal guidance to the trustee as to his or her wishes with respect to the administration and distribution of trust property. Although the memorandum is not legally binding, a financial institution serving as trustee will invariably carry out the client’s wishes. However, while utilized to some extent in the US, it should be noted that discretionary trusts are more common in Great Britain.
The law governing an offshore trust established by an international private banking client will usually be the law of the country in which the trust is created and administered, which will control the administration and ultimate distribution of trust property to the beneficiaries. It is usually possible to move an offshore trust from one country to another if unforeseen changes take place in the country where the trust was originally established. Some trusts provide for automatic removal to another jurisdiction in the event of certain designated triggering events, such as civil uprisings. Other trusts empower a designated person to move the trust to a suitable successor trustee in another jurisdiction.
Advantages and Disadvantages
A primary benefit of using an offshore trust to hold assets is the removal of the trust assets from probate. In this regard, upon the death of the grantor of the trust, the trust assets do not form part of the client’s estate for probate purposes. An offshore trust normally can continue following the death of the grantor without adverse US income tax consequences to the beneficiaries, so long as the beneficiaries are not US citizens or residents. Since most trust instruments will contain provisions similar to those typically found in a last will and testament, the trust has the additional advantage of serving as a will substitute for the private banking client.
Use of the offshore trust vehicle also generally eliminates the need for the private banking client’s foreign assets to be brought back to the client’s country of residence for probate upon the client’s death. It also eliminates the need for separate wills to be maintained in each country in which the client has assets. Upon the death of the grantor, the trust assets either pass directly to the beneficiaries or remain in trust for their benefit, depending on the provisions of the trust instrument.
It should be noted that many of the civil law countries in Latin America have so-called ‘forced heirship’ laws entitling a surviving spouse and/or descendants of the international private banking client to an automatic share of the client’s estate in the event of the client’s death. Tax reporting and other legal requirements also may apply to offshore trusts established by the private banking client under the laws of the client’s home jurisdiction. Private banking clients from countries having forced heirship laws and tax reporting and other requirements potentially applicable to offshore trusts should consult with legal advisers in their countries to determine the impact of any such laws on the establishment and maintenance of an offshore trust.
The principal disadvantage of an offshore trust is that creating and administering the trust can be expensive, generally somewhat more expensive than the establishment and maintenance of a PIC, depending upon the terms of the trust. In addition, if the documents governing the offshore trust are not properly drafted or if the trust is not properly administered, it may be deemed a ‘sham’ trust and disregarded in the event that a dispute arises concerning the disposition of trust assets.
Offshore PICs and trusts are worthy of the international private banking client’s consideration as vehicles for owning and distributing assets. To make the most of private banking services, the international private banking client should discuss with his or her private banker and other legal and financial advisers the potential advantages and disadvantages of such vehicles in light of the client’s personal financial objectives.