Family Governance III

This is the third in my mini-series on good family governance. In the first Note, I defined family governance to mean ‘the facilitation of effective entrepreneurial and prudent management of family assets that can deliver long term preservation of the family wealth’.

An essential element in the preservation of family wealth is to keep costs and risks to a minimum. Last week we looked at keeping fees to a minimum when dealing with a dispute within a family, and the week before we looked at keeping fees to a minimum when dealing with disputes outside the family. Now we look at keeping costs and risks to a minimum when dealing with an investigation from a tax authority.

In my experience, dealing with a tax authority is unlike any other interested party. It has a bottomless pit of resources, a manual as to how to deal with investigations and the ability to impose criminal sanctions.

An economist Dr Pickerty works closely with the OECD. He has calculated a whopping $7,600 billions of private wealth is held offshore which is untaxed. For cash-strapped Governments this is a prize worth fighting for, but until recently they were uncertain as to how to attack them, until Olenicoff.

Olenicoff was a Russian gentleman, under investigation by the IRS. He had $200 billions of untaxed and undeclared monies. The IRS gave him the option, spill the beans as to who and how he was advised or face a jail sentence of 22 years.

It took him just 30 seconds to decide.  He admitted that his advisers were UBS and his trust was a sham. For him it was preferable to pay the tax than go to jail. He was then taxed as if the monies had never been transferred into trust, but had remained in his unfettered ownership. He paid a lot of tax – but kept his freedom.

Until the case of Olenicoff, monies held in offshore trusts were beyond the reach of foreign tax authorities. But this case gave the IRS the ammunition it was looking for – the doctrine of sham.

All the IRS now needed was to get the information they needed about offshore trusts and who set them up, they could then investigate for evasion of tax and use their extensive criminal prosecution powers to impose jail sentences.

The IRS then came up with FATCA.

Under FATCA all financial institutions with assets in the US were obliged to report on all its clients who were US nationals. At the time, many thought it was shooting itself in the foot. Financial institutions, it was thought, would divest themselves of their US assets – but they did not – they preferred to report on their clients even though to do so cost them a fortune. Forbes has estimated that the cost for financial institutions to comply with FATCA is ten times the expected tax take for the IRS

The OECD encouraged by the success of FATCA followed suit. It introduced the automatic exchange of information (the Common Reporting Standard ‘CRS’) on all its member states – other than the US (which already had FATCA). Under CRS financial institutions are obliged to collate and exchange information with the tax authority in which the Settlor is tax resident.

However, despite this sword of Damocles, most fiduciary businesses are sanguine. They are satisfied that they operate their businesses with care, keep proper records and minutes and do not operate ‘sham’ trusts.

But this is to miss the point. Tax authorities are of the opinion that any trust over which the Protector has powers; such as to remove and replace a trustee is prima facie evidence of a lack of intention to transfer total control over the assets to the trustee. The tax authority then has all the information it requires to investigate. 

Olenicoff was faced with a plea bargain – confess that he did not have the necessary intention to relinquish control over his assets to his trustees, and pay tax on the trust assets as if they were not in trust, or go to jail for 22 years.

That may be a sensible decision for a Settlor such as Olenicoff to make albeit costly, but it is not such good news for the professional trustee.

If a trust is a sham, the trustees have no right to recover their professional costs from the trust fund and must return all their fees from inception to the Settlor. It does not take much work to calculate just how damaging such an investigation could be to any fiduciary business.

Good family governance recognises the risks and dangers facing families such as from over-zealous tax authorities and comes up with solutions.

If you have comments or would like to discuss matters relating to, privacy, control, trusts and protection of your assets please contact us direct.

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