Purpose Trusts

The laws of some Commonwealth jurisdictions recognize a type of trust known as a “Purpose Trust”. A purpose trust is one which does not have ascertainable beneficiaries, but rather exists to facilitate the achievement of a particular purpose. The charitable trust is a form of purpose trust with a long history in English law. However, new forms of purpose trusts have evolved in the last several years.

Bermuda was the first common law jurisdiction to permit the purpose trusts. Because there are no beneficiaries, i.e. people who could legally enforce the terms of the trust, a trust “enforcer” must be appointed to ensure that the trustees carry out their obligations in fulfilling the trust’s purpose. Purpose trust legislation in Bermuda, the Cayman Islands and the handful of other Commonwealth jurisdictions which permit purpose trusts also provide for a hybrid purpose trust that is a purpose trust during the settlor’s lifetime, but a more traditional trust for the benefit of individual beneficiaries afterwards. The Cook Islands and Cyprus go even farther, allowing purpose trusts with no enforcer, and making no provisions for the courts to appoint an enforcer.

A Purpose Trust can exist for a specific purpose, such as to own a corporation, or for a general purpose such as to further the creation and preservation of fine art. Purpose trusts are developing uses in a commercial context to take transactions off a company’s balance sheet or to provide a means for asset securitization. Another popular use has been to own shares in private trust companies.

Because of doubts regarding the U.S. tax treatment of purpose trusts, they have yet to become popular with U.S. planners. However, this is good because it means purpose trusts have not been over-marketed or identified as having a specific anti-creditor purpose, as have foreign asset protection trusts.

Of course, our focus is what use purpose trusts can serve in an asset protection context. Purpose trusts are created in a similar fashion to other trusts. A purpose trust is simply an agreement between a settlor and a trustee, memorialized in a trust instrument. As mentioned above, some purpose trust statutes require that an “enforcer” be appointed, who protects the trust assets to ensure that they are used for the purpose the settlor intended.

Purpose Trust Structure

A particularly good use of a purpose trusts is as the owner of an offshore management company.. A typical arrangement is to first create the Purpose Trust, and then have the offshore trustee of the Purpose Trust create an International Business Company (“IBC”). The IBC then enters into a contract to act as the manager of one or more LLCs, or as the general partner of a one or more limited partnerships, etc., all of which contain valuable assets.

If the Purpose Trust has been settled by a foreign person who is resident outside the U.S., it likely will be difficult for a creditor to prove a connection between the Purpose Trust and the U.S. person whose assets are being managed. The fact that the Purpose Trust has no identifiable individual beneficiaries will make it difficult for a creditor to pierce the corporate veil; after all, if the veil is lifted, who is under it?

Control over the Purpose Trust is maintained by having a trusted person as the Enforcer. Also, the management company IBC owned by the purpose trust can hire and appoint some trusted person to be responsible for its day-to-day affairs in managing assets. The purpose trust can be an excellent vehicle in an effective offshore management company structure without the U.S. owner of the asset being directly involved, and without implications that the trust’s assets and the assets of the companies managed by the IBC really belong to the settlor because the beneficiaries of the purpose trust are the endless number of charitable organizations that might further the trust’s purpose and also, after the settlor’s death, his heirs, but not the settlor.

By way of contrast with Foreign Asset Protection Trusts, which only personally benefit the settlor and his designated beneficiaries, the Purpose Trust has other legitimate commercial uses other than tax avoidance and asset protection. Purpose Trusts are sometimes used, for example, to hold corporate stock where the shareholders desire that no one person, or group of persons, be in control of the stock. This is useful in situations involving the sale of the corporation, or where the shareholders have a deadlock that cannot be resolved by conventional means, and thus the shares or voting rights are thus temporarily conveyed to the Purpose Trust so that the appointed Trustee can make the necessary decisions. Because of these commercials uses, it will be difficult for a creditor to argue that a purpose trusts is ipso facto an asset protection device, as is fairly easy to do with a FAPT. Furthermore, a settlor must go offshore to settle a purpose trust. They simply are not provided for under the laws of any U.S. jurisdiction. Indeed, a number of commercial purpose trusts have been created in Bermuda, in particular, by U.S. companies.

U.S. Tax Treatment of Civil Law Entities and Purpose Trusts

The detailed tax treatment of exotic civil law organizations and purpose trusts is beyond the scope of this book. There are very complex and unresolved issues as to how an individual entity will be treated for U.S. tax purposes. Nevertheless, some offshore promoters claim that because these entities are not corporations, partnerships or trusts under U.S. business and trust laws, and are not specifically mentioned in the Internal Revenue Code and Regulations that, therefore, they live some sort of unique tax-free existence.

Don’t be fooled by such claims. IRS Revenue Ruling 73-254 makes it clear that the tax treatment of an entity will be determined by its classification under U.S. tax law, and not by reference to state or foreign law. In other words, under U.S. tax law, each entity fits into a particular pigeonhole, even if it doesn’t really fit all that well. There are only four such pigeonholes: trust; a corporation; a partnership; or a disregarded entity.

Just exactly which pigeonhole one of these entities will be crammed into will depend upon the facts and circumstances of that particular case. If the entity is not structured correctly that there could be very adverse tax consequences much worse than with a domestic entity owing to the great number of tax landmines that exist for foreign entities in the U.S. tax law. Tax uncertainty is another reason that militates in favor of restricting the use of these entities to holding only shares in another corporation that is used as a management company for valuable assets, as opposed to placing the valuable assets in these entities themselves.

Purpose Trust Terms

• Purpose Trust
  A form of trust which has no beneficiaries, but instead exists to serve some purpose such as to benefit cancer research. Because the trust has no beneficiaries, it is sometimes used in the asset protection context for holding title to management companies.