© Copyright 2000 Wealth International, Ltd.
The following article stems from years of researching and applying offshore and asset protection strategies and will shed light on what is perhaps the most advantageous, yet least understood and most overlooked aspect of financial structuring and business planning – the effective use of contracts.
Our treatment of the subject is focused primarily on the use of private contracts in conjunction with offshore trusts, although, as will be demonstrated later in this article, the very same principles can be effectively applied to trusts, foundations, corporations, and limited liability companies, whether sitused onshore or offshore. In general, setting up these types of arrangements with a WIL Trust to effect the many possible personal and financial benefits available is much more cost-effective and much simpler than setting up similar arrangements with one of the other types of entities mentioned.
First, some background
We live in a society ruled by paper – paper money, deeds, titles, paper marriages, and even birth and death certificates. Be it a house, car, or marriage, it is paper, not physical possession, use, or association, that conveys and denotes ownership and/or legal standing.
Most who use domestic or foreign trusts know their value is derived from the relinquishment of legal ownership of assets to the trustee. However, to truly surrender ownership of an asset, one must relinquish all paper relevant thereto. Surprisingly, what is rarely understood about trusts is that additional benefits can be realized by relinquishing all beneficial interest, i.e., the certificate of beneficial interest, capital unit certificate, (or the implicit paper control of being a beneficiary even if no certificates have been issued) AS well as all Trusteeship. Remember, ownership on paper is legally deemed to be ownership of the thing itself, as evidenced by IRS grantor trust rules, wherein any "US person" that is the grantor of a foreign trust with US beneficiaries is taxed on all income of said trust as if it were his or her own (See Appendix 2 of Going Offshore: Is It for You).
The question then, arises: If one conveys an asset to a trust and at the same time retains no legal control (is not the Trustee or Protector), nor retains any equitable interest in the asset (Beneficiary), how does one benefit?
For the answer, we will address our main focus:
The Power of Private Contractual Agreements
So-called common law trust promoters frequently refer to Article 1, Section 10 of the United States Constitution as legal authority for the set up of contractual trusts within the U.S. It reads, “No state shall. . . impair the obligation of contracts ...”
Contracts, however, have far more uses in financial and business structuring than the establishment of trusts and are limited only by the knowledge and creativity of oneself or one's financial planner or attorney, few of whom use contracts most effectively, or have more than scant knowledge of offshore asset protection and financial strategies.
The possible contractual arrangements available are many and varied and are adaptable to fit whatever situation arises. Loan agreements, contractor agreements, consultancy agreements, use agreements – all have their place in asset structuring.
A contract must involve an actual equitable exchange. For example, contractual “permission” to live in a house owned by a trust or other entity must require payment of a fair rental or lease fee, or performance of some other valuable service in consideration, or a court would likely deem that the contract lacked substance and was therefore, a sham. Though both are necessary, having real substance is almost always more important than having proper form. This applies to contracts and to the financial structures used, i.e., both must have real substance.
How contracts may be used to obtain practical benefits
We will use a loan agreement as a simple example. Suppose there is a foreign trust to which you are not a party (not the Settlor, Trustee, Protector, or a Beneficiary). You have $50,000 in a savings account. You negotiate a private loan agreement (that would not appear in the databases of any governments) with the Trustee of the foreign trust whereby you will lend $50,000 from the savings account to the trust at 5% interest per annum. The trust might then invest the money offshore in a mutual fund, annuity, or other instrument paying 10% or more per annum. As the holder of a loan agreement, you have the same security as if you were the beneficiary of the trust, perhaps even more security if the trust is discretionary, but you have none of the liabilities. If you are the beneficiary of a discretionary trust, it is within the Trustee’s discretion to pay or not pay you profits out of the trust or to withhold the profits for further investment, or simply to pay at a later date. The Trustee could not be sued for breach of fiduciary duty merely because he or she decided to withhold the funds, as it is within his or her power to do so. With a loan agreement, however, the Trustee is legally obligated to abide by the terms and conditions of the loan to pay the principal and interest at the times stipulated in the agreement.
Another valuable option: The trust hires you as a consultant to do research and advise the Trustee of investments to make on behalf of the trust for which you could be paid a consultancy fee or ongoing salary.
Here is a more complex example that is not at all uncommon in the United States. In this case, multiple structures are utilized, demonstrating that the principles discussed herein apply equally to trusts, foundations, corporations, and limited liability companies, as well as to onshore and offshore arrangements.
You own a successful business – a sole proprietorship, i.e., it is in your name, and you are the sole owner. The business is not incorporated, though you might be using a “dba” so that the business and accounts have a separate name from you. This year the business generates a $350,000 profit.
You are able to write off a relatively small portion of that $350,000 as expenses, but, as a “sole proprietor”, you are required to declare the bulk of the profits as income on your IRS Form 1040. You are hit hard in taxes and are eager to do something with the remaining profits, so you pay down your outstanding debts such as your mortgage and car loans. You figure that, next year, your business will do equally well, perhaps even better, and yet, with no debt, your expenses and deductions will be smaller. One option would be to take the profits, pay your taxes and expenses, and invest the surplus back in the business, or in other investment vehicles.
But there are favorable alternatives. If a previously formed limited liability company existed, the creator and majority owner of which was a U.S. trust, you could transfer (not gift or sell) the business into the LLC in exchange for a 5% ownership in the LLC. This exchange is a tax-free event – you have not made a profit as you might have had you sold the business outright for cash. In recognition of your knowledge and expertise in regards to the affairs of the business, the LLC might then hire you to manage the business. Your annual salary for managing the business could be, say, $45,000.
To continue our example, suppose in the following year, the business produces $378,000 in profit. These profits belong to the LLC, not to you. You receive your $45,000 salary and are responsible to pay personal income taxes on that amount. You are in a much lower tax bracket than you would have been had you made the $378,000 directly, and you will pay far less in taxes. So far, so good. Your $45,000 salary is a tax write-off for the LLC. The LLC can also take advantage of many other “corporate” type tax deductions that are not available to you personally. (See this section of Going Offshore: Is It For You?). If the LLC were structured to replicate the form of a partnership (LLCs are structured to mimic substantive characteristics of either corporations or partnerships), it would function as a pass-through vehicle and thus would pay no taxes. All of the profits generated by the LLC, and the accompanying tax liability, would be passed on directly to the members of the LLC. In this case, the majority member is a U.S. trust.
At this point there are a variety of options available, depending on how the U.S. trust is structured, how the beneficial interest in the trust is held, what types of investments it is deemed advisable to participate in, and other factors. This article, however, is not intended as an exhaustive course in financial structuring, tax law, or otherwise. However, through the examples cited, W.I.L. has endeavored to make abundantly clear the vast benefits and advantages available through the intelligent and well-informed use of contractual agreements in conjunction with select financial structures.
Contact us for more information about our services.
NOTE: This report is presented with the understanding that the publisher is not engaged in rendering legal or accounting services. Questions relevant to the specific tax, legal, and accounting needs of the reader should be addressed to practicing members of those professions. This information was gathered from sources believed to be reliable but it cannot be guaranteed insofar as it applies to any particular taxpayer. Wealth International, Limited specifically disclaims any liability, loss, or risk, personal or otherwise, incurred as a consequence directly or indirectly of the use and application of any of the techniques or contents of this report. No copies of this material may be made or redistributed without the express written consent of Wealth International, Ltd.
