Coming to America: U.S. Trusts for Non-U.S. Persons N O R T H E R N T R U S T GLOBAL FAMILY & PRIVATE INVESTMENT OFFICES Coming to America: U.S. Trusts for Non-U.S. Persons Title Slides, Title Page Options, Titles, Cover Page STEP BENELUX 25 June 2014 Daniel F. Lindley Managing Director, Global Family Offices - EMEA +44 (0) 207 982 3524 dfl2@ntrs.com © 2014 Northern Trust Corporation northerntrust.com

Table of Contents An Introductory Outline Scenario 1: The Generous Parent Scenario 2: The Foreign Non-Grantor Trust Scenario 3: The Foreign “U.S.” Trust Delaware – leading trust jurisdiction in the U.S. Concluding Thoughts

An Introductory Outline It is increasingly common for families to have cross-border circumstances that give rise to a multitude of U.S. income, gift, estate and generation-skipping transfer tax consequences, particularly when trusts are involved. N.B. –The term “U.S. person” has different meanings for U.S. income taxes and U.S. gift, estate and GST taxes.

Modern Cross-Border Scenarios: The Generous Parent Scenario 1: The Generous Parent Parent is a Belgian citizen and resident. She would like to make a substantial lifetime gift for the benefit of her daughter, a Belgian citizen residing in the United States. Should the parent make the gift outright or establish an irrevocable gift trust in the United States? If a trust, will U.S. gift taxes apply and will the trust be subject to future estate or generation-skipping transfer taxes? How will the trust be taxed for U.S. income tax purposes?

How the Generous Parent Can Save U.S. Estate Taxes Gift tax: Non-citizen non-domiciliaries are subject to U.S. gift, estate and generation- skipping transfer tax on their U.S.-situs assets only. Intangible assets do not have a U.S. situs for gift tax purposes (cash can be an intangible if delivered outside the U.S.). If the gift from the Belgian parent consists of cash or securities, it will not be subject to U.S. gift tax. Estate Tax: U.S. citizens (wherever they live) and U.S. “residents” (regardless of their citizenship) are subject to U.S. gift, estate and generation-skipping transfer taxes on their worldwide assets. U.S. estate tax is imposed on all wealth transferred directly from U.S. daughter upon her death. Proper use of a U.S. trust will give the daughter economic benefit of the assets (income, discretionary principal), but keep the assets out of daughter’s estate and avoid subjecting foreign wealth to U.S. estate tax in future U.S. generations. Our focus on the affluent market is unmatched in the industry. 40% of our business reflects the focus on personal clients. We provide our PFS clients access to professional expertise, an advice oriented experience and a client centric philosophy to help our clients achieve their long term goals in the most cost effective, low risk and objective approach. Practice tips: (1) Beneficiary’s interest in trust must not include a power to appoint the trust assets to herself, her estate or her creditors. (2) Watch for tax consequences of the gift in the donor’s home country. (3) Gifts from foreign persons to U.S. persons, including U.S. trusts, are subject to information reporting requirements.

Trusts Save U.S. Transfer Taxes A Delaware trust can continue indefinitely, without any fixed term. The economic benefit of a Delaware dynasty trust, in comparison to an outright gift, is inescapable. Delaware Dynasty Trust Taxable Outright Transfers in Trust To the Next Generation Transfers To the Next Generation Every 25 Years Every 25 Years Year 1 $1,000,000 $1,000,000 Year 25 Value $16,289,000 $16,289,000 Transfer Tax — $6,450,200 Year 50 Value $55,160,000 $33,865,000 Transfer Tax — $13,238,400 Year 75 Value $184,900,000 $67,245,000 Transfer Tax — $26,900,000 Ending Value $184,900,000 $40,345,000 Dynasty Benefit = $144,555,000 Assumptions: Federal estate tax rate: 40%* Return on investment assets: 5% No state income taxes. No distributions from trust or consumption of principal or income by persons receiving outright transfers. * 2014 highest marginal estate tax rate.

Modern Cross-Border Scenarios: The Foreign Non-Grantor Trust Scenario 2: The Foreign Non-Grantor Trust Many years ago, grandparents in Europe established a foreign trust for the ultimate benefit of their grandchildren, following their deaths. Grandchildren are U.S. citizens and residents. The surviving grandparent has died and the grandchildren will now receive distributions from the trust. How will a distribution from a foreign trust to a U.S. beneficiary be taxed? Would a U.S. domestic trust result in a better outcome?

Domesticating a Foreign Trust with U.S. Beneficiaries When the non-U.S. grantor of a foreign trust dies leaving U.S. family members as beneficiaries, the trust becomes a non-grantor trust. The family should consider domesticating the foreign non-grantor trust to a U.S. domestic trust before it accumulates undistributed net income. A foreign non-grantor trust is subject to unfavorable U.S. income tax rules on undistributed net income. Distributions from the foreign trust will likely carry out accumulated income that is subject to income tax and an interest charge based on the average number of years of accumulation. Capital gains and qualified dividends included in the accumulation will be treated as ordinary income. U.S. persons who receive distributions from foreign trusts are subject to additional reporting obligations, with substantial penalties for noncompliance.

Positioning for Domestication Appoint U.S. trustee and other power holders for the foreign trust. Make sure foreign persons connected with trust renounce all powers. Settlor powers Foreign co-trustee Trust protector Investment managers Adopt U.S.-style trust agreement for domestic trust Directed trust provisions for investment and distribution advisors Delaware governing law Choose U.S. courts for primary supervision Negate Rule against Perpetuities U.S. trustee accepts trust documents for new domestic trust Post-domestication decanting Trustee of domesticated foreign trust exercises discretion over principal to distribute all assets to the new U.S. domestic trust.

Flipping the switch: Foreign to Domestic Resulting trust should satisfy the court test and the control test to attain domestic trust status. Delaware Court of Chancery should be designated as primary court for trust supervision. Non-U.S. persons should have no authority over substantial decisions.

Modern Cross-Border Scenarios: The Foreign “U.S.” Trust Scenario 3: The Foreign “U.S.” Trust Patriarch is the life income beneficiary of an irrevocable Guernsey trust established by his father some years ago. At patriarch's death, his children will be entitled to the principal of the trust. Patriarch wants to defer indefinitely mandatory principal distributions. Can a U.S trust offer greater flexibility? What are the U.S. income tax consequences with a U.S. trust?

Moving a Foreign Trust to the U.S. for Significant Modifications There may be circumstances in which a client wants to change the design of his or her trust to address a particular need, but the laws of the current jurisdiction do not permit the proposed change. The client wants the trust to continue indefinitely so that the assets will not pass outright to the beneficiaries at the client’s death and distributions will remain subject to the discretion of the trustee.  The client wants to appoint investment advisors or distribution advisors for the trust, without any involvement of the trustee in investment or distribution decisions. The client would like to defer informing the beneficiaries of the existence of the trust or client anticipates a potential challenge to the terms of the trust. In these and other circumstances, a trust located in Delaware may be the answer. Practice tip: This foreign trust is not suitable for U.S. beneficiaries because of U.S. income tax considerations.

Moving a Foreign Trust to the U.S. without Exposure to U.S. Income Tax Non-U.S. clients can maintain a trust with a U.S. trustee, governed by U.S. state law, but ensure that the trust is treated as a foreign trust for U.S. income tax purposes. By giving a non-U.S. person authority over any substantial decisions involving a trust, the trust will fail the “control” test and qualify as a foreign trust. “Substantial decisions” include: Whether and when to distribute income or principal The amount of distributions Whether to terminate a trust Whether to remove, add or replace a trustee Investment decisions Only U.S. source income will be subject to U.S. income tax. Generally speaking, U.S. source income includes interest from U.S. bonds and notes, dividends from U.S. corporations, and proceeds and rents from U.S. properties. Capital gains on intangible U.S. assets are not source income. Practice tip: This foreign trust is not suitable for U.S. beneficiaries because of U.S. income tax considerations.

Positioning for Domestication into a Foreign U.S. Trust Appoint U.S. trustee and other power holders for the foreign trust. Make sure foreign persons remain connected with trust. Settlor powers Foreign co-trustee Trust protector Investment managers Adopt U.S.-style trust agreement for foreign trust Directed trust provisions Delaware governing law Choose U.S. courts for primary supervision Negate Rule against Perpetuities U.S. trustee accepts trust documents for new foreign trust Post-domestication decanting New U.S. trustee of original foreign trust exercises discretion over principal to distribute all assets to the new foreign trust.

Delaware – leading trust jurisdiction in the U.S. Delaware – a leading trust jurisdiction in the U.S. As a premier trust jurisdiction, Delaware offers many advantages for individuals, families, and businesses. Delaware's Court of Chancery has more than 250 years of history developing legal precedent in trust and corporate law, and holds a preeminent position in developing this body of law in the United States.

The Appeal of Delaware as a Trust Jurisdiction Delaware repealed its rule against perpetuities in 1995, allowing trusts of unlimited duration and greatly extending the period in which family assets will not be subject to federal estate and generation-skipping transfer taxes. Delaware does not impose a state fiduciary income tax on irrevocable trusts for nonresident beneficiaries, which creates an opportunity for clients to avoid state income taxes on accumulated trust income. Delaware law explicitly allows trustees to take direction from investment and distribution advisors, without liability for the advisors’ performance or decisions. Delaware is a leading proponent of the concept of freedom of disposition, as evidenced in its confidential treatment of trusts, its enforcement of no-contest provisions, its novel pre-emptive notices and its broad decanting statute. Delaware’s court system for resolving trust matters is second to none. A client may establish a Delaware trust for his or her own benefit and, within defined circumstances, use the trust to protect the assets against future creditor claims.

Fiduciary Income Tax Savings In addition to U.S. income taxes, U.S. domestic trusts are subject to income tax in many of the fifty states, with tax rates as high as 9% or more. Most states treat capital gains as ordinary income. Since 1971 Delaware has not imposed a fiduciary income tax on irrevocable trusts for non-resident beneficiaries. Absent a taxable connection or “nexus” with another state, capital gains and ordinary income can accumulate in irrevocable Delaware trusts without incurring a state income tax.

Direction Trusts Since 1986 Delaware law has allowed trustees to take direction from advisors (including investment advisors, distribution advisors and trust protectors), without liability for their decisions or results. Offshore jurisdictions do not absolve trustees of liability for following advisor directions, so trustees have to review and consider “directed” investment activities and distribution decisions.

The Direction Trust as an Enterprise Trust Values Mission Goals Custody, Reporting, Accounting & Beneficiary Communications Managers Asset Discretionary Administration Directed Trustee Investment Consultant Discretionary Committee Investment Advisor Special Assets Advisor Tax Advisor Special Asset Management Trust Protector Tax Planning & Compliance Trust Modification Fiduciary Removal

Confidentiality Delaware trusts are not subject to any public registration or filing requirements. In the event of litigation, the Court of Chancery often seals the record of trust proceedings on application. Delaware law even permits a trustee to withhold knowledge of a trust’s existence from future or discretionary beneficiaries for “a period of time,” if the trust deed so directs. 12 Del. C. § 3303(a). The concept of a trust that remains “secret” from its beneficiaries for a period of time is surprisingly attractive to clients who do not want unproductive descendants. The trust deed for a “secret” trust must have someone – a trust protector, for example – who can receive statements from the trustee and monitor the trustee’s conduct.

Freedom of Disposition: No-Contest Clauses Delaware law recognizes the validity of no-contest or in terrorem clauses in trusts and wills. These provisions have the effect of forfeiting the interests of a beneficiary who challenges the validity of a trust or will. The general rule enforcing a forfeiture does not apply to: A beneficiary who “substantially prevails” in challenging the instrument. An agreement in settlement of a dispute among the beneficiaries. An action to determine whether a proceeding triggers the no-contest provision. An action for construction of the instrument.

Concluding Thoughts There are a number of common circumstances in which it may be useful for a non-U.S. person to create a U.S trust. Once a client has made the decision to establish a U.S trust, the selection of Delaware as the specific situs is self-evident given its tax-neutral posture and its highly favorable body of trust laws. Since 2006 Northern Trust Corporation has maintained a separate subsidiary in Delaware, The Northern Trust Company of Delaware, to provide fiduciary services to clients and their families across the globe. As of 31 March, 2014, The Northern Trust Company of Delaware administers trust assets in excess of US $16 Billion. Practice tips: (1) In any cross-border trust planning of this nature, be sure to consider home country consequences as well as treaty modifications of the applicable rules. (2) Special rules cover U.S. expatriates. Proceed with caution if an expatriate is involved.

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