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In common law legal systems, a trust is a relationship whereby property (real or personal, tangible or intangible) is held by one party for the benefit of another. A trust conventionally arises when property is transferred by one party to be held by another party for the benefit of a third party, although it is also possible for a legal owner to create a trust of property without transferring it to anyone else, simply by declaring that the property will henceforth be held for the benefit of the beneficiary. A trust is created by a settlor (archaically known, in the context of trusts of land, as the feoffor to uses), who transfers some or all of his property to a trustee (archaically known, in the context of land, as the feoffee to uses), who holds that trust property (or trust corpus) for the benefit of the beneficiaries (archaically known as the cestui que use, or cestui que trust). In the case of the self-declared trust, the settlor and trustee are the same person. The trustee has legal title to the trust property, but the beneficiaries have equitable title to the trust property (separation of control and ownership). The trustee owes a fiduciary duty to the beneficiaries, who are the "beneficial" owners of the trust property. (Note: A trustee may be either a natural person, or an artificial person (such as a company or a public body), and there may be a single trustee or multiple co-trustees. There may be a single beneficiary or multiple beneficiaries. The settlor may himself be a beneficiary.)
The trust is governed by the terms under which it was created. The terms of the trust are usually written down in a trust instrument or deed but, in England and Wales, it is not necessary for them to be written down to be legally binding, except in the case of land. The terms of the trust must specify what property is to be transferred into the trust (certainty of subject-matter), and who the beneficiaries will be of that trust (certainty of objects). It may also set out the detailed powers and duties of the trustees (such as powers of investment, powers to vary the interests of the beneficiaries, and powers to appoint new trustees). The trust is also governed by local law. The trustee is obliged to administer the trust in accordance with both the terms of the trust and the governing law.
In the United States, the settlor is also called the trustor, grantor, donor or creator. In some other jurisdictions, the settlor may also be known as the "founder".
Roman law had a well-developed concept of the trust (fideicommissum) in terms of "testamentary trusts" created by wills but never developed the concept of the "inter vivos trust" that applied while the creator was still alive. This was created by later common law jurisdictions.
At the time, land ownership in England was based on the feudal system. When a landowner left England to fight in the Crusades, he needed someone to run his estate in his absence, often to pay and receive feudal dues. To achieve this, he would convey ownership of his lands to an acquaintance, on the understanding that the ownership would be conveyed back on his return. However, Crusaders would often return to find the legal owners' refusal to hand over the property.
Unfortunately for the Crusader, English common law did not recognize his claim. As far as the King's courts were concerned, the land belonged to the trustee, who was under no obligation to return it. The Crusader had no legal claim. The disgruntled Crusader would then petition the king, who would refer the matter to his Lord Chancellor. The Lord Chancellor could do what was "just" and "equitable", and had the power to decide a case according to his conscience. At this time, the principle of equity was born.
The Lord Chancellor would consider it "unconscionable" that the legal owner could go back on his word and deny the claims of the Crusader (the "true" owner). Therefore, he would find in favor of the returning Crusader. Over time, it became known that the Lord Chancellor's court (the Court of Chancery) would continually recognize the claim of a returning Crusader. The legal owner would hold the land for the benefit of the original owner, and would be compelled to convey it back to him when requested. The Crusader was the "beneficiary" and the acquaintance the "trustee". The term "use of land" was coined, and in time developed into what we now know as a trust.
The primogeniture system, in which the first-born male inherited all the property and "usually assumes the responsibility of trusteeship of the property and of adjudicating attendant disputes", could be considered a trust.
"Antitrust law" emerged in the 19th century when industries created monopolistic trusts by entrusting their shares to a board of trustees in exchange for shares of equal value with dividend rights; these boards could then enforce a monopoly. However, trusts were used in this case because a corporation could not own other companies' stock:447 and thereby become a holding company without a "special act of the legislature". Holding companies were used after the restriction on owning other companies' shares was lifted.:447
The trust is widely considered to be the most innovative contribution to the English legal system. Today, trusts play a significant role in most common law systems, and their success has led some civil law jurisdictions to incorporate trusts into their civil codes. Curaçao for example has introduced a trust in its Civil Code from 1 January 2012, which does only allow express trusts, constituted by a Notarial deed. France has recently added a similar, though not quite comparable, notion to its own law with la fiducie, which was modified in 2009; la fiducie, unlike the trust, is a contract. Trusts are widely used internationally, especially in countries within the English law sphere of influence, and whilst most civil law jurisdictions do not generally contain the concept of a trust within their legal systems, they do recognise the concept under the Hague Convention on the Law Applicable to Trusts and on their Recognition (partly only the extent that they are parties thereto). The Hague Convention also regulates conflict of trusts.
Although trusts are often associated with intrafamily wealth transfers, they have become very important in American capital markets, particularly through pension funds (essentially always trusts) and mutual funds (often trusts).
Property of any sort may be held on trust, but growth assets are more commonly placed into trust (for tax and estate planning benefits). The uses of trusts are many and varied. Trusts may be created during a person's life (usually by a trust instrument) or after death in a will.
In a relevant sense, a trust can be viewed as a generic form of a corporation where the settlors (investors) are also the beneficiaries. This is particularly evident in the Delaware business trust, which could theoretically, with the language in the "governing instrument", be organized as a cooperative corporation, limited liability corporation, or perhaps even a nonprofit corporation.:475–6 One of the most significant aspects of trusts is the ability to partition and shield assets from the trustee, multiple beneficiaries, and their respective creditors (particularly the trustee's creditors), making it "bankruptcy remote", and leading to its use in pensions, mutual funds, and asset securitization.
Trusts may be created by the expressed intentions of the settlor (express trusts) or they may be created by operation of law known as implied trusts. Implied trusts is one created by a court of equity because of acts or situations of the parties. Implied trusts are divided into two categories: resulting and constructive. A resulting trust is implied by the law to work out the presumed intentions of the parties, but it does not take into consideration their expressed intent. A constructive trust is a trust implied by law to work out justice between the parties, regardless of their intentions.
Typically a trust can be created in the following ways:
In some jurisdictions certain types of assets may not be the subject of a trust without a written document.
Generally, a trust requires three certainties, as determined in Knight v Knight:
The trustee may be either a person or a legal entity such as a company. A trust may have one or multiple trustees. A trustee has many rights and responsibilities; these vary from trust to trust depending on the type of the trust. A trust generally will not fail solely for want of a trustee. Where a trust is absent any trustees, a court may appoint a trustee, or in Ireland the trustee may be any administrator of a charity to which the trust is related. Trustees are usually appointed in the document (instrument) which creates the trust.
A trustee may be held personally liable for certain problems which arise with the trust. For example, if a trustee does not properly invest trust monies to expand the trust fund, he or she may be liable for the difference. There are two main types of trustees, professional and non-professional. Liability is different for the two types.
The trustees are the legal owners of the trust's property. The trustees administer the affairs attendant to the trust. The trust's affairs may include investing the assets of the trust, ensuring trust property is preserved and productive for the beneficiaries, accounting for and reporting periodically to the beneficiaries concerning all transactions associated with trust property, filing any required tax returns on behalf of the trust, and other duties. In some cases, the trustees must make decisions as to whether beneficiaries should receive trust assets for their benefit. The circumstances in which this discretionary authority is exercised by trustees is usually provided for under the terms of the trust instrument. The trustee's duty is to determine in the specific instance of a beneficiary request whether to provide any funds and in what manner.
By default, being a trustee is an unpaid job. In modern times trustees are often lawyers, bankers or other professionals who will not work for free. Therefore, often a trust document will state specifically that trustees are entitled to reasonable payment for their work.
Trusts are often confused with legal persons, but are mere relationships, not entities. Thus, they have no legal existence independent from the trustee and his or her ownership of the subject matter of the trust. In order to sue a trust, one must sue the trustee in his or her capacity as trustee for a specific trust; conversely, if the trust needs to sue someone, the lawsuit must be brought by the trustee in his or her capacity as such.
The beneficiaries are beneficial (or equitable) owners of the trust property. Either immediately or eventually, the beneficiaries will receive income from the trust property, or they will receive the property itself. The extent of a beneficiary's interest depends on the wording of the trust document. One beneficiary may be entitled to income (for example, interest from a bank account), whereas another may be entitled to the entirety of the trust property when he attains the age of twenty-five years. The settlor has much discretion when creating the trust, subject to some limitations imposed by law.
Common purposes for trusts include:
Trusts go by many different names, depending on the characteristics or the purpose of the trust. Because trusts often have multiple characteristics or purposes, a single trust might accurately be described in several ways. For example, a living trust is often an express trust, which is also a revocable trust, and might include an incentive trust, and so forth.
A directed trust is a trust in which the trustee is directed by a number of other trust participants in implementing the trust's execution. That trustee is referred to as a Directed Trustee. Examples of other trust participants include a distribution committee, trust protector, or investment advisor. A directed trustee's role often includes: following distribution and investment instructions, holding legal title to the trust assets, providing fiduciary and tax accounting, coordinating trust participants and offering dispute resolution among those participants. Typically, these duties and the other participants in the trust are defined and governed by the trust document itself.
High net-worth families face an ever increasing set of challenges managing their wealth across generations. Major changes in trust law, combined with modern investment strategies, new tax factors and complex family and financial advisor dynamics, have created demands that traditional trusts and trust companies are not well equipped to handle. In the face of these demands, many families, based on guidance from their expert advisors, are moving away from conventional trusts that rely on single or co-trustees to new “multi-participant” trusts, with a directed trustee central to the administration of their trust. This arrangement is also commonly referred to as "open-architecture" trust design. As families move to gain more control over certain trust functions, multi-participant trusts have emerged as a powerful tool for achieving optimal estate planning results, while limiting risks to participants. The participants, or "agents" of this new form of trust are granted specific powers by the trust based on their skills, location in advantageous trust jurisdictions or past relationships. They are responsible, and therefore liable, only for matters that they are best equipped and prepared to manage. This approach is an advance over the traditional unitary trust model, where single or co-trustees lack either the in-depth expertise or the appetite for risk needed to effectively manage the gamut of issues that trusts face.
While the preceding list is a great starting point in trust education, this is an ever-expanding field of law. New types of trusts continue to be created, as the IRS continues to expand tax law, and individuals seek to find new ways to properly transfer their wealth to individuals, charities, etc.
Trusts can be used to avoid taxes and regulation, although in the United States the IRS allows trusts to be taxed as corporations, partnerships, or not at all depending on the circumstances.:478 Tax avoidance concerns have historically been one of the reasons that European countries have been reluctant to adopt trusts.
The trust-preferred security is a hybrid (debt and equity) security with favorable tax treatment which is treated as regulatory capital on banks' balance sheets. The Dodd-Frank Wall Street Reform and Consumer Protection Act changed this somewhat by not allowing these assets to be a part of (large) banks' regulatory capital.:23
In the United States, a living trust refers to a trust that may be revocable by the trust creator or settlor (known by the IRS as the Grantor). Living trusts are often used because they may allow assets to be passed to heirs without going through the process of probate. Avoiding probate will normally save substantial costs (the probate courts, in some states, charge a fee based on a percentage net worth of the deceased), time, and maintain privacy (the probate records are available to the public, while distribution through a trust is private). Both living trusts and wills can also be used to plan for unforeseen circumstances such as incapacity or disability, by giving discretionary powers to the trustee or executor of the will.
The grantor/settlor may also serve as a trustee or co-trustee. In the case where two or more co-trustees serve, the trust instrument may provide that either trustee may act alone on behalf of the trust or require both co-trustees to act/sign. The trust instrument may also provide that the other co-trustee shall act as sole trustee if the grantor becomes incompetent and is unable to continue administering the trust.
There are also some negative aspects to a living trust in the United States. Beneficiaries do not save on federal estate or state inheritance taxes. Setting up a trust may be expensive, and the expense is immediate, not delayed until after the grantor's death. The legal drafting of the trust instrument, which creates the trust, usually costs much more than the legal drafting of a will. Trust administration can be more expensive than the administration of a will in the long run, as most state laws allow a fee of 1% of the estate's gross assets to be paid to the trustee for every year the trust is in existence. The fees for probate estate administration under a will are usually from 1% of the gross estate (for very large estates) to 4% of the gross estate (for very small estates), but this is a one-time fee, not yearly. The same one-time fees apply when a person dies without a will or a trust (dies Intestate): State laws require that an intestate probate be opened at the local courthouse, that the decedent's closest relatives be identified, located and notified, and that the decedent's real and personal property be collected, accounted, and distributed to said relatives.
Important safeguards contained in the probate laws of most U.S. jurisdictions do not apply to trust administration. If the decedent leaves a will, his/her probate proceedings must be conducted under the auspices of the probate court. Unlike trusts, wills must be signed by two to three witnesses, the number depending on state law. Several safety provisions of probate law in the U.S. protect the decedent's assets from mismanagement, loss, and embezzlement, such as the requirement that the executor of the will be bonded, the real property insured, the executor’s sale of real estate monitored, and itemized accountings filed with the court during and at the end of probate administration. These procedures do not occur when a decedent's estate passes by trust. Trusts are conducted in private, unless a conflict develops and one of the parties seeks resolution by a court order.
Living trusts generally do not shelter assets from the U.S. Federal estate tax. A married couple having a trust can, however, effectively double the estate tax exemption amount (the amount of net worth above which an estate tax is levied) by setting up the trust with a formula clause. A formula clause takes advantage of the unlimited spousal deduction allowed under the internal revenue code. When the first married individual dies, the trust pays out to the beneficiaries an amount up to the total unified credit. The amount is set by the formula clause, not strict dollar amounts, because the unified credit increases over time. Without a formula clause, the unified credit could be wasted. The remaining amount of the estate (after the unified credit is exhausted) is paid to the spouse. Thus, when the first spouse dies, no estate tax is owed (just as if the individual died intestate). However, when the second spouse dies, the distribution to the trust beneficiaries is subject to that decedent's unified credit. The rest is subject to estate tax. If the married couple had died intestate, the first decedent's unified credit is lost because everything is transferred to the spouse upon his/her death. A formula clause is necessary only if the value of the estate is larger than the amount of the unified credit. Due to changes in Federal Estate Tax Laws that affect the year 2010 and later, using the Unified Credit formula may have some unintended consequences for persons who die during 2010 and later.
For a living trust, the grantor/settlor will often retain some level of relevance to the trust, usually by appointing him- or herself as the trustee and/or as the protector under the trust instrument (in jurisdictions where protectors are recognised). Living trusts also, in practical terms, tend to be driven to large extent by tax considerations. If a living trust fails, the property will usually be held for the grantor/settlor on resulting trusts, which in some notable cases, has had catastrophic tax consequences. A living trust is not under the control and supervision of the probate court, and property held by such a trust is not part of a decedent's probated estate.
Testamentary trusts are created at the winding up of a deceased estate following a specific stipulation in the deceased person's will that a trust must be set up. Testamentary trusts are usually created to hold assets on behalf of minor children, since minor children can not in terms of South African law inherit assets freely (in the absence of a trust, assets from the deceased estate left to minor children are held in a state instutition, the Guardian's Fund, and released to the children in adulthood or their parents or guardian must furnish security to the value of the inheritance). Bewind trusts are created as trading vehicles providing trustees with limited liability and certain tax advantages.
There are two types of living trusts in South Africa, namely vested trusts and discretionary trusts. In vested trusts, the benefits of the beneficiaries are set out in the trust deed, whereas in discretionary trusts the trustees have full discretion at all times as to how much and when each beneficiary is to benefit.
There are three parties in a living trust, namely the founder, the trustees and the beneficiaries. The trust is managed by the trustees for the benefit of the beneficiaries. The beneficiaries can be any legal persons, including living people, other trusts, and registered businesses. Trustees may also be beneficiaries. The founder may be a trustee and a beneficiary, although it is to be regarded with circumspection.
The trust is created by drafting a trust deed (usually in co-operation with an attorney specialising in trust law) and registering the trust with the local High Court (the Master of the High Court is the court official that administers trusts). The trust becomes effective as soon as it is registered.
Until recently, there were tax advantages to living trusts in South Africa, although most of these advantages have fallen away with new legislation. The remaining advantage of a living trust is the protection of assets from creditors. In an ideal situation, since assets held by the trust are not owned by the trustees or the beneficiaries, the creditors of trustees or beneficiaries can have no claim against the trust (there are exceptions). A common scenario of using living trusts for asset protection is a husband and wife acting as trustees along with a third unrelated trustee. The trust is granted a loan equal to the value of their assets, then the trust buys their assets using the loan, and finally the trust pays off the loan over time. When any of trustees die, the trust and any assets owned by it, remain unaffected.
In terms of the provisions of the Insolvency Act (Act 24 of 1936) assets transferred into a living trust remain at risk from external creditors for 6 months if the previous owner of the assets is solvent at the time of transfer, or 24 months if he/she is insolvent at the time of transfer. After 24 months, creditors have no claim against assets in the trust, although they can attempt to attach the loan account, thereby forcing the trust to sell its assets.
Assets can be transferred into the living trust by selling it to the trust (through a loan granted to the trust) or donating cash to it (any natural person can donate R100 000 per year without attracting donations tax; 20% donations tax applies to further donations within the same tax year).
In terms of South African tax law, living trusts are considered tax payers. Two types of tax apply to living trusts, namely income tax and capital gains tax (CGT). A trust pays income tax at a flat rate of 40% (individuals pay according to income scales, usually less than 20%). The trust's income can, however, be taxed in the hands of either the trust or the beneficiary. A trust pays CGT at the rate of 20% (individuals pay 10%). Trusts do not pay deceased estate tax (although trusts may be required to pay back outstanding loans to a deceased estate, in which the loan amounts are taxable with deceased estate tax).
The taxpayer whose residence has been "locked" in to a trust has now been given another opportunity to take advantage of these CGT exemptions. The Taxation Law Amendment Act was promulgated on 30 September 2009 and takes effect on 1 January 2010 allowing a window period of 2 (two) years from 1 January 2010 to 31 December 2011 for the opportunity of a natural person to take transfer of the residence with advantage of no transfer duty being payable or CGT consequences. Whilst taxpayers can take advantage of this opening of a window of opportunity is not likely that it will ever become available thereafter.