Wealth planning with a different kind of legal animal: foundations

Photo of a stag in the forest
By Douglas Sinclair, The CA Magazine

26 May 2017

Douglas Sinclair considers the pros and cons of the foundation as a wealth planning strategy.

Generally, clients looking for a UK wealth planning vehicle will consider one of the classic native species such as a trust, family limited company, or the (semi-mythical) family limited partnership. 

However, for clients willing to look further afield, another option may be a foundation (Latin name trustius companious).

What is this exotic creature? 

One way to describe a foundation is “a company that behaves like a trust”. While that is a simple explanation, there is, in fact, no single definition of a foundation, and in each case its structure will depend on factors such as its jurisdiction of establishment, the terms of its constitutive documents and the way it operates in practice. 

While that is the case, a good general explanation is provided by the Guernsey Registry: 

… a legal entity which is created when a person provides assets for a specific purpose. The foundation holds the assets for purposes set out in its constitutive documents and is administered according to contractual rather than fiduciary principles – principles that are more widely understood than those that underpin trusts. The foundation is a distinct legal entity, but unlike a company, it has no shareholders.

Therefore it appears to be very similar to a trust, but with two crucial differences: it has a separate legal personality and it is administered on contractual rather than fiduciary principles. 

For these reasons, it is more readily understood by civil law jurisdictions that have traditionally struggled with the concept of a trust.

So now we know what we are looking for, where can we find it? Traditionally foundations were to be spotted in the more mountainous regions of Liechtenstein, but they have migrated across many other civil law jurisdictions and recently small but thriving colonies have become established in the crown dependencies.

Who can thrive in this environment?

Could foundations make the short hop across the Channel to the UK? This is most likely to happen as a result of the natural migratory patterns of the Hnwi (high-net-worth individual) or their rarer cousins, the Uhnwi (ultra-high-net-worth individual). 

While such actions may lead to foundations coming to the UK, they are unlikely to thrive due to the (tax) climate. In particular, the way in which foundations are subject to tax in the UK is one of the more mysterious aspects of their behaviour.

As UK tax law contains no specific provisions regarding foundations, they must be categorised as another form of entity for tax purposes, e.g. a trust or company. 

It is not impossible for a foundation to be subject to different categorisations for different taxes.

The difficulty with this is that while, with Liechtenstein foundations at least, the starting point seems to be a trust, that is just a starting point and the tax treatment will need to be established on a case by case basis. This will involve taking account of factors such as its constitution and how it operates in practice.

While this could see a foundation categorised in a relatively simple way (e.g. a standard trust), it could mean that a foundation is subject to a more stringent or unexpected tax regime. For example, a “settlor interested trust” that is also subject to the “gifts with reservation” regime.

Alternatively, a categorisation as a company could lead to unexpected exposure to taxes such as ATED (annual tax on enveloped dwellings). In fact, it is not impossible for a foundation to be subject to different categorisations for different taxes and for those categorisations to change over time.

Are foundations an attractive option?

While this lack of certainty exists, foundations are unlikely to be an attractive option for UK-based clients. The general view that offshore entities are expensive to operate is also likely to dampen enthusiasm. 

For clients coming to the UK with interests in foundations, thought should be given to converting them into one of the more traditional UK species of legal entity. While such entities may not be as exotic as the foundation, there is a lot to be said for their comparative simplicity and ease of operation.

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