Asset structuring through trusts and foundations

Case 1a: Recognition of foundations and trusts, attribution to the founder in the case of a FL foundation

1. facts of the case

A., resident in the canton of Baselland, owned various properties in the Czech Republic, which he transferred to the company he owned in the Czech Republic, D. sro, in 2007. In 2008, he sold 90% of the shares in D. sro to E. Ltd., based in the British Virgin Islands. This company, in turn, sold its stake in D. sro to the Liechtenstein family foundation F., which A. had set up for the benefit of his family.

The foundation's main purpose was "the investment and administration of the foundation's assets as well as donations to beneficiaries determined in accordance with the bylaws and regulations. In addition to members of certain families, beneficiaries can also be other third parties not belonging to these families as well as non-profit institutions and organizations. The foundation serves to finance living expenses, education and health, to secure and/or improve the existing standard of living in general, to promote and support the beneficiaries economically in the broadest sense and to pursue similar purposes."

Between 2007 and 2011, A. did not declare the registered shares in D. sro or the F. Foundation in his tax returns. A tax review and penalty procedure was initiated.

NB: The wording of Liechtenstein law states that a founder can only revoke the foundation without conditions or amend its foundation charter if he has expressly reserved such a right (see Article 559, paragraph 4 of the PGR). In this case, no such right of revocation or amendment was contained in the foundation charter.

Questions

1. How should the F. Foundation be treated from a Swiss tax perspective?
2. What are the tax consequences for A. if the foundation is treated transparently from a Swiss tax perspective?
3. If Liechtenstein takes the view that the foundation is an independent tax subject, can A. invoke the existence of double taxation, which is to be avoided by virtue of the DTA-FL?
4. Which state has the right to tax the shares in D. sro (= real estate company)?

Case 1b: Recognition of foundations and trusts, attribution to the beneficiaries of a US trust

1. facts of the case

Father V., resident in the USA, left two sons after his death. Son S. is resident in Switzerland. Son U. is resident in the USA. At the time of death, the two sons received small amounts directly from their father's estate. The large remainder was transferred to the T. Trust in accordance with the trust deed and the father's wishes. The trust has total assets of CHF 500 million.

Since 2014, annual payments have been made from this trust to the sons. S. receives distributions of CHF 150,000 – 200,000 per year. He declared these payments in his annual Swiss tax returns as an inheritance from his father.

According to the trust deed of the “T. Irrevocable Family Trust”, the key points of the trust can be summarized as follows:

• Settlor: Father V., deceased, USA
• Executor: Son U., USA
• Beneficiaries: 
  • 1st place: son U., USA, and son S., Switzerland, as well as the descendants of the two sons.
  • 2nd rank and following: various classes of beneficiaries across different generations of blood relatives; who receives how much is determined by the current and future trustees.
• According to the trust deed, the trustees can pay out assets or income at their own discretion, evenly or unevenly, whereby the payments can be made to the beneficiaries in the first rank and their descendants.
• Distributions from the trust (so-called HEMS standard [1] ): Distributions are generally at the discretion of the trustees, but they may only make distributions for the "preservation of the health and reasonable comfort of the beneficiary and their descendants, for a complete education (including preparatory, school, postgraduate and vocational training) or for the maintenance of a beneficiary's usual standard of living" (so-called HEMS standard).
• From the age of 30, each beneficiary has the right to receive 5% of the trust capital.
• Trustees: son U., USA, and son S, Switzerland. If the two sons no longer act as trustees, then the grandson E. (son of S.), Switzerland, becomes trustee.
• After the death of the first beneficiaries (S. and his brother), it is intended that the descendants will generally benefit “per stripes” (according to tribes).
• The two trustees determine the distributions annually. They must make these decisions unanimously.
• There is no possibility for the trustees to dissolve the trust.
• The trust is considered a taxable entity in the USA and pays substantial income taxes there. S. also pays taxes on the distributions received in the USA, at least USD 50,000 per year.

The tax periods 2020 ff. are still open. The tax periods 2014-2019 have been definitively assessed. A supplementary tax procedure has been initiated against the son S. for these periods.

Questions

1. How should the trust be assessed from a Swiss tax perspective?
2. What are the tax consequences for S. if the trust is treated transparently from a Swiss tax perspective?
3. Can the definitively assessed tax periods be corrected in the post-tax procedure?
4. If the trust assets are attributed to S., is there double taxation in Switzerland and the USA, which could be avoided under the double taxation agreement with the USA?

¹ HEMS standard: HEMS stands for "Health, Education, Maintenance and Support" and means that distributions are only permitted for these purposes. Under US tax law, the obligation to comply with the HEMS standard means that the trust assets do not fall into the (taxable) estate of the beneficiary, even if the beneficiary also acts as trustee. In this case, the assets are allocated to the trust for tax purposes, and the trust is therefore recognized for US tax purposes.

Case 2: Taxation of distributions from a Swiss family foundation

1. facts of the case

The C. family foundation is a family foundation within the meaning of Article 335, paragraph 1 of the Swiss Civil Code. Its purpose is to provide the couple A. and B. and their descendants (beneficiaries) with “contributions to the cost of their equipment, by promoting their education or training of any kind and, if necessary, to enable and facilitate their economic and academic advancement.”

During the disputed tax period, the C. family foundation made various donations to the three children of the married couple A. and B. It should be noted that one daughter came of age during the disputed tax period.

According to the foundation deed, a board of trustees (foundation council) elected by the adult shareholders decides on the donations.

Addition: The C. family foundation was established in 1950. The founder, who has long since died, contributed a share package to the foundation, which at the time was worth CHF 1 million. Today the value is CHF 2 million.

Questions

1. Is the establishment of a family foundation such as the one in question permissible under civil law? Can the tax authorities invoke the civil law invalidity of a family foundation?
2. How are the donations taxed for the beneficiaries?
3. What applies with regard to the daughter who has reached adulthood?
4. Are the donations at the level of the C. family foundation tax deductible?
5. Suppose the C. family foundation distributes 2% of the invested share package (value = CHF 40,000 at the time of distribution) to the daughter so that she can use it to finance her LL.M. studies at Harvard. Can the daughter claim that this is a tax-free distribution of assets?

Case 3: Change of status in a trust

1. facts of the case

J. (*1945), a Swiss citizen, resident in England, has two sons, N. (*1980) and M. (*1983), both also Swiss citizens. The two sons have no descendants. J.'s asset and estate planning consists of a trust structure, which had its background in tax planning in England, in addition to his last will and testament.

The trust regulation can be summarised as follows:

- J. set up the trust in 2015 as settlor under Jersey law as an irrevocable discretionary trust.

- The trustee is Z. Trust Company Ltd. in Jersey. J. can express wishes regarding the administration and use of the trust assets, but these are not legally binding for the trustee.

- As beneficiaries J. (= Settlor), his son M. and his descendants as well as five named non-profit institutions are intended (in this order).

- Protectordes Trusts is a long-standing advisor to J.

- There is a letter of wishes in which J. declares that he should be the sole beneficiary during his lifetime and that after his death, his son M. should have this right.

J. is planning to move to Switzerland to be closer to his sons when he gets older.

Questions

1. How should the trust be assessed for tax purposes after J. moves to Switzerland?

2. What are the tax consequences of J.’s death?

3. After J. moves in, he realizes that his son M. leads a dissolute lifestyle. He decides to amend the trust deed and remove his son and his descendants from the list of beneficiaries. After his death, only the five named non-profit institutions should be considered as beneficiaries.

What are the tax consequences of this change to the trust deed? During J.'s lifetime or upon his death?

Case 4: Tax exemption for an inheritance foundation

1. facts of the case

B. died on November 7, 2014. In her will dated September 22, 2013, she appointed a newly established foundation as her sole heir, excluded relatives from the inheritance and made certain legacies.

The will states: " All remaining assets will go to a foundation that is to be set up after my death. This is to be set up as described below. If difficulties arise because I do not have sufficient legal knowledge, please make corrections in my favor. " This is followed by relatively detailed explanations of the purpose, headquarters, foundation assets and foundation board. However, the will does not (yet) contain any information on the irrevocable use of funds for the tax-exempt purpose in the event of the foundation being dissolved (earmarked purpose).

The "Foundation A" was entered into the commercial register in 2015 as follows. The purpose of the foundation is: " The foundation is intended to enable economically disadvantaged people to provide their animals with medical treatment that they would not be able to afford. It is also intended to enable people in a tight financial situation to continue to keep an animal. The foundation is non-profit and does not pursue a profit-making purpose ."

The first application for tax exemption of the foundation was rejected by the Zurich Cantonal Tax Office in 2016 due to a lack of altruism, since in particular the functions of the chairman of the foundation board and the managing director were carried out jointly and the foundation board members did not work on a voluntary basis.

As part of a second application for tax exemption in 2017, the foundation submitted, among other things, the foundation deed signed by the foundation board but not amended by the foundation supervisory authority - now with a dissolution clause that ensured the irrevocable use of funds for the tax-exempt purpose. The role of the foundation board president and the managing director were also no longer performed by the same person. As a result, the foundation supervisory authority approved the amended foundation deed (on May 31, 2017) and the change was entered in the commercial register. However, the Zurich Cantonal Tax Office also rejected the second application for tax exemption in 2018.

Questions

1. What are the general requirements for tax exemption? Do the foundation board members have to work on a voluntary basis to qualify for tax exemption and is the fact that the foundation board and managing director are both members of the same person sufficient to deny tax exemption?
2. Can a tax exemption be refused due to the disproportion between grants and personnel and administrative costs?
3. Is an explicit clause in the statutes necessary, according to which the irrevocable earmarking of the funds is fixed even in the event of dissolution, in order to exempt a testamentary foundation (“hereditary foundation” ⁰¹ ) from tax?
4. If a tax exemption were to be granted in this case, from what point in time could the foundation be tax-exempt? From the date of death (November 7, 2014) or only from May 31, 2017 (date of the amendment order with sufficient dissolution clause)?

⁰¹ "Hereditary foundations" are foundations that are established by a testamentary disposition (cf. Art. 493 of the Swiss Civil Code). For information on hereditary foundations, see Thomas Sprecher, Stiftungsrecht in a nutshell, 2nd ed., Zurich/St. Gallen 2023, 25 ff.