Cook Islands Trust for U.S. Assets Protection

PROTECT YOUR ASSETS IN OFFSHORE

Reasons to use offshore structures

It's about protection, privacy and taxes...

"The West is good for making money. It is better to use offshores for storing money." My professor in International Taxation class.

While developed countries offer a wealth of opportunities, its complex legal and tax system can often hinder business growth and wealth accumulation. By establishing an offshore company, clients can unlock a range of benefits, including enhanced asset protection and streamlined business operations. Let's delve into these advantages in detail:

Enhanced Asset Protection. The American and European legal systems, though robust, exposes business assets to potential vulnerability from lawsuits, creditors, and other claims. Incorporating your business offshore can provide a stronger shield for your assets. Many offshore jurisdictions offer robust legal frameworks that protect assets akin to a sturdy castle wall. There may be shortened statute of limitations, higher standard of burden of proof etc. This provides peace of mind and safeguards your wealth from potential threats.

Simplified Taxation and Low Overall Tax Burden. Navigating the intricate U.S. Internal Revenue Code can be a complex and costly endeavor. However, some offshore jurisdictions operate with no-tax or significantly lower corporate and individual tax rates. By establishing an offshore company, you can retain a larger portion of your hard-earned income, enabling you to reinvest in your business, build personal wealth, and optimize your tax burden responsibly.

Confidentiality and Privacy. Maintaining confidentiality of business and personal financial information can be challenging in the U.S., with public record disclosures and reporting requirements. Offshore jurisdictions often offer a cloak of privacy for company ownership and financial activities. This ensures that your sensitive information remains shielded from prying eyes, allowing you to operate with discretion and protect your privacy.

Streamlined Business Operations. Bureaucratic red tape and complex regulations can hamper business growth in the U.S. Establishing an offshore company can alleviate these burdens. Many offshore jurisdictions offer streamlined business administration, simplified company formation procedures, and reduced reporting requirements. This frees you from administrative shackles, enabling you to focus on core business activities, such as growing your company and achieving your goals.

Access to Global Markets. Operating through an offshore entity provides you with a "passport" to new and exciting international markets. By expanding beyond the limitations of the U.S. and E.U. market, you can access wider customer bases, tap into diverse talent pools, and forge strategic partnerships. This opens up opportunities for exponential growth and broadens your horizons.

Asset protection strategy for U.S assets

U.S. Settlor

Beneficiaries of the Trust

Management

U.S. LLC

U.S. Assets
(bank accounts, real property, etc.)

Cook Islands Trust

Cayman Islands Company

U.S. LLC

U.S. Assets
(bank accounts, real property, etc.)

Trustees

Protector

U.S. LLC

U.S. Assets
(bank accounts, real property, etc.)

Why to establish a trust as a holding vehicle?

Unlike companies, trusts have no "owners"...

A trust can be defined as a fiduciary relationship in which one or more persons (also known as the grantor or settlor) transfers legal title to a trustee(s), who manages the property for the benefit of a designated beneficiary (which can be the settlor themself or a third party). When the settlor of the trust is the beneficiary, the trust is called "self-settled." Within a fiduciary relationship, one party is bound to act exclusively in the best interests of another, according to the established terms of their bond. The trustee holds "legal title" to the property, and the beneficiary holds "equitable title" to it. In essence, the trustee acts as a legal owner who manages the property according to the trust document, while the beneficiary holds the right to benefit from the trust's assets according to the document's terms (equitable title).

When it comes to asset protection, trusts and companies (in form of a corporation, LLC, partnership) are two commonly utilized legal structures. While both serve as effective tools for safeguarding assets, there are fundamental differences between the two. Unlike companies, trusts are not "owned" by another person. While companies may shield individuals from certain liabilities, creditors can target an individual's shares in the company to satisfy personal debts. In contrast, trusts provide an additional layer of asset protection, as trust assets are not easily accessible to creditors seeking to collect on the settlor's debts. Assets within a trust are held separately and distinct from the personal assets and debts of the settlor.

A company is a separate legal entity owned by shareholders or members. It offers liability protection to its owners and separates personal assets from those owned by the company. This limited liability feature can shield shareholders from personal liability in many cases. However, it's important to note that if an individual has personal debts, their shares in the company may be at risk. Creditors can seek to seize these shares to satisfy the individual's obligations.

Employing offshore trusts can create strategic advantages in dispute resolution scenarios. Compared to traditional planning methods, they may provide leverage for reaching more favorable settlements. The effectiveness of this approach hinges on the negotiating table. When creditors encounter a debtor whose assets reside in a properly established foreign trust, they face significant hurdles. Such trusts often operate under legal frameworks offering protections like non-recognition of U.S. judgments, strong confidentiality, and complex legal challenges. The realization of these obstacles often incentivizes creditors to pursue swift and cost-effective settlements favoring the debtor.

What country suits best for establishing a trust?

Based on overall parameters, Cook Islands Trust works best for U.S. assets protection and international tax planning...

When selecting a jurisdiction for trust establishment, it is crucial to consider factors such as (1) non-recognition of foreign judgements, (2) fraudulent conveyance provisions, and (3) possibility of settlor to retain certain powers and benefits over the corpus (property) of the trust.

By choosing an offshore jurisdiction that offers non-recognition of foreign judgments, a debtor can effectively shield their assets from being subject to claims arising from debts incurred elsewhere. This means that even if a creditor successfully litigates their case in the jurisdiction where the debt emerged, they would not be able to enforce their judgment in the offshore jurisdiction where the trust is established. Creditors would need to repeat the litigation process in the offshore jurisdiction and face the uncertainty of a potentially different legal system. As a result, the debtor's assets held within the trust would remain protected and out of the reach of the creditor.

Fraudulent conveyance provisions must be established in the offshore jurisdiction that you choose. Your analysis must begin with the examination of the Statute of Elizabeth, which was enacted in England in 1571. This statute is the foundation for fraudulent conveyance laws in England and the Commonwealth, and it has influenced the creation of the Uniform Fraudulent Transfer Act in the United States of America. The purpose of this statute is to safeguard the interests of all creditors by rendering any conveyance null and void if it is made with the intention of obstructing or defrauding creditors. Given that a creditor seeking to enforce a judgment in an offshore jurisdiction (where the assets of a trust are located) may attempt to challenge a transfer to the trust based on fraudulent conveyance grounds, it is crucial that the chosen jurisdiction explicitly overrides the provisions of the Statute of Elizabeth.

Possibility of settlor to retain certain powers and benefits over the corpus (property) of the trust is the third mist important criteria. While several factors dictate the success of a trust, the settlor's ability to retain certain powers and benefits over the trust's property, the corpus, occupies a crucial. This ability, often referred to as a "reservation of powers," acts as a delicate dance between relinquishing control and securing personal advantages. From income streams and administrative influence to contingencies and ultimate ownership, the potential benefits for the settlor are numerous. Yet, this dance carries risks. Excessive control can blur the lines between ownership and separation of assets, potentially subjecting the trust to taxation or creditor claims. Striking the right balance between self-interest and legitimate trust structure becomes paramount. Therefore, while not the sole pillar of success, the settlor's reserved powers and benefits deserve thorough consideration, demanding careful calibration to ensure the trust's effectiveness and integrity.

The Cook Islands, along with other jurisdictions like Bermuda, the Cayman Islands, and the Isle of Man, has emerged as a favorable choice for trust formation. The Cook Islands currently have the highest number of registered asset protection trusts compared to any other nation globally. In this review, we will explore why the Cook Islands stands out as a preferred jurisdiction for establishing a trust.

Long Judicial History of Trusts & Codified Laws. Selecting a jurisdiction with a well-established judicial history of trusts is critical for ensuring the effectiveness and reliability of your trust structure. The Cook Islands has a long-standing history of trust law, providing a solid foundation for trust establishment. This history is marked by numerous landmark cases that have set favorable precedents for the protection of trust assets and beneficiaries' rights. Unlike other jurisdictions with trust laws scattered throughout multiple acts, Cook Islands trust laws are codified into one statute, which makes them easier to research.

Self-settled trusts are allowed. The Cook Islands has enacted comprehensive legislation specifically designed to enhance asset protection and safeguard trust assets from potential creditors. The jurisdiction's legal framework allows for self-settled asset protection trusts, even if the settlor retains control of the trust. This feature provides flexibility while offering robust protection for trust assets. Additionally, the Cook Islands' law explicitly validates the trust and its protection in the event the settlor files for bankruptcy, ensuring the continuity and effectiveness of the trust even in challenging circumstances.

Asset Protection and Fraudulent Transfer Laws. Asset protection is a primary concern when establishing an offshore trust, and the Cook Islands excels in this area. The jurisdiction's laws impose a high burden of proof on creditors seeking to challenge a trust as a fraudulent transfer. Creditors must establish their claims beyond a reasonable doubt, providing significant protection for trust assets. Furthermore, the Cook Islands' law includes a provision that prevents actions for fraudulent transfer if the settlement or establishment of the trust occurred before the creditor's cause of action accrued. Additionally, the statutes stipulate that if a transfer is determined to be fraudulent, it does not invalidate the entire trust. Instead, only the property that is deemed fraudulently transferred is made available to satisfy the creditor's claim. The Cook Islands has laws that state that a transfer to a trust is not voided in the event of the settlor's bankruptcy, unless the transfer is deemed fraudulent according to the standard rules.

The Cook Islands is one jurisdiction that does not enforce U.S. judgments, including judgements in bankruptcy litigation. This provision safeguards the trust against future creditors. The Cook Islands enforces a one-to-two-year statute of limitations for legal challenges claiming a trust was created to avoid debts ("fraudulent transfers"). This means creditors have one year from the trust's funding or two years from the event underlying their claim to take legal action in the Cook Islands. Failure to do so within the relevant timeframe bars them from making such claims in the future.

Privacy and Confidentiality. Privacy and confidentiality are paramount when it comes to offshore trust planning. The Cook Islands prioritizes client confidentiality and has stringent privacy regulations in place. Legal proceedings involving such trusts are conducted in camera, and any written rulings pertaining to them are not made available to the public. The jurisdiction imposes strict penalties for any unauthorized disclosure of trust-related information, ensuring the highest level of privacy protection for trust beneficiaries.

Political and Economic Stability. Political and economic stability are vital factors to consider when selecting an offshore trust jurisdiction. The Cook Islands, as a self-governing territory in free association with New Zealand, enjoys a stable political climate and a well-established legal system based on English common law. This stability provides assurance that the jurisdiction will continue to support and uphold trust structures effectively.

Professional Expertise. The Cook Islands has a well-developed offshore financial sector that offers a wide range of professional services. Trust service providers in the jurisdiction possess extensive expertise in trust administration, asset protection, and wealth management. By working with experienced professionals in the Cook Islands, individuals can ensure that their trusts are structured and managed with the highest level of competence and professionalism.

Using Cook Islands Trusts for U.S. assets protection

Careful and thorough drafting of trust instruments...

Form the U.S. assets protection perspective, when drafting an offshore trust instrument, it is important to consider the following recommendations:

The settlor should explicitly state that the laws of the chosen jurisdiction will govern the trust.
The trust administration should be carried out within the selected jurisdiction.
The trustee's place of business or residence at the time of establishing the trust should be located in the chosen jurisdiction.
The assets held by the trust should be situated within the selected jurisdiction.

The general rule is that the situs of personal property, as opposed to real property, is typically determined by the owner's domicile. In the case of an offshore trust, this would be the foreign trustee. It is important for the foreign trust to avoid holding a direct interest in U.S. real property because the jurisdiction where the land is located has exclusive control over all matters related to it. Additionally, some states have restrictions on aliens holding legal title to land.

If the client wishes to protect real estate through a foreign trust, it is recommended to convert the real property into personal property. This can be achieved by transferring the real estate to a partnership or corporation in exchange for intangible personal property, such as partnership interests or stock, and then transferring those shares or interests to the foreign trust.

It is worth noting a court case, Nastro v. D’Onofrio, 263 F. Supp. 2d 446, 455 (D. Conn. 2003), which held that under the UFTA (Uniform Fraudulent Transfer Act), a U.S. district court had the power to require a U.S.-formed corporation to modify ownership records and issue new stock certificates in favor of the debtor. Therefore, it is advisable to use corporations that are not subject to U.S. jurisdiction to enhance asset protection.

In terms of asset protection, a corporation provides more security than a partnership since the stock of a corporation must be physically seized to be subject to creditor attachment. If the stock is held by a foreign trust, it would be deemed owned by the trustee, making the situs of the interest the foreign country.

However, it is important to consider potential adverse tax consequences and the possibility of a court disregarding the settlor's selection of jurisdiction for public policy reasons that favor creditors in the state. Normally, corporate distributions are taxable event for U.S. income tax purposes.

When using interests in a U.S. limited partnership or LLC to fund a foreign trust, additional asset protection can be achieved by establishing a mechanism for transferring the underlying assets offshore. One such mechanism is granting the foreign trustee the power to liquidate the interests held by the foreign trust and receive a proportional share of the entity's assets. This power can be defined in various ways, such as explicitly granting the trustee the right to liquidate the interest or holding a put option.

COOK ISLANDS

Mistakes to avoid...

Be careful of U.S. personal jurisdiction over trustees or beneficiaries...

Accessing assets shielded within a foreign trust can be a complex endeavor. While a U.S. judgment may not directly enforce on assets hidden outside its reach, there are alternative pathways for creditors to pursue. One approach involves exerting pressure on individuals connected to the trust. For example, threatening incarceration for contempt of court could incentivize a beneficiary to cooperate or reveal hidden assets. Additionally, uncovering the trust's footprint can be achieved through meticulous investigation of financial records and tax returns.

Even if the trust resides in a jurisdiction that disregards U.S. legal pronouncements, creative legal strategies can still bring assets back within reach. If the court can establish jurisdiction over the beneficiary or trustee, it gains leverage to compel asset transfers. For instance, if the trust allows, the court could order the beneficiary to relinquish their trust interest. Similarly, if the court holds personal jurisdiction over the trustee, it can command the transfer of both tangible and intangible assets, even if located elsewhere. However, establishing such jurisdiction requires demonstrating the trustee's "minimal contacts" with the relevant state. Activities like conducting business, holding trust assets, or actively soliciting business within the state can qualify as these minimal contacts. Additionally, specific state laws might further restrict court jurisdiction over foreign trusts.

Beyond these general principles, several specific scenarios can establish personal jurisdiction over the trustee:

Secured interests: Acquiring legal claims on property located within the United States.
Joint ventures: Partnering with an entity situated within the state.
Conspiracy involvement: Participating in a conspiracy that operates within the state's borders.
Physical presence: Having a representative physically present within the United States.
Financial ties: Engaging in business activities involving U.S. bank accounts or similar financial instruments.
Local property claims: Asserting ownership of trust assets physically located within the state.

These avenues highlight the intricate legal landscape surrounding foreign trusts and asset recovery. Careful navigation of these complexities is crucial for any creditor seeking to pursue assets shielded within such trusts.

Clauses to include in the trust agreement

The outcome of an offshore trust can be influenced by various factors, such as the trust's drafting, the trustees chosen, the level of expertise and effort put into challenging the trust, and the level of expertise and effort dedicated to defending it. Here are the most important clauses you need to pay attention while drafting your trust agreement:

Anti-duress clause. In cases where a trust allows the settlor to retain specific powers such as the ability to remove and replace trustees, there is a possibility that a creditor may attempt to force the settlor to discharge the foreign trustee and arrange for the assets to be brought back to the United States. To address this concern, it is advisable to include an anti-duress clause in the trust. This clause would instruct the foreign trustee to disregard any orders or instructions given under duress. The primary objective of such a provision is to safeguard the settlor against coercive actions by a U.S. court, thereby mitigating the risk of being held in contempt. It is important to note that the defense of impossibility of performance can be invoked to counter contempt charges.

Trustee Removal Clause. In situations where a United States court can legally require domestic trustees to assume control over trust assets, it is crucial for the trust to grant the offshore trustee the authority to remove any domestic trustee under specific circumstances. By including this provision, the trust can circumvent the necessity of having the domestic trustee voluntarily resign, a course of action that could potentially expose the trustee to penalties or sanctions.

Flee Clause. At some point, it may be necessary to consider relocating assets to safeguard them from creditors, potential political instability, or alterations in legal regulations. To facilitate such a change, the trust agreement can incorporate provisions that allow for modifications in trustees, the jurisdiction where the trust is established, or (3) the assets held within the trust. These provisions, often referred to as "flee clauses," grant discretionary power to the trustee or a trust protector to effectuate the change of situs. This can be achieved by appointing new trustees, transferring assets to another jurisdiction, or amending the trust to comply with the laws of a different jurisdiction.

Trust Protector Clause. It is a prevalent practice to appoint a trust protector or advisor for foreign trusts. This individual, or a committee of trust protectors, is granted the authority to replace trustees and veto specific actions taken by the trustees. To ensure the protector's safeguard against being compelled to exercise control over the trust, it is advisable to draft their powers as negative powers and subject them to anti-duress provisions. By doing so, the protector is protected from any orders that may require them to take control over the trust.

U.S. funding and taxation of a foreign trust

How the US taxes income and distributions from a foreign trust hinges on two things: the type of trust (domestic or foreign) it is and where the beneficiaries stand residency-wise when they receive the money. In the intricate world of US tax law, distinguishing between foreign and domestic trusts is crucial.

If a trust doesn't satisfy both the 'court test' and the 'control test,' it automatically becomes a foreign trust, triggering specific tax and reporting obligations for the trust and its beneficiaries. The 'court test' is fulfilled if any U.S. court, whether federal, state, or local, can hold the primary power to make decisions and issue orders concerning the trust's administration. This power should cover most, if not all, aspects of the trust's management. The 'control test' is satisfied when one or more U.S. persons hold the decisive authority, through voting or other means, to make all crucial decisions regarding the trust's management, without any other party capable of vetoing their choices (except in the exceptional case of the grantor or beneficiary acting in a fiduciary role).

U.S. persons are U.S. citizens, resident aliens and other persons, considered to be U.S. tax residents under Subchapter N of Internal Revenue Code.

U.S. Income Taxation of Foreign Trusts

The United States income tax liability associated with a foreign trust depends upon its classification as either a 'grantor' or 'non-grantor' trust. Income derived from a grantor trust is, as a general rule, attributed to the trust's grantor for tax purposes, rather than to the trust itself or its beneficiaries. Conversely, income generated by a non-grantor trust is generally only subject to US taxation upon distribution to US beneficiaries, with the exception of US-sourced or effectively connected income earned and retained by the trust, which would necessitate the non-grantor trust paying US income tax for the year in which such income is earned.

Foreign Grantor Trust. Within the framework of US federal income tax law, a trust acquires the classification of a 'grantor trust' when the individual who established the trust (grantor) maintains a substantial degree of influence and control over the trust's assets. As a consequence of this retained dominion, the grantor is deemed the owner of the trust for tax purposes. The designation of 'grantor trust' for US income tax purposes can also extend to foreign trusts established by US persons through gratuitous transfers. This classification applies when the foreign trust contains one or more beneficiaries who are US persons, or harbors the potential for future distributions to such individuals. In the majority of situations where a US person funds a foreign trust, the trust will be categorized and taxed as a grantor trust.

U.S. Grantors who established a foreign trust classified as a grantor trust, are obligated to report all income and gain generated by the trust on their individual income tax return (Form 1040) for the corresponding tax year in which such income or gain was earned. Consequently, the foreign grantor trust itself remains exempt from any US income tax liability while the grantor bears the sole responsibility for reporting and remitting taxes on its income and gains. The trustee of a foreign grantor trust with a US owner must file Form 3520-A, Annual Information Return of Foreign Trust With a US Owner, with the IRS each year. The definition of "distribution" for US income tax purposes encompasses a broader range of transactions, including uncompensated use of trust property and loans to US beneficiaries. If an intermediary receives property from a foreign trust as part of a plan that had a primary objective of avoiding US taxes and subsequently transfers that property, including cash, to a US person, the US person is deemed to have received the property directly from the foreign trust.

The Internal Revenue Code and applicable regulations restricts the eligibility of a nonresident alien to be classified as the grantor of a trust according to the US grantor trust rules. However, there are specific circumstances in which the grantor trust rules do apply to an nonresident alien grantor.

Importantly, the Internal Revenue Code establishes specific consequences on nonresident aliens who transfer assets, either directly or indirectly, to a foreign trust within a five-year window prior to establishing US residency. Such transfers are generally deemed, for tax purposes, to have occurred on the date the nonresident aliens officially assumes US residency status.

Foreign Non-Grantor Trust. Any trust not classified as a "grantor trust" under US tax law falls under the "non-grantor trust" category. Foreign non-grantor trusts are generally exempt from US taxation, except for income derived from US sources or considered "effectively connected" to US business activities.

For any distribution to a US beneficiary, the trustee must provide a "Foreign Nongrantor Trust Beneficiary Statement." This statement details the distribution amount, its composition (including current or prior year income, and corpus), but unlike statements for foreign grantor trusts, it is not filed with the IRS. If the trust generates US source or effectively connected income, the trustee must file Form 1040-NR to report and pay the corresponding US tax liability.

US beneficiaries receiving distributions from foreign non-grantor trusts must file Form 3520 by the specified deadline. The Beneficiary Statement, if received, must be attached to Form 3520. Without the statement, beneficiaries must utilize the "default" method for calculating their US tax liability on the distribution, potentially resulting in higher taxes than the "actual" method available with the statement.

Beneficiaries are responsible for US taxes on current year trust income included in the distribution, and may face additional taxes ("throwback tax") on prior year income. Interest charges may also apply to the throwback tax.

Tax Implications of Funding Foreign Trust

If a US person transfers assets to a foreign non-grantor trust, it is possible that the transfer will be treated as a sale or exchange of the transferred property. In such cases, the US transferor is required to recognize any gain and fulfill their US tax obligations on the transfer of appreciated assets to the foreign trust. However, these gain recognition rules do not apply if the transfer is made to a trust where the US transferor is considered the grantor (i.e., a foreign grantor trust with a US owner).

U.S. reporting & disclosure requirements arising from foreign trust arrangements

Before delving into forms, establishing a solid foundation is crucial. Here's what you need to do:

1. Appoint a U.S. Agent: While not mandatory, a U.S. Agent acts as your offshore trust's designated representative with the IRS, simplifying communication and potentially protecting some privacy.

2. Obtain a U.S. Tax Identification Number (TIN): Even if your trust isn't subject to U.S. taxation, it needs a TIN for identification purposes.

3. File a Gift Tax Return (if applicable): If funding your trust is considered a taxable gift under U.S. law, you'll need to file IRS Form 709.

Establishing offshore trust may entail extensive U.S. reporting and disclosure requirements, if:

The trust has a foreign financial account.
The trust owns non-U.S. entities.
The trust assets include non-U.S. entities or financial accounts exceeding $50,000.
The trust invests in a U.S. business or offshore corporation operating in the U.S.
The transfer assets to foreign corporations or partnerships held by your offshore trust.

Pay close attention to the following forms:

1. IRS Form 3520-A (by March 31st): This trust-filed form details its assets, investments, income, and distributions. It's not electronically fillable, so mail it in on time!

2. IRS Form 3520 (with the tax return): Each grantor and beneficiary files this form, reporting income and distributions received from the trust during the year.

3. FINCEN Form 114 (FBAR) (April 15th, extendable to October 15th): This form is mandatory if your trust holds any foreign financial accounts with a balance of $10,000 or more.

These additional forms come into play depending on your specific trust setup:

Form 5471: If the trust owns non-U.S. entities treated as corporations for tax purposes.
Form 8858: If the trust owns non-U.S. entities treated as disregarded entities for tax purposes.
Form 8938: If the trust holds assets worth at least $50,000, including non-U.S. entities or financial accounts.
Form 5472: If the offshore trust invests in a U.S. business or an offshore corporation doing business in the U.S.(investment ≥ 25% of the business).
Form 926: If you transfer assets to a foreign corporation held by your offshore trust.
Form 8865: If you transfer assets to a foreign partnership held by your offshore trust.

Deadlines can vary, but most forms are due by April 15th of the following year. Remember the crucial March 31st deadline for Form 3520-A. Failing to comply with IRS reporting requirements can lead to hefty penalties, potentially reaching 50% of the account balance for willful violations. Don't let this deter you; seek professional guidance to ensure accurate and timely reporting.

Reporting cryptocurrency held in offshore trusts remains a dynamic landscape. While FBAR currently doesn't require it, keep your eyes peeled for potential rule changes. Similarly, Form 8938's application to foreign exchange-held cryptocurrency is unclear. Consulting a tax professional is crucial in this evolving space.