Americans Connected with Offshore Foundations  

Americans Connected with Offshore Foundations

Foreign entities have their advantages and can be very beneficial if structured and deployed thoughtfully.  If not, be prepared for problems.  Especially if you’re not compliant with all relevant US laws.

Among the various options for foreign entities, launching a foreign foundation company is a complex undertaking that requires consideration of legal issues that potentially subject the foundation to government scrutiny by regulatory agencies such as –

The foundations are entities that are technically not owned by anyone, and are separate legal persons in law.   Generally, foundations are founded by a founder, controlled by a foundation council, and may have beneficiaries.  In civil law countries foundations are often used in place of trusts because generally speaking, many civil law countries have challenges understanding trusts.  Various foreign jurisdictions of course have their own complexities. The 2017 Cayman Islands Foundation Companies Law (Foundation Law) for example, introduced a corporate vehicle that plays dual roles: the foundation can exist as a separate legal personality and limited liability company, or it can function like a trust.

Let’s take a deeper dive into this?

What is it?

Under certain circumstances, the Foreign foundation should be reported as a trust and under other circumstances, it may be reported as a foreign company.  It depends on the fact pattern

Cayman Foundation Law is said to “exclude[] the creation of any inadvertent common law trust rights and limits the beneficiary’s rights to those expressly stated by the foundation company,” yet this is not what is actually occurring in practice.

If a United States person sets up an offshore foundation that is deemed to be operating as an incorporated trust, then the foreign trust is subject to U.S. tax filing requirements.

These requirements include either Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Foreign Gifts and/or Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner.

Additionally, U.S. taxpayers with an ownership interest in a foreign corporation may be required to file a Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.

Establishing an offshore foundation may shift ownership into the hands of another legal entity and away from the actual beneficial owner.

The Foundation Law actually requires both a secretary (a person licensed to provide company management services in the Cayman Islands) and a supervisor (a person, other than a member, who has a right to attend and vote at general meetings).

Lack of Transparency and Concealment of Beneficial Ownership:

Foundation companies are often not required to report beneficial ownership, allowing for the potential to evade other legal requirements.

Further, taxpayers with offshore financial accounts often transfer funds from their offshore accounts through the use of prepaid debit cards issued by offshore banks.

The IRS has gone after tax evasion in Swiss and other offshore accounts, and has collected a staggering $10 billion. Then, the IRS turned to virtual currencies like Bitcoin, after a court allowed an IRS John Doe summons for bitcoin and other virtual currencies. Now, the IRS is going after some debit card use, too.

How does the IRS get on to you, you might wonder? If the IRS knows who you are, it can audit or investigate you. But increasingly, one important technique is the John Doe Summons. In 2008, the lid came off the hushed world of Swiss banking when a judge allowed the IRS to issue a John Doe summons to UBS for information on U.S. taxpayers using Swiss accounts. Now, the IRS has turned to certain debit cards.

For example, Sovereign Management & Legal LTD (SML) offered ATM/debit cards called “Sovereign Gold Cards” and engaged in the formation of anonymous foundations in offshore locations such as Panama (See Forbes magazine – https://www.forbes.com/sites/robertwood/2017/01/25/irs-hunts-debit-cards-for-tax-evasion-as-court-approves-john-doe-summons/?sh=3d94aec0738b). The structure of these offshore foundations offers anonymous corporations with an account “plus nominee director and shareholder service for complete anonymity.”

In the case of Privatbank IHAG Zürich AG (IHAG), the bank assisted clients in establishing foundations used to hold their assets at IHAG.

The beneficial owners of the foundation accounts were properly identified as beneficial owners of the foundations on certain forms pursuant to Swiss laws; however, on IRS Forms W-8BEN, the foundations were identified as the beneficial owner indicating intentional concealment of true beneficial ownership.

For example, in 2006, an account held in the name of a Panama company was opened. In connection with the opening of the account, bank documents identified a U.S. person as the beneficial owner of the assets.

However, a Form W-8BEN signed by two Swiss citizens and a citizen of Liechtenstein falsely declared that the Panama company was the beneficial owner. The U.S. person instructed IHAG not to communicate with him by phone and insisted on using code names when communicating with IHAG.

Ultimately, the DOJ deemed the acts of IHAG to constitute criminal activity subject to federal penalties.

Similarly, in United States v. Hough, 803 F.3d 1181, 1183 (11th Cir. 2015), the defendant and coconspirator owned two medical schools generating millions of dollars in the Caribbean.

Instead of reporting the income, the couple established entities (including a foundation) to hide it in multiple offshore accounts.   The court supported the defendant’s convictions for attempting to defraud the IRS because she failed to disclose her financial interest in foreign bank accounts.

Are you US exposed and involved in foreign foundations?  Get advice.

Key Points

  1. Foundations are commonly utilized as “will substitutes” by many wealthy foreign families from civil law jurisdictions to own, manage and distribute both business and passive investment assets over multiple generations.
  2. Foundations may provide results similar to the use of “common law” trusts where trusts are otherwise not recognized, although some jurisdictions now do so, at least for certain purposes (e.g., Switzerland and the Netherlands).
  3.  In general, the IRS may treat an entity as a “trust” if “it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share  in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.” See Treas. Reg. §301.7701-4(a). 
  4. In Oak Commercial Corp., 9 T.C. 947 (1947), aff’d sub nom, Aramo-Stiftung v. Commissioner, 49-1 USTC ¶9205 (2d Cir.), the IRS treated a Stiftung which held cash, stock and securities as a corporation. The Commissioner had asserted that the Stiftung was a personal holding company, but the petitioner did not contest such determination in its brief.  
  5. In Estate of Swan, 24 T.C. 829 (1955), rev’d. on other grounds, 57-2 USTC ¶11,714 (2d Cir.), the petitioner argued that the U.S. assets of the Stiftungs were not includible in the decedent’s gross estate on the theory that the Stiftungs should be considered as foreign corporations, and that the transfers of cash on deposit in the U.S. and securities of U.S. corporations to the Stiftungs was for valuable consideration. The Tax Court focused upon the nature of the Stiftungs and concluded that they were in the nature of revocable trusts, and that the assets transferred to them were includible in the decedent’s gross estate. 
  6. An Anstalt is a hybrid between a company limited by shares and a foundationIn Rev. Rul. 79-116, 1979-1 C.B. 213, which involved a Liechtenstein Anstalt which held the stock of a foreign corporation, the IRS concluded that the Anstalt was classified as a grantor trust without actually analyzing the characteristics of the Anstalt. 
  7. See IRS Advance Memorandum 2009-012 (Chief Counsel Advice), issued by the IRS Associate Chief Counsel (Passthroughs & Special Industries):
  8. The attributes of a Liechtenstein Anstalt are generally the following: 
    1. 1. Usually formed by a Liechtenstein attorney or trust company (the “Founder”) to protect the anonymity of its actual owner or beneficiary. 
    2. 2. “Founder’s rights” provide unlimited control and powers of administration, including the power to dismiss directors, distribute profits, or liquidate the Anstalt.
    3. 3. Managed by a Board of Directors appointed by the Founder. The Board has power with respect to all matters that are not specifically reserved to the Founder, but the Board must observe all limitations on its authority contained in the Articles and in instructions issued by the Founder.
    4. 4. The beneficiaries are the persons entitled to receive the profits and/or liquidation proceeds of the Anstalt. The right to appoint beneficiaries is usually set forth in the articles and may be reserved to the Founder or granted to the Board or to third persons. If no beneficiaries are appointed, the Founder or his successors are presumed to be the beneficiaries.  May hold intellectual property and interests in other companies and conduct any type of business except banking. 
    5. 6. If the articles permit the Anstalt to engage in commercial or industrial activities or a trade, the Anstalt is required to keep proper books and records as well as prepare annual financial statements. 
    6. 7. The liability of an Anstalt is limited to the extent of its assets, and no personal liability extends to the Founder, the Anstalt’s Board, or the beneficiaries.  
    7. 8. In most situations the primary purpose for the establishment of an Anstalt is to conduct an active trade or business, and to distribute the income and profits therefrom to the beneficiaries.  
    8. 9. The beneficiaries are usually the previous owners of the business assets contributed to the Anstalt, and in most situations, the Founder acts as a nominee or agent of the beneficiaries in conducting the active trade or business of the Anstalt.
  9. The Chief Counsel’s Office concluded that Liechtenstein Anstalts generally are not properly treated as trusts under Reg. §301.7701-4(a) because, in most situations, their primary purpose is to actively carry on business activities. Therefore, the Chief Counsel’s Office advised that, in most cases, Liechtenstein Anstalts are properly classified as business entities under Treas. Reg. § 301.7701-2(a).
  10. On the other hand, if the facts and circumstances indicate in a particular case that an Anstalt was created for the primary purpose of protecting or conserving the property of the Anstalt on behalf of beneficiaries, the Anstalt in such a case may be properly classified as a trust under Treas. Reg. §301.7701-4. In such a case, it will be necessary to confirm that all of the elements of a trust are present: (1) a grantor, (2) a trustee that has legal title and a legal duty to protect and conserve the assets for the designated beneficiaries, (3) assets, and (4) designated beneficiaries.
  11. As a bottom-line, under current law, many practitioners believe that an Anstalt potentially could successfully claim status either as a trust or corporation for U.S. tax purposes.
  12. If corporation status is desired, consider memorializing it through filing Form 8832. 
  13. A Stiftung is characterised by having a permanent object (Zweck) and a need to have endowment property (Stiftungsvermögen). It can be established both as legal entity and as a sheltered foundation (Treuhandstiftung).  Per IRS Advance Memorandum 2009-012 (Chief Counsel Advice), the attributes of a Liechtenstein Stiftung are generally the following: 
    1. 1. A legal entity under Liechtenstein law, formed by filing a foundation charter or by will or testamentary disposition. 
    2. 2. A Stiftung may be a family foundation that provides benefits to members of a designated family, or a charitable or religious foundation. 
    3. 3. No members or board of directors—instead, managed by administrators who are responsible for the proper management and conservation of the Stiftung’s assets, including the investment and management of its assets and the distribution of income and/or capital to the beneficiaries. The Founder states the objectives of the Stiftung and appoints its administrators. The Founder may appoint himself as an administrator and may reserve the right to discharge and appoint administrators. 
    4. 4. The Founder transfers specific assets to the Stiftung that are then endowed for specific purposes. 
    5. 5. Unlike an Anstalt, a Stiftung cannot be organized to engage in the active conduct of a business, but in certain cases a Stiftung may conduct commercial activities if such activities serve its noncommercial purposes. 
    6. 6. Legal liability only up to the amount of its contributed capital and net assets. In contrast to Anstalts, the Chief Counsel’s Office concluded that Liechtenstein Stiftungs generally are properly treated as trusts under Reg. §301.7701-4(a) because, in most situations, their primary purpose is to protect or conserve the property transferred to the Stiftung for the Stiftung’s beneficiaries and is usually not established primarily for actively carrying on business activities.
  14. On the other hand, if the facts and circumstances indicate in a particular case that a Stiftung was established primarily for commercial purposes as opposed to the purpose of protecting or conserving property on behalf of the beneficiaries, it should instead be properly classified as a business entity under Treas. Reg. § 301.7701-2(a).
  15. As a bottom-line, under current law, many practitioners believe that a Stiftung potentially could successfully claim status either as a trust or corporation (the latter through filing Form 8832) for U.S. tax purposes. 
  16. If trust status is desired for a Stiftung, consider memorializing it through U.S. tax filings other than the inapplicable Form 8832 (e.g., Form 3520). 
  17. Stiftung=Trust? Rost v. United States, 44 F.4th 294 (5th Cir. 2022).  In 2005, the taxpayer, a US citizen, formed a Liechtenstein stiftung (“Stiftung”).  He transferred large sums of cash to the Stiftung’s UBS and other Swiss bank accounts in 2005 and 2007, but failed to then report either the Stiftung’s creation or the subsequent transfers.  In 2010, UBS notified the taxpayer that it intended to turn over his bank records to the IRS. He then consulted with counsel for the Stiftung, who advised him of this associated U.S. tax and compliance obligations, suggested the OVDP, and that he had unable to find a way to not treat the Stiftung as a trust. In 2013, the taxpayer’s attorney-in-fact filed late Forms 3520 and 3520-A on his behalf.  In 2014, the IRS assessed $1,380,252 in related penalties for the late filings of Form 3520 and Form 3520-A. After a CDP hearing, the IRS Appeals Office reduced the penalties by 50%. The taxpayer paid them, and then sought a refund based in part upon the Stiftung not being properly classified a “trust” subject to reporting on those forms.   After the taxpayer’s death, his executor became the plaintiff and then the appellant after the district court held for the government.  The court determined that: (1) the Stiftung should be treated as a trust rather than a business entity under the facts and circumstances test of Morrissey v. Commissioner, 296 U.S. 344 (1935); and (2) as a “foreign trust” under the applicable U.S. tax law “court” and “control” tests found in Treas. Reg. §§ 301-7701-7(c) and (d). 
  18.  In applying the facts-and-circumstances test, the Fifth Circuit looked specifically to the Stiftung’s organizing documents and found the Stiftung had numerous characteristics of a trust, including:
    1. The Stiftung had been organized for the specific purpose of supporting its beneficiaries
    2. The Stiftung’s organizational documents specifically prohibited it from conducting commercial trade. 
    3. 3. The Board members acted as independent trustees.
    4. 4. The entity had beneficiaries who were the taxpayer’s family members, but they were neither involved with nor had any knowledge of the Stiftung.
    5. 5. There was no sharing of Stiftung profits.
  19. Foundation Document Drafting Issues From a U.S. Tax Standpoint
    1.  Most importantly, a U.S. tax practitioner should review the foundation documents to ensure that they include the language needed for them to hopefully have the desired U.S. tax treatment and consult with local counsel regarding the potential effects of the applicable law.
    2. What if someone has the power to add or remove foundation beneficiaries, control or direct distributions, or change the governance of the entity?
    3. Does it matter whether such a power is ever actually exercised?
  20. BEFORE a U.S. person receives a distribution from the foundation or the death of the founder, whether the foundation should be treated as a foreign corporation, a foreign revocable trust, or a foreign irrevocable trust—and report it consistently thereafter for U.S. tax and compliance purposes.
  21. Reporting a Foundation as a Foreign Trust
    1. No “box” to check on IRS Form 8832 to treat an entity as a “trust”, so…
    2. Report foundation distributions on Form 3520 Part III as coming from a foreign trust. 
    3. U.S. income taxation will depend upon the nature of the trust—grantor, nongrantor, income or principal distribution, DNI or UNI, etc.
    4. Obtain a Foreign Grantor or Nongrantor Trust Beneficiary Statement signed on behalf of the foundation (and appoint a U.S. Agent) as appropriate.
    5. U.S. beneficiaries may have U.S. reporting obligations associated with the foundation’s underlying assets—e.g., the FBAR, Form 5471, Form 8621, etc.
  22. Reporting a Foundation With Uncertain U.S. Tax Treatment 
    1. If you’re not certain how to report the foreign foundation, but do not believe that it should be treated as a “trust,” consider filing a “protective” Form 3520 and/or 3520-A to report what may or may not be a “trust” with the intention of starting the running of the applicable statute of limitations and hopefully being able to demonstrate reasonable cause to avoid any otherwise applicable penalties. 
    2. Add “Protective Filing” to the top of the return and state that after providing and reviewing all of the relevant information regarding the foreign entity in question, the taxpayer has reasonably concluded that the form does not have to be filed but is doing so anyway “in an abundance of caution.” 
    3. Attach a statement detailing the available information that led to that conclusion and confirm that the taxpayer made diligent efforts to obtain other relevant information that the foreign entity would not provide (if any).
  23. Foundation Document Drafting Issues— Is It a Grantor Trust? 
    1. Under IRC § 672(f), when computing the income of a U.S. citizen or resident or a domestic corporation, in general, a domestic or foreign trust may be treated as a grantor trust only if either: 
    2. 1. The foreign person settlor may revoke the trust, either: (a) without the approval or consent of any other person, or (b) with the consent of a related or subordinate party who is subservient to the grantor; or (c) in the event of the grantor’s incapacity, by a guardian or other person with unrestricted authority to exercise such power on the grantor’s behalf; or 
    3. 2. The trust is irrevocable, and during the lifetime of the grantor, income or corpus is only distributable to the grantor or the grantor’s spouse. 
  24. Limited exceptions apply to distributions in discharge of the grantor or the grantor’s spouse’s legal obligation and certain IRC §677 grantor trusts in existence on September 19, 1995.
  25. Foundation/Grantor Trust—Possible Planning Opportunities
    1. As a grantor trust, with proper planning for the foundation and its asset holding structure, all of the underlying income earned thereby can be treated as that of the founder/settlor, thus avoiding any DNI or UNI-related issues for future U.S. person beneficiaries. 
    2. Consider appropriate CTBEs for eligible foreign entities, but don’t trigger USRPI gains or expose U.S. situs assets to U.S. estate tax if practically possible
    3. If the foundation is a “qualified domestic trust” for purposes of IRC § 645, the special election made thereunder may provide for additional U.S. income tax savings with regard to income not taxable to an NRA for an additional limited period following the death of the founder/settlor, even if the related trust income is later distributed to a U.S. person beneficiary.
    4. If left intact, the foundation may provide valuable wealth preservation and U.S. estate tax avoidance benefits for its beneficiaries, even if later redomiciled as a trust to a U.S. state with favorable creditor-protection laws.

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