Does the use of trusts allow clients to efficiently protect investments made abroad against adverse actions of foreign states? While the trust concept existed in common law jurisdictions for many centuries,1 if asked a decade ago, this question most probably wouldn’t have attracted significant practical interest. Although by that time, trusts were already routinely used in a wide variety of international commercial and investment transactions, such use was overshadowed by their traditional perception as a device for organizing intergenerational wealth transfer as well as an asset protection tool2 or, in the case of offshore trusts, as a device for obtaining confidentiality and tax advantages or, even, tax evasion.3
The utility of trusts as vehicles for making foreign investments started to gradually come out of these shadows in the beginning of the 2010s with the introduction of the global Standard for Automatic Exchange of Financial Account Information in Tax Matters—the Common Reporting Standard.4 Even though the exact scope of application of this standard to different types of trusts may still be open to a certain debate, on its face, it was broad enough to make residents of jurisdictions participating in automatic exchange of information seriously consider possible consequences of discovery of their undeclared foreign trusts by national tax authorities.5 Unsurprisingly, certain users of foreign trusts, who were previously paying significant amounts of money for their creation and maintenance, had to ask themselves whether these expenses were still justified, as the objective of getting tax advantages was becoming increasingly difficult to achieve. Once this question was asked, the search for a possible answer could have led them to consider using their existing trusts for other purposes, notably, as investment vehicles, or promptly liquidating them before being caught by the Taxman.
BEPS Project
An additional factor strengthening the perception of trusts as useful vehicles for making investments abroad was the launch of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project,6 resulting in the introduction of the “substantial activity” requirements7 and their extension to the so-called “no or only nominal tax jurisdictions.”8 Following these international developments, a number of such jurisdictions, notably, British Virgin Islands9 and Cayman Islands,10 amended their domestic legislation by introducing substance requirements. The most typical of them included the need to hire an adequate number of suitably qualified employees physically present in this location, to have adequate expenditures incurred in this jurisdiction, as well as physical offices or premises as may be appropriate for the core income-generating activities.11 Thus, from the perspective of entrepreneurs willing to continue their global operations out of these jurisdictions for reasons other than minimization of taxation, the introduction of the substance requirements inevitably resulted in increased operational costs. At the same time, as the substance requirements were applicable to corporate entities, but not to trusts,12 those unwilling to bear these costs could have considered restructuring their cross-border commercial and investment activities through trusts. As a result, the introduction of the substance requirements, rapidly becoming a global trend, combined with the comprehensible desire of business to mitigate increasing operational costs, may have inadvertently pushed entrepreneurs choosing an appropriate vehicle for structuring their foreign investments to turn to trusts.
Blue Bank v. Venezuela
While on the business side, the popularity of trusts as vehicles for making investments abroad is growing, and this trend is likely to continue, on the legal side, it’s hampered by the existing shortcomings of their protection under bilateral and multilateral international investment treaties.13 These shortcomings were clearly revealed by the decision rendered in 2017 by the arbitral tribunal operating under the auspices of the International Centre for Settlement of Investment Disputes (ICSID)14 in Blue Bank International & Trust (Barbados) Ltd. v. Bolivarian Republic of Venezuela,15 which became one of the first ICSID rulings expressly dealing with the status of trusts and their participants under investment treaties. In this decision, the arbitral tribunal ruled that the claimant, a Barbados company, acting in its capacity as trustee of the “Qatar Trust,” a trust set up under the laws of Barbados, couldn’t bring a claim under the bilateral investment treaty between Barbados and Venezuela. Unlike common law judgments, arbitral awards don’t have value of a binding precedent but will still certainly be carefully considered by tribunals subsequently addressing similar issues.16 Thus, in view of the ruling in Blue Bank, before using a trust for making investments abroad, a prospective settlor should carefully review the availability of protection to the trust as well as to its participants under applicable international investment treaties.
Shortcomings for Trusts
A major obstacle potentially hampering the widespread use of trusts as vehicles for foreign investments is that very few international investment agreements expressly include them in their definitions of “company” (“enterprise”), one of two categories of protected “investors” (another one is “natural persons”). A typical example of this definition may be found in U.S. bilateral investment treaties (BIT), based on the 1994, the 2004 or the 2012 U.S. Model BIT,17 notably in the 2007 United States-Azerbaijan BIT. That BIT provides that “company” means any entity constituted or organized under applicable law, whether or not for profit, and whether privately or governmentally owned or controlled, and includes a corporation, trust, partnership, sole proprietorship, branch, joint venture, association or other organization.18 A similar approach is used in certain BITs concluded by Canada,19 Hong Kong Special Administrative Region,20 Kazakhstan21 and Switzerland,22 as well as in the definition of “enterprise” in the 2018 United States-Mexico-Canada Agreement.23
Despite the absence of an express reference to trusts in a certain investment agreement, a trust can still be considered an “investor” within the meaning of this agreement, provided it fits under one of the broader categories listed in its definition. For example, the definition of “investor” in the Energy Charter Treaty (ECT) includes “a company or other organization organized in accordance with the law applicable in that Contracting Party.”24 Viewed from the outside, the lasting relations among settlor, trustee, beneficiary and protector may create an impression of the existence of a certain organizational structure.25 Thus, one can argue that trusts could be considered “organizations” and, consequently, “investors” within the meaning of the ECT. However, in view of the absence of arbitral awards (let alone the binding precedents) on this subject, a potential settlor making large-scale investments into the energy sector through an English trust can’t be certain that in the event of a future dispute, his trust would be covered by the scope of this Treaty. This lack of certainty is likely to prevent investors from relying on trusts under the treaties that don’t expressly refer to them.
Another major obstacle that could potentially hamper the use of trusts as investment vehicles is the requirement that claimants other than natural persons willing to bring an investment treaty claim under the auspices of the ICSID shall be “juridical persons.”26 Unlike the so-called statutory trusts, such as Delaware statutory trusts, common law trusts aren’t juridical persons.27 Thus, even though certain investment treaties may expressly include trusts into the definition of “investor” and allow them to bring their claims against host states to the ICSID, this requirement would prevent common law trusts from benefiting from the well-developed institutional framework of the ICSID arbitration. Instead, to protect their rights as investors, these trusts would have to pursue their claims through other types of arbitration, such as under the auspices of the Arbitration Institute of the Stockholm Chamber of Commerce or in accordance with the Arbitration Rules of the United Nations Commission on International Trade Law. Although these other possible types of arbitration aren’t necessarily better or worse than ICSID arbitration, this limitation certainly results in a significant restriction of common law trust’s procedural choices.
Shortcomings for Trust’s Participants
When a certain trust can’t directly bring its investment treaty claim, it may be safely assumed that each of the trust’s participants, namely the settlor, trustee, beneficiaries and, if appointed, protector, would seriously consider the possibility of bringing their individual claims against the host state. Because the trust assets are held in the name of its trustee, the trustee would naturally be the most likely candidate for the role of a prospective claimant with respect to these assets. Despite these reasonable expectations, in Blue Bank, the arbitral tribunal reached an opposite conclusion. Having analyzed the relevant provisions of the Barbados International Trusts Act (the Act), it noted that this Act was carefully drafted so as not to describe the legal relationship created between the trustee and the trust assets in terms of “ownership,” “legal title” or the like. Instead, the Act referred to the trust assets as a separate fund, not parts of the trustee’s “own estate” and provided that title to the trust assets was held “in the name of the trustee,” not that the assets were “owned” by the trustee.28 The tribunal concluded that by acting in its capacity as trustee, Blue Bank couldn’t be considered as having committed any assets in its own right, as having incurred any risk or as sharing the loss or profit resulting from the investment.29 In the end, on the basis of its analysis of the trust deed, it also pointed out that the party that would come closest to satisfying the requirements of “ownership” with regards to the assets of the Qatar Trust was a beneficiary of this trust.30
Because the tribunal reached its conclusions in relation to specific circumstances of a particular case, this decision by itself shouldn’t preclude trustees from acting as claimants with respect to trust assets under different factual circumstances. After all, the separation of legal title and beneficial ownership rights with respect to certain assets shouldn’t exclude the holder of a bare legal title (such as a trustee) from the protection under investment treaties.31 That’s why, while on its face the award in Blue Bank may appear to have far-reaching negative consequences for the investment protection available to trustees, its practical impact would be much more limited. Nevertheless, this decision still clearly reveals the major shortcoming of investment protection currently available to trust participants—the impossibility to accurately predict whether trust assets would be qualified as an “investment” made by this participant before the conditions of a particular trust are analyzed on the basis of a substance-over-form approach by an arbitral tribunal in the event of a dispute.
The application of this approach to the trust’s beneficiaries leads to the conclusion that their ability to bring an investment treaty claim would essentially depend on the scope of their rights with respect to the trust’s assets under a trust deed and the law applicable to this trust. From this perspective, a beneficiary of a fixed-term trust would have an easier task of justifying its status as a claimant than a member of a certain class of beneficiaries of a discretionary trust, whose rights haven’t yet been vested. On the other hand, as a protector doesn’t typically hold any legal title with respect to the trust’s assets, the recognition of these assets as his “investment” within the meaning of the applicable investment treaty would be highly unlikely, unless he also acts as settlor and/or beneficiary of a particular trust.
Applying the same approach to the settlor, one can conclude that his ability to bring an investment treaty claim against the host state for its actions adversely affecting the trust’s assets essentially depends on the scope of the settlor’s rights with respect to these assets. At one end of the broad spectrum of possible solutions, a settlor of an irrevocable trust without reserved powers couldn’t be considered as retaining control with respect to the trust’s assets and, therefore, wouldn’t be able to justify its status of claimant. At the opposite end of this spectrum, a settlor of a revocable trust retaining significant reserved powers and appointing himself as protector of this trust, with extensive powers over the trustee’s decisions concerning investment of the trust’s assets, could have an easier task in convincing an arbitral tribunal that these assets should be considered as his “investment” within the meaning of the applicable investment treaty. An obvious downside of this solution is the settlor’s risk that such trust would be recognized as a controlled foreign company (in case this concept exists in the legislation of the country of his tax residence) or, worse, considered a sham trust.
This impossibility to clearly determine the status of the trust’s assets as investments before the dispute arises certainly creates vast opportunities for lawyers to demonstrate to the arbitral tribunal their analytical skills and abilities of persuasion. However, for a prospective investor, understandably interested in stability and predictability, this situation would be clearly unsatisfactory. Thus, it may be expected that the quest for investment protection would lead to significant changes in the trust industry as well as changes in international trust law.
A Look Into the Future
A major change in the trust industry that may be already predicted is the increasing offering of trusts as vehicles for foreign investments by wealth management professionals operating in jurisdictions that expressly include trusts in the definition of “investor” in investment treaties. The United States is among the jurisdictions that have an extensive network of bilateral and multilateral investment treaties,32 many of which specifically refer to trusts. That’s why one may expect that U.S. wealth management professionals could clearly be among the possible winners in the short term.
One may also expect that more and more wealth management professionals operating in other trust jurisdictions attracted by these new opportunities would rapidly enter into the international race for new clients and their trust assets. To make their jurisdictions attractive for settlors using trusts for making investments abroad, national authorities may be tempted to enter into new bilateral investment treaties expressly referring to trusts or amend their existing treaties. Nevertheless, because the negotiation of an international agreement could require significant time, as a first step, the national authorities could already proceed with modification of their domestic trust legislation.
The first possible change could be the introduction into domestic legislation of statutory trusts, which would have the status of juridical persons and, consequently, would be considered “investors” under the treaties including organizations or juridical persons in their definition of this term. This change would contribute to further differentiation between the legal status of common law trusts primarily used for asset protection and estate planning and statutory trusts predominantly used for investment and commercial activities. The second possible change could be the amendment of domestic legislation with a view of clear denomination of the trustee’s title to the trust’s assets as legal ownership. This modification would address one of the reasons for denial of the claimant’s status as trustee in Blue Bank, namely the absence of such reference in domestic trust law. Thus, one may expect that the quest for investment protection would secure the place of trusts as vehicles for foreign investments for years to come and give this centuries-old legal concept a new lease on life.
Endnotes
1. See, e.g., George T. Bogert, Trusts, 5-8 (6th ed. 1987); A.J. Oakley, Parker and Mellows: The Modern Law of Trusts, 1-6 (9th ed. 2008).
2. See, e.g., John H. Langbein, “The Secret Life of Trusts: The Trust as an Instrument of Commerce,” 107 Yale L.J. 165 (1997-1998); Steven L. Schwarcz, “Commercial Trusts as Business Organizations: Unraveling the Mystery,” 58 Bus. Law. 560-561 (2003).
3. See, e.g., Schmidt v. Rosewood Trust Ltd. (Isle of Man) [2003] UKPC 26 (par. 1), www.bailii.org/uk/cases/UKPS/2003/26.html; Stewart E. Sterk, “Asset Protection Trusts: Trust Law’s Race to the Bottom,” 85 Cornell L. Rev. 1035, 1048 (2000).
4. Organisation for Economic Co-operation and Development (OECD) (2017), Standard for Automatic Exchange of Financial Account Information in Tax Matters, Second Edition, OECD Publishing, Paris, at p. 3, http://dx.doi.org/10.1787/9789264267992-en.
5. OECD (2018), Standard for Automatic Exchange of Financial Information in Tax Matters—Implementation Handbook, Second Edition, OECD, Paris, Chapter 6 (Treatment of trusts in the CRS) (paras. 234-295), http://www.oecd.org/tax/exchange-of-tax-information/implementation-handbook-standard-for-automatic-exchange-of-financial-acccount-information-in-tax-matters.htm.
6. OECD (2013), Addressing Base Erosion and Profit Shifting, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264192744-en.
7. OECD (2013), Action Plan on Base Erosion and Profit Shifting, OECD Publishing, Paris, http://dx.doi.org/10.1787/97892642020719-en.
8. OECD (2018), “Resumption of application of substantial activities for no or nominal tax jurisdictions—BEPS Action 5,” OECD, Paris, at p. 11 (par. 21), www.oecd.org/tax/beps/resumption-of-application-of-substantial-activities-factor.pdf.
9. The Economic Substance (Companies and Limited Partnership) Act, 2018 (British Virgin Islands), https://eservices.gov.vg/gazette/sites/eservices.gov.vg.gazette/files/newattachments/Act%20No%2012%20--%20Economic%20Substance%20%28Companies%20and%20Limited%20Partnerships%29%20Act%202018-%20Revised%2017%2012%202018%20%28clean%29%20%281%29_0.pdf.
10. The International Tax Co-operation (Economic Substance) Law, 2018 (Law 45 of 2018) (Cayman Islands), www.gov.ky/portal/pls/portal/docs/1/12738510.PDF.
11. Supra note 9, art. 8(1)(b) (BVI).
12. Ibid., art. 2 (legal entity) (BVI); supra note 10, Schedule 1 (relevant entity).
13. Generally speaking, these treaties offer protection to the investments made by investors from one contracting jurisdiction in the other contracting jurisdiction by prescribing certain substantive standards of treatment of these investments by the host states. They also specify procedural methods for resolving international investment disputes through various types of arbitration.
14. The International Centre for Settlement of Investment Disputes (ICSID) was established in 1966 by the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the ICSID Convention), https://icsid.worldbank.org/en/Pages/about/default.aspx.
15. Blue Bank International & Trust (Barbados) Ltd. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/12/20, Award (April 26, 2017), www.italaw.com/sites/default/files/case-documents/italaw8768.pdf.
16. Bayindir Insaat Turizm Ticaret Ve Sanayi A.S. v. Islamic Republic of Pakistan, ICSID Case No. ARB/03/29, Decision on Jurisdiction (Nov. 14, 2005), par. 76, www.italaw.com/sites/default/files/case-documents/ita0074.pdf.
17. See 1994 U.S. Model Bilateral Investment Treaty, art. 1(a), available in Kenneth J. Vandevelde, U.S. International Investment Agreements, at pp. 817-824 (2009); 2004 U.S. Model Bilateral Investment Treaty, art. 1, Vandevelde, at pp. 825-852; 2012 U.S. Model Bilateral Investment Treaty, art. 1, https://investmentpolicy.unctad.org/international-investment-agreements/
treaty-files/2870/download.
18. Treaty between the Government of the United States of America and the Government of the Republic of Azerbaijan Concerning the Encouragement and Reciprocal Protection of Investments (Aug. 1, 1997), art. I(a), https://2001-2009.state.gov/documents/organization/43478.pdf.
19. Agreement between the Government of Canada and the Government of the Union of Soviet Socialist Republics for the Promotion and Reciprocal Protection of Investments (Nov. 20, 1989), art. I(d)(ii), www.treaty-accord.gc.ca/text-texte.aspx?id=101516 (applicable to the Russian Federation).
20. Agreement between the Government of Hong Kong and the Government of Australia for the Promotion and Protection of Investments (Sept. 15, 1993), art. I(b)(i), www.tid.gov.hk/english/ita/ippa/files/01.IPPAAustraliae.PDF.
21. Agreement between Japan and the Republic of Kazakhstan for the Promotion and Protection of Investment (Oct. 23, 2014), art. 1(3), https://investmentpolicy.unctad.org/international-investment-agreements/treaty-files/3283/download.
22. Agreement between the Swiss Confederation and the United Mexican States on Promotion and the Reciprocal Protection of Investments (July 10, 1995), art. 1(1), www.admin.ch/opc/fr/classified-compilation/20112855/199603140000/0.975.256.3.pdf.
23. Agreement between the United States of America, the United Mexican States and Canada (Dec. 12, 2019), art. 1.5, https://ustr.gov/trade-agreements/free-trade-agreements/united-states-mexico-canada-agreement/agreement-between.
24. Energy Charter Treaty, art. 1(7)(a)(ii), www.energycharter.org/fileadmin/DocumentsMedia/Legal/ECTC-en.pdf.
25. Article 11(2) of the Russian Tax Code lists trusts among foreign structures without legal personality.
26. ISCID Convention, art. 25(2).
27. National Conference of Commissioners of Uniform State Laws: Uniform Statutory Trust Entity Act 1 (2009).
28. Blue Bank, supra note 15, par. 169 (referring to the Barbados International Trusts Act, par. 3(2)).
29. Ibid., par. 163.
30. Ibid., par. 170.
31. See, e.g., Saba Fakes v. Republic of Turkey, ICSID Case No. ARB/07/20, Award (July 14, 2010), par. 134, www.italaw.com/sites/default/files/case-documents/ita0314.pdf.
32. As of Feb. 6, 2020, there were 39 bilateral investment treaties in force for the United States, https://investmentpolicy.unctad.org/international-investment-agreements/countries/223/united-states-of-america?type=bits.