Foreign Trusts, 2006

Foreign Trusts, 2006Statistics of Income Bulletin Fall 2009trust arrangements, as shown by these examples, isone reason trusts are increasing in popularity.A trust may be “foreign” or “domestic.” Undercurrent law, a trust is treated as foreign unless twoconditions both apply: 1) a court in the United Statesexercises primary supervision over the trust; and2) one or more persons in the United States haveauthority to control all substantial decisions of thetrust. The creation of a trust may result in U.S.income tax obligation on the grantor, the trust, and/orthe beneficiary. In general, domestic trusts are taxedas U.S. citizens or residents, whereas foreign trustsare taxed as nonresident aliens.Factors a grantor might consider in selectinga jurisdiction in which to create a trust include thepolitical and economic stability of a country, available banking and trust facilities, applicable trustlaws, and tax laws. For example, foreign trusts maybe created by U.S. persons seeking to take advantageof favorable treatment of property in certain jurisdictions.9 These countries generally have property,tax, and privacy laws favorable to foreign persons.For instance, they may seek to attract foreign investment by having no income tax or by offering lowincome tax rates. In addition, their courts may refuseto honor adverse judgements made in other jurisdictions. Also, it is not uncommon for certain jurisdictions to have bank or commercial secrecy laws thatprevent foreign governments from obtaining financial information about persons transacting businessin their countries.A trust may be a “grantor” or “nongrantor” trust(see Notes and References, Note 1). The grantormay also hold a reversionary interest in the trust,meaning that the grantor has a right to future enjoyment of trust property. The grantor is then treatedas the “owner” of the portion of the trust to whichhis or her power or interest applies.10 Generally,the grantor trust’s income and expenses attributableto the U.S. owner must be included on the owner’sU.S. income tax return. In addition, under “grantortrust rules,” foreign trusts to which U.S. persons havetransferred property are treated as grantor trusts ifthey have any U.S. beneficiaries.11A nongrantor trust is one in which the grantordoes not retain any control over the trust assets orincome, and the grantor is not treated as the owner bythe Internal Revenue Code. Generally, the incomefrom a nongrantor trust is taxed to the beneficiariesas it is distributed.Filing Characteristics of Forms 3520A Form 3520 must be filed by any U.S. person who:1) transferred money or other property to a foreigntrust after August 20, 1996; or 2) held a “qualifiedobligation” (note) from a foreign trust which wasissued after August 20, 1996; or 3) was a U.S. ownerof all or part of a foreign trust at any time during thetax year; or 4) received a distribution from a foreigntrust; or 5) received a loan from a foreign trust afterAugust 20, 1996; or 6) received certain gifts orinheritances from a foreign person after August 20,1996.12 Since a foreign trust may have more thanone U.S. owner and more than one U.S. beneficiary,multiple Forms 3520 may relate to one foreign trust(which, in turn, would file one Form 3520-A, if ithad a U.S. owner).More than 90 percent of U.S. persons filingForm 3520 were individuals (Figure B). Other filingentities included corporations, executors, partnerships, and domestic trusts. The majority of Forms3520 filed reported trust transactions or trust ownership, although 33 percent of Forms 3520 related togift or bequest transactions (Figure C).Figure BForms 3520, by Type of Filer, Tax Year 2006Type of filerTotalNumber ofreturns7,956Percentage uals7,17690.2Partnerships1441.8Trusts5276.69For a discussion of these issues, see Consolidated Application Note, Guidance In Applying the 1998 Report to Preferential Tax Regimes, Center for Tax Policy andAdministration, Organization for Economic Co-operation and Development (OECD), March 22, 2004; and Harmful Tax Competition, An Emerging Global Issue (1998),Organization for Economic Co-operation and Development (OECD).10 See the Explanation of Selected Terms section of this article for a definition of “owner” of a foreign trust.11 Grantor trust rules are contained in sections 671 through 679 of the Internal Revenue Code.12 Forms 3520 filed by U.S. persons receiving certain gifts or bequests generally do not represent transactions with related foreign trusts.231

Foreign Trusts, 2006Statistics of Income Bulletin Fall 2009Figure CForms 3520, by Type of Transaction, Tax Year2006Type of transaction [1]TotalNumber oftransactionsPercentage oftotal8,302100.05,20062.6Grantor trust3,37440.6Nongrantor trust1,24114.9Trust transactions, totalUnknown trustGift or bequest transactionsTransaction not specified5857.02,74833.13544.3[1] Taxpayers may use a particular Form 3520 to report both trust and gift orbequest transactions. Consequently, the sum of total trust transactions, gift orbequest transactions, and unspecified transactions is greater than the totalnumber of Forms 3520 filed, which was 7,956 for Tax Year 2006.NOTE: Detail may not add to total because of rounding.Gratuitous Transfers to Foreign TrustsReported on Form 3520Gratuitous transfers are transactions in whichproperty is transferred to a foreign trust for less thanfair market value or for no consideration in return.Gratuitous transfers are a common method for U.Spersons establishing new foreign trusts or addingassets to an extant trust to transfer control of propertyto the foreign trust. For 2006, 1,642 million ingratuitous transfers were reported by U.S. persons on752 Forms 3520.Table 1 presents the fair market value of transferred property, classified by the country in which theforeign trust was created. The total value of transferred property varied widely by country, rangingfrom a low of 0.2 million for trusts created inPanama to a high of nearly 236 million for trustscreated in Jersey. Aggregate transfers of over 100million were also reported to trusts created in theCook Islands, Liechtenstein, St. Christopher/Nevis,the Bahamas, and New Zealand.Figure D presents historical information aboutproperty gratuitously transferred to foreign trusts for1990 through 2006. During that time, the total value232of transferred property rose from 273 million peryear for Tax Year 1990 to a high of 2,190 millionper year for Tax Year 2002. For the period from1990 through 1998 and for 2006, the average transferper trust was approximately 2 million. For 2002,however, the average transfer per trust was approximately 5 million.In addition to gratuitous transfers, property maybe transferred by U.S. persons to a related foreigntrust in exchange for a “qualified” obligation (ornote) from the trust. For these cases, “arm’s length”relationships are established between the foreigntrusts and the persons holding the obligations.13For 2006, there were 8 such transfers, with the fairmarket value of the obligations totaling 5 million.These transfers are excluded from the data shown inFigure D and Table 1.Distributions from Nongrantor Foreign Truststo U.S. Persons Reported on Form 3520Distributions of 2,878 million from nongrantortrusts were reported on Forms 3520 for 2006, anincrease from the 311 million of nongrantor trustdistributions reported for 2002. (Distributions fromgrantor trusts reported on Form 3520-A will bediscussed in a later section of this article).14 Table2 presents the value of these distributions classifiedby selected country of the foreign trust. The largestamount of distributions, 1,956 million, was attributable to trusts located in Switzerland. Other countrieswith large aggregate distributions were Liechtenstein( 315 million), the United Kingdom and NorthernIreland ( 106 million), and Bermuda ( 104 million).In addition to, and separate from, these distributions, foreign trusts loaned approximately 531million to U.S. persons. A loan from a foreigntrust is treated as a distribution unless the obligation issued is a “qualified” obligation, i.e., an obligation that is reflective of an arm’s-length relationshipbetween the trust and taxpayer.There are special “throwback rules” that applyto distributions from foreign trusts. In general, theserules are designed to prevent the accumulation of13 In an “arm’s-length” relationship, the parties in the relationship are on equal footing, free and independent of each other, and without some special relationship to eachother. Hence, an agreement between two parties in an “arm’s-length” relationship reflects fair, realistic conditions and requirements. The Internal Revenue Regulationsrelating to “qualified” obligations of foreign trusts are intended to impose an “arm’s-length” relationship between the foreign trust and the person holding the obligation.Consequently, the interest rates and maturity of qualified obligations must reflect market conditions.14 This article shows separate distribution amounts for taxpayers filing Forms 3520 and Forms 3520-A. These separate statistics do not represent duplicate amounts ofdistributions from the same transactions. Instructions for the 2006 Form 3520 specify that distributions properly reported by a foreign grantor trust on Form 3520-A need not beseparately disclosed again on Form 3520 by a beneficiary. In addition, the distribution amount presented for Form 3520 filers is for nongrantor trusts only.

Foreign Trusts, 2006Statistics of Income Bulletin Fall 2009Figure DForms 3520 With Gratuitous Transfers: Number and Total and Average Transfer Values,Selected Tax Years, 1990-2006[Money amounts are in thousands of dollars]Tax yearNumber of returns withtransfers(1)Transfer value 0067521,641,9812,183[1] Fair market value. Amounts are in current dollars.income by a trust during the trust’s high-incomeyears for distribution to beneficiaries during thetrust’s low-income years in order to minimize beneficiaries’ tax liability by taking advantage of the structure of the marginal tax rates. If distributions froma foreign trust exceed a certain amount for a taxyear—generally, the “distributable net income”of thetrust in that year—the excess is considered to be an“accumulation distribution.”The throwback rules are designed to taxbeneficiaries on accumulation distributions ata rate equal to the rate that would have been ineffect had the income been distributed in the yearit was earned by the trust.15 This tax is computedon Form 4970, Tax on Accumulation Distribution of Trusts. An interest charge is also imposedon the tax calculated on accumulation distributions, based on the length of time the tax has beendeferred. For 2006, approximately 105 millionwere treated as accumulation distributions, and thetax attributable to such accumulation distributions(including interest) was 9 million.Gifts or Bequests From Foreign PersonsReported on Form 3520U.S. taxpayers were also required to file Form 3520if they received either: 1) more than 100,000 from anonresident alien individual or foreign estate that wastreated as a gift or bequest, or 2) more than 12,760that was treated as a gift from a foreign corporationor partnership. Recipients of gifts or bequests wererequired to aggregate separate gifts from relatedforeign persons during 2006 in order to ascertain ifthe 100,000 or 12,760 threshold amounts had beenmet. For 2006, 2,869 million were reported as giftsor bequests from nonresident alien individuals orforeign estates, while 22 million were reported asgifts from foreign corporations or foreign partnerships. No U.S. tax was imposed on these gifts orbequests. The total value of gifts or bequests for2006 ( 2,891 million) is an increase of more than 25percent from the value of gifts or bequests for 2002( 2,305 million).Filing Characteristics of Form 3520-A—Foreign Trusts With U.S. OwnersFor 2006, 3,819 Form 3520-A information returnswere filed with the Internal Revenue Service. Thesereturns relate to foreign trusts having at least oneU.S. owner under the grantor trust rules of InternalRevenue Code sections 671 through 679. Thesubstantial increase in the number of Forms 3520-Afiled (from 291 for Tax Year 1990 to 3,819 for TaxYear 2006) reflects increased foreign trust activityby U.S. taxpayers, i.e., foreign grantor trusts havebecome a more common part of taxpayers’ investment portfolios.Table 3 presents income statement, expense,distribution, and balance sheet items for these returnsclassified by the size of the net income or loss of15 The rules for calculation of “accumulation distributions” for foreign trusts are complex, and outside the scope of this article. See Internal Revenue Code sections 665through 667 for additional information.233

Foreign Trusts, 2006Statistics of Income Bulletin Fall 2009the foreign trust. Net income or loss of the foreigntrust may be used as one measure of the return ontrust assets. For 2006, foreign trusts showed a widedistribution of net income, from returns with a netloss (deficit) to returns with income greater than 10 million. The returns with large net income mayreflect the use of foreign trusts as investment vehiclesby corporate or partnership entities.Total income of 2,450 million and totalexpenses of 509 million were reported on allreturns. Most of the income (or loss) reported wasinvestment-related, including interest, dividends,capital gains, and partnership income. Aggregategains were reported in short-term and long-termcapital gain (less loss) and ordinary gain (less loss)income categories. These gains may be the result ofa general increase in global equity asset prices thatbegan in 2002 and continued through 2006.16 Afterdeducting expenses, net income of 1,941millionwas reported—an average of approximately 0.5million per trust. The aggregate value of 1,802million of distributions was smaller than the aggregate size of net income.The largest specific asset items reported onForm 3520-A were other marketable and nonmarketable securities. Together, these two groups ofassets comprised nearly 35 percent of the 31,888million in total assets. Average total assets per trust(in current dollars) rose from approximately 0.5million per trust for 1990 to 8.4 million per trustfor 2006. The largest liability item, 1,232 millionof mortgages and notes payable, made up nearly43 percent of total liabilities. The total net worthreported, 29,008 million, was comprised of 16,254million of contributions to the trust corpus, 2,504million of accumulated trust income, and 10,251million of other net worth.Table 4 presents the Form 3520-A data classified by the country in which the trust or trustee waslocated. Mexico, the Cook Islands, St. Christopher/Nevis, and Bermuda were the most popularjurisdictions for trust location. However, the datashow trusts located across the world. Foreign trustslocated in the Cayman Islands showed the largesttotal income ( 777 million), and trusts located inMexico held the most assets ( 9,091 million). Mostof the income for the Cayman Islands trusts wasSummaryThe 2006 foreign trust statistics, reported on Forms3520 and 3520-A, is consistent with substantial andincreasing interest in Foreign investment by U.S.taxpayers. From 1990 through 2006, the numberof Form 3520 returns filed reporting foreign trusttransactions and certain foreign gifts rose from 133returns for 1990 to 7,956 returns for 2006 while thenumber of Form 3520-A foreign grantor trust returnsfiled rose from 291 returns for 1990 to 3,819 returnsfor 2006. The total value of property transferred,as reported on Form 3520, rose from 273 millionfor 1990 to 1,642 million for 2006. During thesame period, net income reported by foreign grantortrusts increased from 3 million to 1,941 million,and total assets of these trusts increased from 154million to 31,888 million. In addition, for 2006,U.S. persons reported 2,878 million of distributionsfrom foreign nongrantor trusts and 2,891 million offoreign gifts and bequests.Data Sources and LimitationsThe statistics for 2006 presented in this article werebased on all Forms 3520 and 3520-A with tax periods that ended during Calendar Year 2006 filed at theFor a discussion of global equity market conditions from 2002 through 2006, see Financial Market Trends, No. 93, November 2007, Organization for EconomicCooperation and Development (OECD).16234net long-term capital gain income. In addition, thelargest aggregate distribution amount, 404 million,was attributable to trusts located in the CaymanIslands. Distributions in excess of 100 million werealso reported for trusts located in the Isle of Man,Mexico, Argentina, Bermuda, and the Cook Islands.The composition of trust assets differs bycountry and may be reflective of many factors,including the different investment opportunities eachcountry afforded. For example, 48 percent of cashassets were held in the Cook Islands, the CaymanIslands, the Bahamas, and Liechtenstein. A largeportion (over 52 percent) of marketable securitiesassets were held in the Cayman Islands, the CookIslands, Switzerland, the Bahamas, and Liechtensteinwhile the largest portions of nonmarketable securities assets were held in the Bahamas, the CaymanIslands, the United Kingdom and Northern Ireland,and Switzerland. Over 30 percent of real propertyassets were held in Mexico.

Foreign Trusts, 2006Statistics of Income Bulletin Fall 2009Internal Revenue Service’s Philadelphia and OgdenSubmissions Processing Centers.17 All returns wereused for the statistics. Consequently, the data are notsubject to sampling error. However, certain returnsfiled were unable to be located for the study. In addition, other returns for Calendar Year 2006 were filedtoo late to be included in the study. Hence, data frommissing and late-filed returns were not included in thestatistics presented.The data may, however, contain nonsamplingerrors. For instance, since Forms 3520 and 3520-Aare information returns, taxpayer reporting, as originally filed, was occasionally incomplete. Where possible, inconsistencies in the data were resolved toconform to provisions of the Internal Revenue Code.In cases where information reported was not internally consistent, other data on the return were usedto resolve errors. For example, in certain cases, U.S.addresses were reported for the “foreign” grantor trust.In such cases, the location of the trustee was used as aproxy for the location of the grantor trust.The statistics shown in Table 1 pertaining toForms 3520 with gratuitous transfers were classifiedby selected country in which the foreign trust was created. However, the country in which the foreign trustwas created was unavailable for the statistics pertaining to Forms 3520 with nongrantor trust distributionsshown in Table 2. Consequently, these statistics wereclassified by deriving the country of the foreign trustfrom the trust’s address.Since a foreign trust may have more than oneowner and more than one beneficiary, multiple Form3520 filings may relate to the one Form 3520-A filed.In these cases, an attempt was made to match and verify information between the Forms 3520 and the Form3520-A. However, certain returns were unavailablefor the statistics, and it was not always possible tomatch the information.This study (as well as the 1998 and 2002 studies) did not include returns filed by owners of Canadian Registered Retirement Savings Plan (RRSP)trusts. The current filing requirements for Forms 3520and 3520-A exclude filings for RRSP trusts if the trustwould qualify for treaty benefits under the ConventionBetween the United States and Canada with Respectto Taxes on Income and Capital. Other previous SOIstudies of foreign trusts have included RRSP trusts,and data for these trusts are included in the statisticscited in this article for 1990 and 1994. However, forthose study years, the aggregate income, asset, anddistribution values reported for RRSP trusts weresmall in comparison to other trusts located in different jurisdictions. As a result, comparisons usingthe 1990 and 1994 data are not significantly affectedby the exclusion of RRSP trusts for 1998, 2002, and2006.Explanation of Selected TermsBeneficiary —The person who is to receive the benefits (usually income or tangible property) from the trust.A beneficiary may be the person who created the trust.A trust can have multiple beneficiaries.Corpus—The property that is held in trust. For taxpurposes, this property is distinguishable from accumulations of income by the trust.Distributable net income—Distributable net income(DNI) generally is the annual net income of a trustbefore any deduction for distribution to beneficiaries.Executor—A person named in a will by the decedent for responsibility to execute the terms of the will.Grantor—The grantor (or creator or settlor) is theperson who places property (corpus) in trust. In the caseof a revocable trust, the grantor is treated as the ownerof the portion of the trust to which his or her power orretained interest applies. A grantor may add assets toa trust after it is es

3 For more information about foreign trusts for 1998 and 2002, see Holik, Daniel S., “Foreign Trusts, 1998,” Statistics of Income Bulletin, Fall 2001, Volume 21, Number 2 and Holik, Daniel S., “Foreign Trusts, 2002,” Statistics of Income Bulletin, Summer 2005, Volume 25, Number 1.