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Purpose trusts

A purpose trust does not have any beneficiaries, exists for a specific purpose and is commonly used in conjunction with asset financing transactions, securitisations or to hold the shares of a private trust company.
23rd October, 2020

A purpose trust does not have any beneficiaries, exists for a specific purpose and is commonly used in conjunction with asset financing transactions, securitisations or to hold the shares of a private trust company.

Purpose trust legislation exists in many jurisdictions and the following information relates specifically to Isle of Man purpose trusts. However, ILS World has offices and experts based in the British Virgin Islands, London, Portugal, Dubai, Hong Kong and the Isle of Man who will be to assist you.

In practice
A purpose trust is formed as a result of a deed of trust between a settlor and the trustees. To be enforceable the trust instrument must clearly define the purposes of the trust so a court may determine these purposes. The purposes must be certain, reasonable and possible and not unlawful, contrary to public policy or immoral.

There must be at least two trustees, one of whom is a "designated person" (broadly, a regulated professional person within the Isle of Man), as specified in the Act.

To enforce the trust there must be an 'Enforcer'. The Enforcer oversees the actions of the trustee to ensure those actions are in line with the purposes stated in the trust instrument and therefore the Enforcer must have an absolute right of access to any information or document which relates to the trust, the assets of the trust or to the administration of the trust.

The trust instrument must specify the event which causes the trust to terminate and must provide for the disposition of surplus assets of the trust upon its termination.

A purpose trust cannot have any beneficiaries, so all assets in the trust must ultimately be paid out towards the purposes of the trust, as set out in the trust instrument.

The designated trustee must keep a copy of the trust deed, a register and trust accounts. These accounts are open to inspection by the Attorney General but are not available for public inspection.

The trust deed and the purpose
Much care needs to be taken in drafting the trust instrument particularly with regard to its purpose. There are differences in the laws of different jurisdictions which have to be taken into account if a trust is to be established elsewhere. Bermuda Law, for instance, requires a substantive purpose beyond the mere holding of shares.

The Deed will set out the duties of the trustee or trustees and the enforcer.

The Enforcer
The role of the enforcer is to oversee the trustees to ensure the trust is administered in order to satisfy the purpose for which it was established.

The enforcer is appointed within the trust instrument upon creation of the trust, is required to be completely independent of the trustees and may not profit from the trust.

Whilst the enforcer is usually an individual, it can also be a corporate entity.

Where the trustee who is a designated person has reason to believe that the enforcer has either ceased to be independent of the trustees, is incapable, unable or unwilling to act as enforcer, that trustee must give written notice to the Attorney General.

The Attorney General may then apply to the High Court to appoint a successor as the enforcer of the trust.

Uses

Off balance sheet transactions
When, restrictive covenants have been entered into preventing a particular individual or company investing in certain areas, or companies, the investments may now be held within a purpose trust. Because there are no beneficiaries to the purpose trust, a link cannot be established between the investor and the investment. If the trust were set up with a short perpetuity period, then the assets would revert to the settlor on termination.

Corporate finance/asset financing
Purpose trusts can be used to segregate investment funds or asset ownership within a subsidiary (as security from the lender) from group risk.

This is clearly an acceptable form of asset protection. It is becoming common in ship and aircraft finance/construction and in leasing transactions. In all of these cases the trust ends when the loan is satisfied, while in the interim the lender/financiers' cash flow is protected. The lender is further protected because the ownership of the subsidiary cannot change until the trust is terminated.

Division of voting and economic benefit
It is sometimes necessary to demonstrate 'control' is not vested in a particular entity. Different classes of shares in a company can be created with voting control being in the hands of one party and dividend rights in the hands of another. Thus voting shares may be placed in a purpose trust and the remaining shares held by the party seeking the economic benefit.

Ownership of trust companies
Some settlors of conventional trusts have concerns control could be transferred to trustees over which a settlor has no influence. A purpose trust established to own a family trust company will usually overcome this difficulty. It enables the trustee to carry out its duties independently and gives assurance to the settlor the board of directors of the trust company can be changed at any time by the shareholders ie the purpose trust. Another advantage is that on the death of the settlor the shares of the trust company are outside the settlor's estate and will therefore not pass to heirs who might otherwise control the trust company in a way not intended by the settlor.

Securitisation
Many structures creating international securitisation which in the past have used a charitable trust can now be set up using a purpose trust.

Social benefits
A trust may have social, though not charitable, objectives. For instance, a trust could be set up to benefit an area of outstanding beauty and to provide funds for its maintenance.

Investment in family companies
Much has been written about the difficulty of trustees of a non-purpose trust holding shares in family companies where the economic purpose is poor. If instead a purpose trust were put in place to invest in family companies, the trustees would be fulfilling their trustee duties and therefore these actions should not be criticised.

Acceptance
International recognition must be considered when setting up a purpose trust and whether the courts of the jurisdictions of the situs of the trust property, the domicile and residence of the settlor and beneficiaries, and any other relevant jurisdictions will recognise the purpose trust as a valid trust. Those states which have ratified the Hague Convention on trusts have undertaken to recognise trusts 'for a specified purpose'.

Taxation
An Isle of Man purpose trust has no liability to tax in the Isle of Man provided there is no taxable Manx source income.

A taxable event occurs on the termination of the trust if the assets revert to the settlor. There may also be tax implications of the initial transfer of assets into the trust and it is also recommended specific tax advice is obtained.

Summary
The purpose trust has several significant advantages over conventional trusts in certain situations. An important factor is there is a clearly defined trust deed and strong modern legislation supporting the structure.

Certain changes must be reported to the authorities. The records of the trusts may be inspected by the Attorney General (Isle of Man) and there is a much more visible and comprehensible regulatory framework.

The role of the enforcer is a key feature and the appointed enforcer much remain completely independent of the Trustees.
Its use in segregating assets, in dealing with fixed term events like loan replacement, and in providing a layer of confidentiality and its flexibility make it a valuable planning tool for the 21st century.

What ILS World can provide
We have a considerable amount of expertise in this area. Our professional and highly qualified team have a great deal of experience advising clients on trusts and have built up a reputation for providing a high standard of help, management and support that clients and their professional advisers have come to expect.
We can specifically assist with:
• Arranging drafting of the trust deed
• Providing a designated trustee
• Establishing related corporate structures
• Maintaining trust accounts
• Arranging banking facilities.

Read more about Trusts or for further information contact our Head of Private Clients Gemma Davies at gemma.davies@ils-world.com

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Please note: ILS World does not offer tax advice. If you are not professionally qualified to give tax advice we will be happy to make an appropriate introduction.

Head of private clients

Gemma Davies
Gemma Davies
Head of Private Clients Isle of Man