G Warren Whitaker, Day Pitney LLP
In this article, G Warren Whitaker of Day Pitney LLP discusses recent developments in international and cross-border estate planning.
I recently pulled out the agenda for a conference I chaired on international estate planning 15 years ago. For two days, eight speakers discussed cross-border tax planning techniques: pre-immigration trusts, expatriation, stepping-up basis, PFICs and CFCs, and foreign investment in US real estate. Nothing else was covered.
Then I looked at the agenda for a similar conference at which I spoke earlier this year. The entire first day was spent on compliance: reporting by US persons of their foreign assets and transactions; voluntary disclosure for both US and non-US clients who had not previously reported foreign assets and income to their government; know-your-clients and anti-money laundering rules for lawyers and financial institutions taking on new clients; reporting ownership of LLCs that purchased US real estate and foreign corporations owned by US persons; and reporting and exchange of information under FATCA and CRS. Not until day two did the conference get around to the subject of tax planning. When it did, I found that the substantive tax laws of the US had changed very little in 15 years. The last major changes in the tax treatment of foreign trusts were enacted in 1995. The expatriation and exit tax laws were last changed in 2007. The Tax Cuts and Jobs Act of 2017 brought us the GILTI tax, as well as a lower capital gains tax rate and a higher unified credit against estate and gift taxes, which has only a modest impact on most cross-border planning. The substantive techniques and structures that we have been using in cross-border estate and tax planning have remained approximately the same: grantor trusts, foreign corporations, irrevocable US trusts, LLCs. Yet it feels as if we are living in a totally different world today – because we are.
Fifteen years ago foreigners could invest in the US with few questions asked. We all knew that many of them were not strictly complying with the laws of their home country, and felt that this was often a legitimate decision based on their fear of nationalisation, kidnapping or extortion, or general hostility toward high net worth individuals. US clients could easily (sometimes too easily) open an account or create a trust offshore. Paperwork was minimal, and we all felt that failure to file information returns such as the FBAR was a trivial omission as long as all US taxes were paid.
Today, the world of the international client is awash in paper. Both foreign and US clients must comply with extensive ‘know-your-client’ rules: utility bills, certified copies of passports, proof of source of funds that may have been received decades ago. Americans living abroad have difficulty opening bank accounts because many foreign banks want to avoid any potential accusation that they are assisting Americans in non-compliance with US tax laws. Foreign clients who want to have their assets managed in the US fear exchange of information with their home country, which may lead to exposure of their wealth to an undemocratic, corrupt regime.
Clients bemoan these change, and many lawyers are frustrated and agree that life used to be simpler and the practice of law more efficient. However, there is another side to the picture. When US advisers met with a multinational family 20 years ago to propose a US tax-compliant structure that would provide some tax reduction while protecting their assets from claims, we felt the presence of a spectral competitor in the room. That ghostly rival was the offshore banking system, tempting the client with its siren call of ‘Forget these silly rules! Just leave your money with us and no one will ever be the wiser.’ Compliant estate and tax planners in onshore high-tax jurisdictions lost many clients to this shadowy player. However, once the assault on offshore havens by the US Justice Department began in earnest, the same offshore competitors informed their trusting clients that their names would soon be delivered to the IRS. At this point the wayward clients returned to the compliant onshore advisers they had once spurned, asking for help in disclosing their non-compliant structures and accounts in the Offshore Voluntary Compliance Program. Today, compliant, sophisticated, and frequently complex cross-border tax planning is in demand, and at a premium, as financial institutions refuse to take money from clients who cannot show that they are meeting all legal requirements.
These trends are all the results of the increasing globalisation of the economy. With the end of the Cold War, borders have fallen and the economy has become global, with more individuals moving or investing around the world. It was inevitable that the most developed high-tax jurisdictions, all looking to better their economies, would cooperate to ensure enforcement of their tax laws, and today’s technology allows them to do so much more easily. Although there is currently a political trend in many of these countries towards increased nationalism, this has not yet altered the movement towards greater mutual cooperation in tax collection, enforcement and exchange of information.
I can recall the uproar when the United States adopted automatic reporting by financial institutions of interest and dividend payments in 1982, with enforcement through backup withholding for those who failed to comply. Many people decried the massive, burdensome and intrusive paperwork (it was done with paper back then) that supposedly would cause investors to look outside the US. Yet taxpayers adapted to the new system and foreigners continued to invest in the US economy. Today US residents are accustomed to automatic reporting of dividends and interest to the IRS; in fact, many would find it hard to believe that a few decades ago this income was reported to the IRS based on the honour system. Some day our descendants will say the same about the idea that a person living in one country could deposit assets in another, and thereby easily keep them hidden from taxation in their home country. We are living in the period of transition, and transition is always disruptive for the many people who have become accustomed to a particular way of life, although it always provides more work for lawyers who advise their clients on how to adapt to the changing rules.
Far more troubling to me than the inconvenience to residents of developed countries is the predicament of those who live in less democratic and more dangerous nations. For them compliance with local tax laws, reporting their assets to their government and exchange of information regarding the wealth that they keep abroad are not merely matters of dollars and cents, but of life and death. Kidnappings for ransom are a regular occurrence in some countries, as are imprisonment on trumped-up criminal charges or assassination of high net worth individuals. Residents of these countries have more sympathetic goals, but find themselves treated in the same way as those who live in the US, Canada and the UK regarding disclosure of information and the sharing of that information. When they are asked by a US lawyer or financial institution to show that they have complied with their country’s tax laws, it is frequently impossible for them to do so.
I once asked a lawyer in a particular country whether a gift by a client of mine who resided there was subject to gift tax. He told me his country had a law that would subject the transfer to tax. He then said that the law had been on the books for 40 years, and in that time the country had never collected a penny of the tax it imposed or prosecuted anyone for failure to pay. This client’s home country enacted a law that nobody in the country obeyed, and the country took no steps to enforce it – yet if the client brought his funds to the US, they might be deemed the proceeds of crime and American institutions might be prosecuted by the US for accepting it. Somehow this does not make sense, yet it is where we currently stand.
Confidentiality is often the major goal of these clients, which led them to put their assets offshore, and, therefore, exchange of information is their greatest fear. FATCA started the movement towards universal exchange of information. While FATCA provides for reciprocal exchange of information, the IRS has said that it will exchange information only with foreign jurisdictions that, among other requirements, meet the IRS’s “stringent safeguard, privacy, and technical standards. Before exchanging with a particular jurisdiction, the United States conducted detailed reviews of that jurisdiction’s laws and infrastructure concerning the use and protection of taxpayer data, cyber-security capabilities, as well as security practices and procedures.” The US has now begun sharing data with foreign countries, and one of the first countries chosen was Mexico. Does Mexico safeguard and protect taxpayer data? Most wealthy Mexicans do not seem to think so, but it would be diplomatically offensive for the US to state publicly that another country cannot be trusted with sensitive information. (Although the current US president may not care whether he is being diplomatically offensive towards other countries.) In any event, exchange of information is now taking place and wealthy Mexicans are concerned.
CRS provides for broader and more automatic exchange of information among all covered nations (ie, just about every country except for the United States and North Korea). This has led a flood of money into the US to avoid CRS. (I doubt that North Korea has seen a similar influx.) It is only a matter of time, however, before the US begins cooperating with foreign countries that enact laws making avoidance of CRS a crime. If the US expects foreign institutions to cooperate in enforcing US tax laws, foreign countries will expect the same from US institutions with regard to their tax and reporting laws, and there are signs that this is already taking place.
The recent internet leaks of information such as the Panama Papers and the Paradise Papers, made possible by modern technology, have also accelerated this process. Even if the structure is legally compliant (as most of them certainly were in the case of the Paradise Papers), it must be prepared to withstand scrutiny and massive publicity. Offshore structures that were created carelessly years ago on the theory that “who will ever see this?” are now being picked apart relentlessly.
In short, there are still many legitimate cross-border planning opportunities in the new world of international estate planning, but advisers need to apply a high level of technical expertise to create structures that successfully navigate the myriad of applicable laws of each relevant jurisdiction. The alternative of secrecy coupled with optional tax compliance is no longer available. Prophets may lament about loss of privacy, but this is the world we and our clients all live in, and technically savvy lawyers will play an essential and ever-increasing role in it.