Volume X, Number 1 – April / May 2001
© Donlevy-Rosen & Rosen, P.A.
INTRODUCTION. Many of our newsletter issues and articles have described an effective asset protection plan utilizing a U.S. limited partnership in combination with an offshore trust (“LP/TRUST PLAN”). In this issue, we discuss an additional, and in many ways, a superior structure utilizing a single-member Nevis LLC in combination with a Cook Islands trust. All trustee actions described below are subject to the written approval of the trust protector (who is usually a friend or relative selected by the client upon establishment of the trust).
BACKGROUND. The LP/TRUST PLAN works like this: A U.S. limited partnership is established by the client. The client is designated as the 1% general partner, and the offshore trust established by the client is designated as the 99% limited partner. The client transfers assets into the partnership, and, as the general partner, directly controls and manages those assets. The partnership is required to annually file Form 1065 U.S. Partnership Return of Income.
To take money out of the partnership without tax consequences, the general partner must declare a distribution to the partners (the trust, as the 99% limited partner, receiving 99% of the distribution). The trustee, in its discretion, may then distribute the amount it received from the partnership to the client (as a beneficiary of the trust).
Any effective asset protection plan must ultimately be based on eliminating U.S. court jurisdiction (power) over assets. Applying that rule, if a serious litigation threat or claim arises, the offshore trust, as the majority partner, will vote its partnership interest to dissolve the partnership. When a partnership dissolves, the partners receive their respective capital accounts (99% to the offshore trust). The offshore trust will place the assets it receives in the dissolution in a secure offshore financial institution with no U.S. branch office (so that a U.S. court will not be able to exert pressure in any way on the institution).
LLC/TRUST PLAN. Under the LLC/TRUST PLAN, a single-member LLC is established in Nevis (our clients reap the benefit of our extensive international relationships by paying only half of what is normally charged in Nevis for an LLC). The client’s Cook Islands trust is designated as the member (owner), and the client may be retained by the LLC as its manager (with signature control) or as its investment advisor (securities trading authority, but no signature control).
Under U.S. tax law, an election may be filed with the Internal Revenue Service within 75 days of the formation of the LLC to disregard the entity for all U.S. tax purposes.
What benefits are derived from disregarding the LLC for tax purposes? First, unlike the limited partnership, the LLC will not have to file any U.S. income tax return [all of its transactions will be reported on the trust’s tax return]. Second, even though the LLC is a foreign entity, the U.S. tax withholding rules provide that if the member is a U.S. “person” for U.S. income tax purposes, the LLC is treated as a U.S. person, and no withholding is required. Note: A properly structured Cook Islands trust may be established in a manner which permits it to be treated as a U.S. trust (U.S. person) for U.S. income tax purposes, while at the same time realizing the protective benefits of Cook Islands trust law. A third benefit of the LLC/TRUST PLAN is uncomplicated distributions. Recall from the above discussion the complicated procedure which must be endured to remove funds from the limited partnership to avoid adverse U.S. income tax consequences? Because the LLC is disregarded for tax purposes, “management fees” paid by the LLC to the manager/advisor (client) are treated as paid by the trust. The trust is treated as “owned” by the client for tax purposes, so the “payment” by the trust to the client of such amounts is, in essence, treated as a payment by the client to himself/herself – no tax effect!
MOST IMPORTANT BENEFIT. The most important benefit of the LLC/TRUST PLAN is realized if a significant threat or claim arises. Remember, in the LP/TRUST PLAN, the partnership had to be liquidated. Such a transaction involves legal fees and other costs. With the LLC/TRUST PLAN, the LLC can remain intact, although if the client is serving as the manager with signature authority, he or she would be fired (a simple fax transmittal from the member ). The client may be retained as the investment advisor with securities trading authority, though. Of course, if the LLC has accounts in the U.S. or with U.S. based financial institutions, those accounts would be moved to an offshore financial institution (as described above), but the movement of accounts within the same entity is much more easily accomplished than the movement of accounts out of the partnership and into the trust. Finally, the LLC entity form is easily understood in civil law jurisdictions (such as Switzerland, where accounts might be set up), where the trust legal concept does not exist. Clients who have the LP/TRUST PLAN may wish to consider the tax-free conversion to the LLC/TRUST PLAN.