CRS and FATCA expert

Trusts with Settlor Reserved Powers: The New CRS Avoidance Tool?

Peter Cotorceanu CRS, CRS Avoidance Tool, OECD

In a topic critical to the CRS classification of certain trusts, a divergence is emerging between the prevailing consensus view and the rule as expressed in recent local guidance. To wit, are discretionary trusts for which the settlor reserved control over the investments of the trust assets nonetheless “managed by” their trustees? If the answer is no, then in the absence of subsequent delegation by the settlor of the investment authority to a third-party asset manager or other relevant FI, such so-called settlor reserved investment power trusts (SRIP trusts) ought to be classified as NFEs (rather than Professionally-Managed Investment Entity (PMIE) type FIs). This would mean, for example, that if the trust had a U.S. bank account or no bank account at all,  there would be no CRS reporting obligations, at least at the trust level. Indeed, some advisors are in fact advocating the use of SRIP trusts for the very purpose of avoiding CRS reporting.

In order for a typical private wealth trust to qualify as a PMIE under FATCA and CRS, another FI, such as a corporate trustee, must manage the assets of the trust. From the beginning of the interpretation of FATCA’s application to the trust industry, a debate originated over how the “managed by” test applied to SRIP trusts. Those who believed that standard trustee duties satisfy the test argued that the plain meaning of the term “manage” is broad enough to capture the control exercised by the trustee of a discretionary trust over the distribution of the assets to its beneficiaries. This position was bolstered by the unofficial IRS suggestion to err in favor of an FI status if in doubt. The counter-arguments, however, theorized that FATCA seemed more interested in third parties’ exercise of control over investment decisions. The fiduciary industry and its advisors eventually adopted the view that a trustee does “manage” its trusts regardless of whether the trustee had investment powers. However, the IRS never fully and finally settled the issue and thus the uncertainty persisted through the introduction of CRS.

Then along came CRS. A solitary sentence in the CRS Commentary has given weight to the argument that a trustee does not “manage” a trust unless the trustee has investment powers. Here’s what the Commentary says:

  • However, an Entity does not manage another Entity if it does not have discretionary authority to manage the Entity’s assets (in whole or part).

Some equate the phrase “discretionary authority to manage the Entity’s assets” with “discretionary authority to manage the Entity’s investments” , which is not exactly what the language says. For example, doesn’t a trustee of a discretionary trust have discretionary authority over the trust assets by virtue of the mere fact that the trustee gets to decide whether to distribute them? Quite arguably. That said, the phrase “discretionary authority to manage  . . . assets” is ambiguous. I for one cannot say definitively that a trustee of a discretionary trust without investment powers has such authority. Reasonable arguments support both views.

Recently, two jurisdictions – Singapore and the Bahamas – have issued explicit guidance on this issue. In its CRS FAQs, the Inland Revenue Authority of Singapore (IRAS) stated in FAQ B.5 that a SRIP trust would not qualify as an FI because the manager of the assets held by the trust would not itself be an FI. By negative implication, therefore, the other powers exercised over the assets of a discretionary trust by the trustee do not satisfy the “managed by” test. Just a few weeks ago, the Bahamas made this implication express, stating in Example 3 of its  not-yet-publically-released draft guidance notes that: “A trust where the right to direct investments is reserved to the settlor or is vested in an individual investment manager, would not be an Investment Entity as it would not meet the ‘managed by’ test, notwithstanding it may appoint a trustee that is a Financial Institution.” (Emphasis added).

As neither jurisdiction makes this decision elective or grandfathers trusts already classified as FIs for FATCA and/or CRS purposes, trustees of SRIP trusts in these two jurisdictions confront a challenging decision. The straightforward approach is to accept the NFE treatment. This option, while simple for some SRIP trusts, may not be for other SRIP trusts based on one or more of the following concerns:

  • Conflicting FATCA and CRS classifications;
  • Retroactive reversal of a FATCA classification (especially unwelcome if the trust reported under FATCA);
  • Additional beneficiary disclosure and documentation; and
  • CRS reporting by the bank (or other FI) maintaining the trust’s financial account of beneficiaries or others who otherwise would not be reported due to, for example, differing reporting jurisdiction networks. (This assumes that the trust in question would be classified as a passive, not an active, NFE. This is a reasonable assumption given that almost all trusts that are not FIs will indeed be passive, not active, NFEs.)

Trustees of SRIP trusts presented with one of the above problems may prefer to tinker with the allocation of the investment authority, rather than alter the trust’s classification to passive NFE. In other words, the trustee might indeed be granted some investment discretion, however circumscribed, so that the trust will meet the “managed by” test. As CRS does not dictate how much investment authority equals management over the assets or that such management authority needs to be exercised, a formal delegation of a nominal portion of the settlor’s investment powers to the trustee could suffice to restore the PMIE status of the trust.

Perhaps more alarming than the actual divergence highlighted in this blog (which is defensible and limited to SRIP trusts) is the reminder that the “C” in “CRS” is ever misleading and that the fragmentation of rules remains a threat, especially for the fiduciary industry. As such, trustees and other fiduciaries may not assume that any interpretation settled in one jurisdiction will not be upended in another. So, as they say, watch this space . . . .