Can trusts rely on double tax agreements?

When setting up a foreign structure, discretionary trusts are a useful planning tool for Ultimate Beneficial Owners (“UBO’s). If set up and funded sensibly, discretionary trusts offer many benefits such as continuity of ownership of assets in the case of the death of one of the UBOs, protection against creditors, protection against the volatile South African exchange rates as well as offering protection against the dreaded exit tax where SA resident UBOs emigrate.

As we love them so much, we’ve often written about international trusts but today we look at whether international trusts can benefit from the various reliefs provided by Double Tax Agreements (“DTA’s). 

Basically, is a trust a “person” for DTA purposes?  Well, the answer, as so often in the world of tax, is “it depends”.

We mainly need to consider Article 1: “Persons Covered” and the clause that deals with the definition of “Persons”, generally contained in Article 3. These two Articles determine whether the DTA could be applicable to the entities.

Article 1 of the Model OECD DTA states that “This Convention shall apply to persons who are residents of one or both of the Contracting States”. Article 3 follows with the definition of “persons” being “any legal person, partnership or association deriving its status as such from the laws in force in that Contracting State” (our emphasis). From a general law perspective in South Africa, a trust is not a person. However, trusts are specifically included as “persons” in the definition in the Income Tax Act, which law covers DTAs.

It follows that from a South African perspective, trusts can benefit from South African DTAs. So far so good. But is this also the case in other countries and what will it mean when there is a DTA between two countries where one sees a trust as a person and the other doesn’t? Well this is where things get fun, and will depend on the domestic law (general and tax law) of the relevant country, and the answer will generally be different for civil and common law countries.

Common law vs civil law for trusts

In common law countries, such as the United Kingdom, the United States, and many Commonwealth nations, a trust is not considered a separate legal entity but rather a legal relationship where the trustee holds property on behalf of the beneficiaries. The trustee, who holds legal title, acts as the legal “person” for the trust. In many common law jurisdictions, the trustee is considered the taxpayer for income generated by trust assets. The trustee’s residency often determines which DTAs apply, potentially reducing or eliminating withholding taxes on income such as dividends, interest, or royalties. However, if the trust is “transparent” or “flow-through,” where income is taxed directly in the hands of the beneficiaries, the beneficiaries’ residency becomes relevant for DTA purposes. If the beneficiaries are resident in a country which has a DTA with the income source country, they may benefit from reduced tax rates under that DTA.

On the other hand, civil law countries, such as France and Germany, do not traditionally recognise trusts as separate legal entities, and the concept of a trust as understood in common law does not exist domestically. In these jurisdictions, the application of DTAs to trusts is more complex. While some civil law countries recognise foreign trusts, the absence of a domestic trust framework can lead to uncertainties in how DTAs are applied. In such cases, the focus may still be on the residency of the trustee or beneficiaries, similar to common law countries, but there may be varied interpretations by tax authorities. Some civil law jurisdictions have introduced trust-like arrangements, such as the *fiducie* in France. The application of DTAs to these structures may follow rules specific to the arrangement, with a focus on the residence of the fiduciary or beneficiaries. However, the lack of recognition of trusts as legal entities in civil law countries may lead to inconsistent treatment under DTAs, particularly when dealing with foreign trusts.

Overall, in common law jurisdictions, DTAs generally apply to trusts based on the residency of the trustee or beneficiaries, while in civil law jurisdictions, the application of DTAs can be more complicated due to the lack of recognition of trusts as legal entities. The treatment under DTAs in civil law countries depends on whether the country has specific provisions or agreements that address foreign trusts or trust-like structures, leading to potential differences in tax outcomes for trusts depending on the jurisdictions involved.

Key take-away

There you go, clear as mud!  The lesson is don’t assume trusts are persons for tax purposes and don’t assume DTAs will apply to them. As with all things tax structuring-related – careful upfront planning is needed, contact us if you’d like to discuss.