This blog post outlines how foreign grantor trusts could increase the potential business and reputation risk for South Dakota trust law and trust companies. Potential clients should understand why and if they are comfortable accepting that potential risk.
This blog covers the following:
- The international appeal of South Dakota trust law (heavy details but important)
- Foreign Grantor Trusts - International Tax D
ue Diligence and Risk Assessment (great section for lawyers)
- Covid-19 Effects on Foreign Grantor Trusts
- Reputational Risks & Foreign usage of South Dakota trust law (important part for everyone)
Wealth Advisors Trust Company is the first trust company in South Dakota or probably in America that publicly states that we do not accept foreign grantor trusts. We believe these types of trusts could increase our business and reputational risk. That could potentially harm our domestic trust clients should these risks bear fruit. A risk we are not willing to assume as their fiduciary.
The international appeal of South Dakota trust law
Trusts in South Dakota have unfortunately attracted the attention of wealthy non-US citizens with undisclosed tax issues. Wealthy clients throughout the world invest and hold assets in the United States because this country provides a secure, regulated, and profitable market for investors. If that was not enough, the United States also offers a stable trust and estate law for grantors and beneficiaries. Several of the best trust states, including South Dakota, Nevada, Delaware and Alaska, have sought to structure their trust and estate laws to provide maximum security, trustworthy legal precedent, clear statutory guidance, and consistent enforcement. At the same time, certain international enforcement regimes have increased disclosure in other countries and decreased the appeal of asset protection trusts outside of the US. The result has been that international investors have increasingly sought to form trusts with a South Dakota situs.
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South Dakota banking and trust regulators have clearly identified this risk. South Dakota guidance realizes that "there are legitimate reasons for the movement of foreign trusts and assets to and from domestic financial institutions” [emphasis added]. But they provide a strong word of caution, noting that, "there is also a risk that these types of trusts are created to conceal the sources and uses of funds, the identity of beneficial and legal owners, or to avoid foreign reporting requirements” [emphasis added]. The South Dakota regulators add that "trust customers and beneficiaries may try to remain anonymous to move illicit funds or avoid scrutiny or may seek a certain level of anonymity by creating offshore accounts, or other investment entities, that hide the true ownership or beneficial interest of the trust" [emphasis added].
That is why Wealth Advisors Trust Company does not accept foreign grantor trusts. Indeed, it begs the question, why would any trust company in South Dakota accept foreign grantor trusts with this warning from its regulators?
“A reputation is hard to earn and super easy to lose.”
The numbers are staggering. In 2010, South Dakota trust companies held $57.3 billion in assets. By 2020, the number was $355.2 billion. Billions of dollars have moved from Switzerland and Jersey to Delaware, Wyoming, Nevada, but above all, South Dakota. US trusts with foreign grantors are no longer a cottage industry. Other non-US based foreign trust companies have established trust companies in South Dakota, allured by increasing their AUM and revenue from their international clients. Using America trust laws remains important to their business. South Dakota trust law allows these global trust companies also to offer a solution for beneficiaries and grantors to maintain stable dynastic trusts with minimal disclosure.
While not the intent of South Dakota law, US Federal law is partially appealing for large non-US wealth transfers because the US federal government does not provide beneficial ownership reporting with other countries under the OECD (Organization for Economic Co-operation and Development) Automatic Exchange of Information (AEOI) regime, a little-known international tax reporting system. The federal government reports under its own system (FATCA) to receive information on US investors abroad, but it has not obligated US financial institutions to provide information to foreign governments. This has created an information disparity. States such as South Dakota have massively increased the guidance for foreign grantor trust acceptance and tax reporting to reduce potential misuse of its laws. Moreover, the US has already recognized the need to provide reciprocal reporting and has acknowledged that it will reciprocate information and adopt legislation to do so. This promise started in 2015 and with updates in 2018. But currently, foreign owners can minimize or avoid international reporting by moving a trust to the US, and the potential for the US to implement reciprocal reporting to foreign governments has not slowed the avalanche of foreign trusts moving into the US. The current information gaps caused by current US federal laws increases the risk of all foreign trusts because it is difficult to identify which funds have been reported and are tax compliant in all jurisdictions.
“Money is neither smart nor dumb.”
Until the US comes into compliance with this reporting US trust companies may feel a false sense of security regarding the lack of foreign tax enforcement. South Dakota trust statutes and guidance as well as from other state regulatory agencies have created clear guidance on acceptance, oversight of foreign trusts and required tax reporting. But US trust companies still face extreme difficulty in knowing whether US trust accounts with foreign grantors or beneficiaries are fully compliant with their country’s tax authorities.
Once beneficial ownership reporting is made available, many of these underlying foreign tax issues will likely come to the surface. Such issues could be substantial. Beneficial ownership reporting has increased international tax revenues by over €100 billion, but the US has not started this reporting. It is apparent that the US now houses an estimated $500 billion in foreign assets, and many were held in jurisdictions now subject to beneficial ownership reporting (i.e. Switzerland, Jersey, Liechtenstein, the Cayman Islands, and others).
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Foreign Grantor Trust - International Tax Due Diligence and Risk Assessment
This huge influx of money into foreign grantor trusts has outpaced trust companies in South Dakota and elsewhere in America the ability to perform due diligence on those clients – particularly tax due diligence. International tax compliance requires an understanding of foreign tax laws and an identification of foreign tax risk, which is simply not possible for many corporate fiduciaries, and many believe they have no obligation with respect to foreign taxes.
The misconception arises from the lack of international reporting and a memory of the now dead “Revenue Rule,” which prevented one country from enforcing the tax laws of another. Such a belief may lead corporate trustees to a false sense of security about accepting funds that are potentially the proceeds of foreign tax evasion. South Dakota regulatory and compliance agencies suggest the risk can exist for these types of situations. Even guidance from the Financial Crimes Enforcement Networks (FinCEN) may (at first glance) appear to minimize a trustee’s potential risk. In 2018, FinCEN provided a fact specific advisory that financial institutions are not required to file a suspicious activity report (SAR) based solely on a customer’s inquiry into or participation in a foreign tax regularization program.
” Wealth Advisors Trust Company does not accept foreign grantor trusts. Just common sense.”
But this limited guidance assumed that there were no other indications of tax evasion. Thus, a trust company in South Dakota or elsewhere in America may fail to grasp the unpriceable risk related to a client’s foreign tax voluntary disclosure program, i.e. an inquiry into a pre-existing requirement to pay tax in another jurisdiction.
In addition to minimizing the potential risk associated with this money, many trustees cannot properly identify foreign tax evasion. Their duties in this area are complicated by differing tax codes and reporting requirements throughout the world, which make this due diligence extremely difficult for most trust companies in South Dakota or elsewhere in America.
Many trust companies cannot identify whether funds were properly disclosed to the appropriate taxing authorities. Certain states, such as South Dakota have implemented forward thinking guidance through their Foreign Trust Acceptance & Oversight Guidance and their Foreign Trust Taxation & Reporting Guidance. Some trustees use a tax attestation form, signed by an accountant in the client’s taxing jurisdiction. This disparity shows trustees are minimizing the potential risk.
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In reality, significant risks could apply if a client’s assets are the proceeds of tax evasion proceeds. A trustee that receives international funds with knowledge or facts indicating foreign tax evasion may violate US law, such as mail or wire fraud statutes. Such transactions may even create criminal money laundering issues if the transactions related to foreign tax evasion and the US financial system. At least in South Dakota the regulatory and compliance bodies have identified this risk and implemented strict guidance on acceptance of future funds, along with tax compliance oversight and reporting guidance. These actions now protect the reputation of South Dakota trust law.
“Business risk definitions must consider reputation risk. Just ask the owners of the Robinhood discount broker app.”
Covid-19 Effects on Grantor Foreign Trusts
Covid-19 has had multiple effects on countries – social and economic. Politicians are adept at finding new sources of tax revenue. Pretty much since the creation of a standard medium of exchange called money. Pandemics and wars historically have had unintended consequences. The sprouting moment of those consequences is unknowable.
US citizens using a trust company in South Dakota, during their due diligence process, should ask, “Do you accept foreign grantor trusts?”
Reputation Risk & Foreign Usage of South Dakota trust law
It is important to note that we are discussing a small, but dangerous subset of foreign assets. This in no way impacts our view of non-US people, who bring enormous benefits to the US in terms of energy, ideas, and capital. Without them, the vibrancy of the American system would stagnate. But certain irrevocable foreign structures and assets are dangerous because they exploit US federal law and South Dakota trust law to avoid reporting assets to other governments. As evidenced by the South Dakota regulators published guidance. Maybe some trust companies in South Dakota have the depth to understand the scope of the US and foreign tax issues. Most do not. Wealth Advisors Trust Company admits to lacking this expertise. Moreover, we believe that the magnitude of this risk is so large and the required diligence so difficult that we will not accept foreign assets until this issue has been resolved.
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A business’s reputation comes from its core values and mission of serving clients. The company's leaders know they must focus on their core competencies. The trust company acceptance of a foreign grantor trust includes admission of in-depth knowledge of all domestic and foreign tax issues relating to that new trust client. A corporate fiduciary has the highest standard of care regarding the trustee services offered. Taking a prudent approach on what trustee services are offered, assuming one agrees on the last sentence, is cautious. For example, offering escrow trustee services or qualified plan trustee services does not share any characteristics with offering personal trust trustee services. Foreign grantor trusts do share common traits with domestic grantor/non-grantor trusts except for the complication of foreign tax issues.
“Stick with what you really know and every day will come up smelling like a rose.”
The allure of increased AUM and revenue with foreign grantor trusts creates a massive incentive. We all know that when the press talks about anything's greatness, sometimes that greatness can create dislocations of incentives. South Dakota trust statutes lead America in breadth and depth. We believe the responsibility of trust companies in South Dakota should take great care exercising great prudence to negate any reputational risk. South Dakota regulatory and compliance agencies have provided great guidance on how to protect the reputation of South Dakota trust law. Even at the cost of reducing AUM and revenue growth. US domestic trusts hold over $1 trillion in assets. In our opinion, there is no need for a trust company in South Dakota to take more business risk when the opportunities are overflowing domestically. That is our business approach.
We believe by not accepting foreign assets, Wealth Advisors Trust Company has reduced its business risk.
Conclusion on how Foreign Grantor Trusts increase the reputational risk to South Dakota trust law
Foreign grantor trusts created by and/or for the benefit of foreign nationals and trusts that hold foreign and domestic assets (“foreign trusts”) increase uncertainty. This leads to potential business and the reputational risk for South Dakota trust law and trust companies based in South Dakota. Accepting trusts funded from foreign assets with non-US citizens may subject South Dakota trust companies to unpriceable fiduciary and reputation risk. Should these risks come to fruition these could harm the trust company and affect its ability to serve their domestic trust clients. We believe that potential risk too great and as a fiduciary will not accept this potential unpriceable risk. Clients come first.
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Financial advisors, estate attornies and their clients should ask prospective trust companies if they accept foreign grantor trusts. Is that potential risk to the grantor/beneficiary acceptable?
"Wealth Advisors Trust Company, taking a leadership mindset, is the first trust company stating and implementing no acceptance of foreign grantor trusts."
Most South Dakota irrevocable foreign trusts do comply with all applicable US state and federal laws. That is a fact. Why would a trust company based in South Dakota write a stern blog about foreign trusts? It is not to win a popularity contest with peers in South Dakota.
As stewards, or legally as a corporate trustee, our role centers on controlling various business risks of the trusts we administer. In our opinion, there is an unpriceable risk to the corporate trustee arising from potential foreign taxes and liability from non-US persons historic income and current asset disclosures to their own country. We believe that trustees may be required to pay large taxes, penalties and interest to foreign tax authorities once the US begins reporting.
It could be that Wealth Advisors Trust Company stands alone in excluding foreign grantor trusts from its trustee service offering. But we believe current federal law has created a risk that we are not willing to accept.
Chris Saddock, JD, LLM, Saddock Companies, a former international tax attorney specializing in corporations, partnerships, trusts, FATCA, CRS and Tax Reform. His extensive education, experience and history serving Ultra High Net Worth clients on domestic and international tax issues gives Chris a panoramic view of all issues allowing for a coordinated approach to solving tax legal issues.
Christopher Holtby, Chief Learning Officer, Wealth Advisors Trust Company, applies his business building, love of learning, operational, and wealth management expertise gained at Ernst & Young to be the Chief Learning Officer. Learning never stops.
 Individuals who are not US citizens and are not domiciled in the US or US income tax residents