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| STEP JOURNAL JANUARY 2010 | VOLUME 18 ISSUE 01WWW.STEP.ORG

JOURNAL JANUARY 2010 | VOLUME 18 ISSUE 01 WWW.STEP.ORG www.step.org STEP JOURNAL WEALTH STRUCTURING ANALYSIS FOR

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STEPJOURNAL

WEALTH STRUCTURING ANALYSIS FOR TRUST AND ESTATE PRACTITIONERS

REGIONAL fOcus: Asia fEATuRE: Latin America INTERNATIONAL: Luxembourg specialised investment fund dOmEsTIc: Intestacy

JANUARY 2010 | VOLUME 18 ISSUE 01

America INTERNATIONAL: Luxembourg specialised investment fund dOmEsTIc: Intestacy JANUARY 2010 | VOLUME 18 ISSUE 01
Regulars 05 06 12 17 18 19 81 82 editoRiAL CoMMent Stephen Arthur steP news

Regulars

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editoRiAL CoMMent

Stephen Arthur

steP news

What’s happening in STEP?

industRy news

International and domestic news

student CoLuMn

Amanda Edwards

oPinion CoLuMn

Martyn Gowar

CRoss-boRdeR CoLuMn

Richard Frimston

steP eVents diARy

Local branch meetings

booK ReView

Cross-border Judicial Cooperation in Offshore Litigation (the British Offshore World)

Feature Article

21 A good wAy to do business

nicolas Malumian outlines trusts in Latin America

AsiA FOCUs

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indiAn FAMiLy

businesses

Ariel sergio goekmen and Michael o’sullivan highlight the findings of a study on the evolution of Indian family businesses

FAMiLy business suCCession PLAnning:

eAst VeRsus west

Christian stewart reflects on some of the differences between the way that East and West tackle succession planning

31 A PAssAge to indiA

geoff Cook describes how Jersey

has been making progress in India

35 tRusts ACRoss tHe FRontieRs

Alexis Medina reviews the STEP Asia Conference

international

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Investment

Julien dif considers the advantages of this Luxembourg collective investment scheme

CAYmAn AnD BvI

Richard grasby discusses Special Trust Structures under Cayman Islands and British Virgin Islands laws

FAmILY Investment

Robin Vos considers whether family investment partnerships are a waste of time or a serious contender

estAte PLAnnInG

Christopher Armstrong and diana Hastings explain how inadequate planning and confused post mortem strategy can permit a debatable application of foreign law to ensnare a foreign estate in a US estate tax trap

DIvORCe

Alex Carruthers asks if Obama’s push for trust transparency will benefit divorcing wives

RestRUCtURInG

william H newton on restructuring extant US investment arrangements of non-US persons

stRAteGY

david wynn on how to formulate an investment strategy in the current climate

PHILAntHROPY

Plum Lomax discusses how clients can differentiate themselves through philanthropy

International section sponsored by
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inside

domestic UK: IntestACY 71 Professor elizabeth Cooke and Joel wolchover outline the recommendations of a
domestic
UK: IntestACY
71
Professor elizabeth Cooke
and Joel wolchover outline the
recommendations of a recent Law
Commission consultation paper on
intestacy procedure
UK: BAnKRUPtCY
74
Margaret Rintoul discusses best
practice for distributing an estate where
insolvency is a factor
76
UK: FAmILY tRADInG
COmPAnIes
Lucy Johnson considers the best ways
for trustees to work with family trading
companies
UK: PeRsOnAL InJURY
78
david Crozier explains the
relationship between personal injury
compensation and financial planning
Domestic section sponsored by
Domestic section sponsored by
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inteRnAtionAL estAte PLAnning Caught in a trap Christopher Armstrong and Diana Hastings explain how inadequate

inteRnAtionAL estAte PLAnning

Caught in a trap

Christopher Armstrong and Diana Hastings explain how inadequate planning and confused post mortem strategy can permit a debatable application of foreign law to ensnare a foreign estate in a US estate tax trap

ABOUT THE AUTHORS (L-R) Christopher Armstrong TEP is the President of Christopher S. Armstrong, A
ABOUT THE AUTHORS (L-R)
Christopher Armstrong
TEP is the President
of Christopher
S. Armstrong, A
Professional Corporation
and Diana Hastings
TEP is a shareholder in
the firm of Friedman,
McCubbin, Spalding,
Bilter, Roosevelt,
Montgomery &
Hastings, A Professional
Corporation

Background facts

The Internal Revenue Service (IRS) assessed the Estate of Noordin M. Charania (Estate) for US federal estate tax (FET) on the full value of 250,000 shares of Citigroup common stock (the shares) held in safekeeping for Mr Charania (decedent) by Fortis Bank, Hong Kong when he died in 2002, notwithstanding that the decedent and his surviving spouse had resided from 1972 to 2002 in Belgium, a community property jurisdiction which grants each spouse an equal undivided interest in marital property absent a matrimonial property agreement. The decedent’s two-page will, executed in 1985, left such property as he owned at death as follows: one third to his spouse and one third to each of his two children, consistent with the requirements of Belgian forced heirship rules. The Estate’s contention that the decedent utilised funds earned while married and a resident of Belgium to purchase the shares was not challenged. The decedent and his spouse had both been born in Uganda at a time when it was still a protectorate of the United Kingdom. They married in Uganda in 1967, at which time Uganda was an independent country. They were expelled from Uganda by Idi Amin in 1972 on account of their Asian ethnicity. All of their assets within Uganda were confiscated, and they owned no assets outside Uganda. They migrated from Uganda to Belgium with the

intention of residing indefinitely in Belgium. By circumstance of birth the The Charanias

acquired UK citizenship, but they never lived in the UK during the decedent’s lifetime. The Tax Court held in Estate of Charania, 133 T.C. No. 7 (14 September 2009) that the decedent owned the whole of the shares (not merely an undivided one half) after determining that Belgian law in force from the time of the decedent’s marriage in 1972 until his death in 2002 would look to the law of the common UK nationality of the decedent and his spouse for the purpose of determining the matrimonial property regime to which they were subject throughout their marriage. This holding sustained the IRS’ determination of a deficiency in the Estate’s payment of FET in the amount of USD2,070,000.01. The Court also held that the IRS did not exceed its statutory authority when it assessed an addition to tax

in the amount of USD511,758.93 for failure to

file the FET return on time.

The Court held that the IRS did not exceed its authority when it assessed an addition to tax for failure to file the FET return on time

Choice of law

As a matter of ‘local law’, the UK adheres to

a regime of separate property for husband

and wife and for conflict purposes looks to

the doctrine of ‘implied contract’, i.e., absent compelling considerations the UK will treat a couple married in the UK as keeping the same marital regime throughout the duration of the marriage, regardless of residence. If a UK court

is required to determine the marital regime

applicable to spouses who were married outside the UK, it will place itself in the position of the court of the jurisdiction where the

marriage occurred and endeavor to replicate what that court would do (so called ‘foreign court’ theory, see De Nichols v. Curlier, 1900 A.C. 21 (HL) ). An example of this is that French community law applied to the determination of marital property rights of a UK domiciliary who had been married in France, because that is what a French court would do. Because the Estate agreed with the Commissioner that ‘ownership of matrimonial property is governed by the law of the common nationality of the spouses, in this case the United Kingdom’, and because neither Estate nor Commissioner were able to discern what marital property regime might have been prescribed by Ugandan law, the argument between the Estate and Commissioner focused upon whether a UK court, applying its foreign court theory, would hold that a Belgian court would adhere to the nationality test (and apply UK separate property law) or to a habitual residence test (and apply Belgian community law). The argument also concerned whether, to avoid application of the law of common nationality, the couple would have had to make formal application to a Belgian court to modify the original regime. Inexplicably, given the undisputed longstanding Belgian residence of the decedent and his surviving spouse, neither the Estate nor the Commissioner described for the Tax Court how the ownership of the shares was reported for purposes of Belgian inheritance tax, which applies to all assets of a deceased resident wherever located (see BNA TMP No. 953, §IV.C.2.a (2008) ). In the absence of such data, which one may infer would have been highly persuasive if presented, the Tax Court concluded that there was no evidence that a Belgian court would recognise mutability, even where marital domicile had changed permanently by reason of politically-motivated expulsion from the original matrimonial domicile, and that the failure to take formal steps to record

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a change of the governing marital property regime in Belgium was fatal to a claim

a change of the governing marital property

regime in Belgium was fatal to a claim of mutation. In consequence, for FET purposes, all of the shares were treated as owned by the decedent at death. There are two bases upon which the Tax Court could have applied ‘local’ Belgian law (viz., community property law) to the determination of the ownership of the decedent’s property acquired during his residence in Belgium, had it reasoned that

such action would be appropriate, taking into account all of the facts and circumstances. Substantial American judicial precedent holds that, when a federal court sits in

a non-diversity matter to determine a

federal question (which would include an interpretation of federal tax law), choices of law are determined by reference to a federal common law standard. Federal common law treats The Restatement (Second) of Conflict of Laws (1969) (the Restatement) as a source of general choice-of-law principles and as

an appropriate starting point for applying federal common law (see Harris v. Polskie Linie Lotnicze, 820 F.2d 1000 ( 9th Cir. 1987) and IRS FSA 33320960 (10/29/96). For example, citing with approval the application of federal common law to a choice of law determination in Chuidian v. Philippine National Bank, 976 F.2d 561, 564 (9th Cir. 1992). Local Philippine law applied here to determine illegality of performance of

a letter of credit. The Restatement, §258

expressly directs one to the ‘local’ law of the jurisdiction that has the most significant relationship with the spouses, and states that greater weight will usually be given to the state where the spouses were domiciled at the time the movable property was acquired, rather than to any other state that the couple may have had contact with. The Tax Court was correctly advised in briefs submitted by the Commissioner that Belgium did not adopt ‘habitual residence’ as the codified test for determination of rights to property acquired during marriage until 2004 and that a Belgian high court decision rendered in 1980 did hold that the law of common nationality determined the marital property regime and that a very controversial high court decision, rendered in

September 1993, did approve the husband’s nationality as the test for determining the marital property regime of an Italian husband and a Belgian wife married in 1952. Neither the Estate nor the Commissioner disclosed to the Court that the Charanias were resident in Belgium, at an evolutionary time during which Belgian courts had begun, as early as 1975, to apply a residence test to determine rights to assets, particularly when it would protect the interests of a spouse who had established residence in Belgium and integrated into Belgian society. See, Schoenblum, Multistate and Multinational Estate Planning (cch 2009), §10.24[a], fn. 716 (citing J.D.I. 1, 1996) which, under the heading ‘Matrimonial property regime – Primary Regime – Law of the Effects of Marriage’, asserts, with supporting citations, that several Belgian court decisions have considered a number of the provisions governing the foundations of spousal asset status: ‘…to be laws of immediate application to be imposed on all spouses established in Belgium, regardless of their nationality’ (emphasis supplied). See also McEleavy, The Codification of Private International Law:

The Belgian Experience, 54 Int’l & Comp Law Qtly 499, 504 (2005) The following is taken from that publication: ‘…one of the specific motivating factors which led to the call for codification [of Belgian private international law and formal adoption of the ‘habitual residence’ test] was a series of controversial and highly criticised decisions rendered by the Cour de Cassation on the law applicable to matrimonial regimes.’

Assessment of federal estate tax on US securities owned by a non-domiciled alien (NDA) at death

The controversy over whether the Estate should be taxed on the whole of the value of the shares at the decedent’s death, or only on one half, begs the question: why was there any FET at all assessable on the shares, given that the decedent was an NDA and that the shares were publicly traded securities of an international bank? Estate planners routinely engaged in the provision of services to NDAs that have investments in US intangibles know that

inteRnAtionAL estAte PLAnning

NDAs are liable for an ad valorem FET on stock of US issuers owned at death, at a flat rate tax of 45 per cent on aggregate value above USD1,500,000, without benefit of any meaningful applicable exemption amount,

or of a marital deduction (if the surviving spouse is a non-US citizen) without the use of

a qualified domestic trust. The FET may be avoided by NDAs through the interposition of a foreign corporation between the NDA and the securities of the US issuer, an act which transforms what the NDA directly owns from US situs property to foreign situs property (See RIA Federal Tax Coordinator R-8012 and Lawrence, International Tax and Estate Planning: a Practical Guide for Multinational Investors §3:2.3 (PLI). American tax policy towards NDA investors is schizophrenic. To encourage investment of capital by NDAs in the United States some provisions of the tax law show particular favouritism to NDAs. For example capital profits, which do not constitute fixed or determinable annual or periodic income, are wholly exempt from federal income tax when realised. Inter vivos gifts of intangible personality with a US situs, made even moments before death by an NDA, are exempt from federal gift tax and are beyond

the reach of FET, subject to certain traps for the unwary contained in IRC §2104(b). No FET is levied on fixed income securities that produce portfolio-interest-exempt income, or upon Treasury Bills or general bank deposits, or upon insurance policies on the life of a NDA who dies. The policy of encouraging investment by NDAs in the US is vitiated by levying a FET upon capital investment in the stock of a US corporation upon the NDA’s death, unless the NDA is knowledgeable enough to know to interpose a foreign corporation as a holding company and is willing to risk the cautions of commentators that the interposed corporation may be treated as

a mere nominee. For example, Stephens,

Maxfield et al., Federal Estate and Gift Taxation 6.04[1] (WG&L 2009). The Tax Court decision is in the process of being appealed to the 1st Circuit Court of Appeals in Boston.

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Document originally authored by Christopher S. Armstrong

S. Armstrong • Contact Christopher • List of Publications & Papers • Web Page: http://www.rmstrnglaw.com

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