Trusting the Process

KleptoCast 8: Casey Michel talks to the Tax Justice Network’s Andres Knobel about how trusts became the next frontier in dodging taxes and shielding assets.


By Casey Michel

Before last year’s Panama Papers revelations pulled back the veil on the financial secrecy innovations pushed by Mossack Fonseca, representatives from the firm met with one of their main clients in Jersey. Given the scrutiny facing individuals and organizations pursuing vehicles like shell companies to shelter assets, one of Mossack Fonseca’s lawyers, according to meeting notes, advised a different tactic. Clients, the lawyer said, should “go more for trusts and complicated structures.”

Indeed, the lawyer may have been on to something, especially as it pertains to keeping funds from investigators, governmental and otherwise. “Lots of the low-hanging fruit of the offshore industry has already been [covered], or is a thing of the past,” a journalist covering the Panama Papers recently told the Kleptocracy Initiative. Now, “journalists should be looking at trusts in particular.” And as a recent report from the Tax Justice Network – “Trusts: Weapons of Mass Injustice?” – notes, many of the refinements surrounding trusts have taken place not in traditional offshore tax havens, but in places like the United States.

While little has been written thus far about the these trust regimes’ transformations into vehicles for financial secrecy, trusts may well present the next frontier for not only shielding assets from tax requirements, but for those who, like many within Mossack Fonseca’s clientele, are looking to shuffle their kleptocratic gains for more nefarious purposes.

What’s Old is New Again

Unlike limited liability corporations or other, more well-known methods of asset protection, trusts date to the Middle Ages, in which elites would entrust goods and belongings to those in their stead. At their most basic, trusts involve a trio of actors: A settlor will transfer assets to a trustee, the latter of whom is then charged with managing such assets for the benefit of beneficiaries. Often, such mechanisms will be employed by parents or grandparents, who, as settlors, will tap an attendant lawyer as trustee to steward assets for the benefit of children or grandchildren, acting as eventual beneficiaries.

While trusts have existed for centuries, recent innovations surrounding both trusts and trust law have allowed secrecy provisions to not only notably expand, but have likewise allowed the settlors to wrest certain controls from the trustees – and even, in certain cases, act as the beneficiaries themselves. As Tax Justice Network’s Andres Knobel recently detailed, a host of boutique, novel trusts have developed over the past few years. Rather than acting as simple vehicles for passing along generational assets, trusts have suddenly developed into a means of secreting wealth. And now, as Knobel notes, trusts “allow wealth to be accumulated for centuries (reducing or avoiding inheritance tax in the meantime),” all the while deepening income inequality.

For instance, certain trusts now allow a “duress clause,” in which the trustee may ignore “any action or instruction” based upon foreign court actions. Likewise, a “flee clause” allows certain trustees to change addresses or even the trustee themselves under certain instances. As Knobel writes, such a clause “only requires the trustee to state on a piece of paper that the trust is now governed by [another] jurisdiction’s laws, or that the trustee is now [another] person, and – voilà – the trust has relocated to a jurisdiction thousands of kilometers away, with no registration or external approval.” Certain “self-settled trusts” even allow the settlor to act directly as the beneficiary – a clear “sham,” Knobel adds. Among such “sham” trust purveyors are traditional tax havens, such as the Cayman Islands and British Virgin Islands. Other jurisdictions with abusive trust regimes include the Cook Islands, Belize, and New Zealand. Many of these jurisdictions, Knobel writes, are “engaging in a race to the bottom … as they seek to drum up trust business.”

Bermuda of the Prairie

One of the more prominent developments vis-à-vis trust expansion over the past few decades deals with “perpetual trusts,” also known as “dynasty trusts.” Indeed, such trusts have gained notable traction in the U.S. – and allowed South Dakota, of all places, to become a “Bermuda of the prairie,” as Bloomberg wrote in 2013.

South Dakota’s growth into one of the primary international players in the trust industry stems directly from the state’s move in 1983 to repeal a provision placing a chronological cap on state-based trusts – effectively allowing “perpetual trusts” to take root. (A few years prior South Dakota also became the first state to repeal limits on interest rates.) As South Dakota’s Director of Banking, Bret Afdahl, recently told the Kleptocracy Initiative, “There’s no personal or corporate income tax in South Dakota, which is critical.”

In the 34 years since, South Dakota – along with, to lesser extents, Nevada and Alaska – has blossomed into one of the jurisdictions most often cited when discussing the growth of the trust industry, and the secrecy provisions therein. Indeed, as Afdahl said, in 1997 South Dakota’s governor enacted a “Trust Task Force,” comprised of private and public sector higher-ups alike, dedicated to monitoring and recommending legislation pertaining to the industry. (As one state legislator said, the “Trust Task Force” is “writing laws essentially for themselves.”)

However, where South Dakota’s trust industry has grown exponentially, so too have concerns about oversight and transparency. South Dakota has “creat[ed] laws that are conducive to a massive exploitation of a federal tax loophole,” Edward McCaffery, a professor at the University of Southern California’s Gould School of Law, told Bloomberg. “We have a tax haven in our midst.” As one South Dakotan in the trust industry said last year, “I was surprised at how many [accounts] were coming across that were formerly Swiss bank accounts, but they want out of Switzerland.”

Given that most of the funds come from out of state – and that, as Knobel detailed, trusts remain steeped in secrecy provisions – South Dakota legislators have also begun expressing concern about not only the monies entering the state, but the effect the industry has had on the state’s broader reputation. “We need adequate mechanisms to make sure people aren’t abused,” State Sen. Craig Kennedy recently told Kleptocracy Initiative. Added State Sen. Jason Frerichs, “If we’re caretakers, what are we giving up?”

Likewise, “perpetual trusts” have come under increasing fire from analysts for both their spiraling costs of administration and inability to deal with all future beneficiaries. After all, if the trust remains intact in a few centuries’ time, there may be thousands upon thousands of beneficiaries to deal with. A 2013 paper from University of Michigan Law Professor Lawrence Waggoner, revised in 2016, noted that “the American Law Institute recently declared the perpetual-trust movement ‘ill advised,’” with one additional analyst calling these types of trusts “loony.”

Thus far, though, there appears little pressure on jurisdictions like South Dakota – or Belize, or the Cayman Islands – to refine their trust oversight, if only because trust structures are necessarily opaque, and increasingly convoluted. “Is there concern [about transparency]? Sure,” Afdahl said. “But, you know, there’s a difference between confidentiality and secrecy. I think we do provide, as a state, confidential treatment of that information. Just like your bank account, I can’t walk into your bank and ask for your bank records as an individual. It’s the same thing as a trust.”

Knobel, meanwhile, believes trusts should be registered, with beneficial owners publicly disclosed. “[R]emember that nobody is obliged to set up a trust: if you want to obtain trust-based privileges and protections from society, then transparency is a minimal price to pay,” he wrote. Such a registry may be a ways off – but given the interest those at Mossack Fonseca clearly displayed about trusts, such a push for transparency appears not only likelier than a few years ago, but perhaps more important than it’s ever been.


Casey Michel has worked as a journalist and researcher in the United States and former Soviet Union. Follow him on Twitter @CJCMichel.