Trusts have been around for a long time. Even though the Dubai International Financial Center (Dubai International Financial Center - DIFC) and the Abu Dhabi Global Market (Abu Dhabi Globla Market - ADGM), both free zones with their own individual legal systems, have introduced trusts only in recent years, trusts and similar legal instruments have a long history, covering many legal systems.

The trust most familiar to both practitioners and businessmen is probably an English common law trust. Trusts originating in medieval England, where nobles who went on crusades had to temporarily transfer their lands to guardians, have turned into a legal instrument that provides tax-efficient protection and wealth growth. Similar legal mechanisms exist in civil law, such as stiftung, and in sharia law, such as waqf.

Taxation

Taxation of trusts is not a simple matter. Since a trust is a relationship, not a person, it doesn't quite fit into the categories of individuals or corporations. In addition, even though the trustee has legal ownership of the assets of the trust, the assets do belong to someone else, that is, the beneficiary or beneficiaries.

Despite this, most jurisdictions treat trusts as individuals for tax purposes and require the trustee to file a separate tax return on the trust, different from his own tax return.

In the UAE, trusts are not subject to income tax. This is not because trusts have a special status, but simply because only oil companies and branches of foreign banks pay income tax at the emirate level in the UAE, and no other corporations or individuals.

However, in order for the trust to be a resident of the UAE, we need to carefully study the composition of the participants who make up the trust relationship.

As a rule, the founder is the least important figure in the trust. This may seem counterintuitive, since the founder contributes assets to the trust, but often this initial contribution is nominal, and other entities, such as family members, later contribute cash or other assets to the trust. For this reason, the founder may disappear from view as soon as the trust is created, even though, as a rule, the founder must contribute to the trust.

The founder – or depositors – of a trust become objects for tax purposes if they reside in a taxable jurisdiction. Very often, a contribution to a trust, whether in cash or other property, leads to the alienation of taxable property for the depositor or entails the payment of gift tax. It is recommended to consult with your tax advisor before making any contributions to the trust.

Conversely, the trustee– or trustees– are crucial to the trust. Just as the residence of a corporation is determined by where its head office and management are located, and not necessarily by the charter under which it was established, the residence of a trust is determined to a large extent by where its trustees live.

This may lead to conflicts between jurisdictions that claim the trust as a resident. Fortunately, tax agreements can help smooth out these disputes.

Place of residence of the trustee

Many jurisdictions allow the creation of trusts and similar instruments. However, the jurisdiction under which the trust is created is not decisive for the jurisdiction of which the trust is a resident.

For example, ignoring the application of tax agreements, a trust established under California law, but in which all trustees are residents of Ireland, is likely to be subject to income tax in Ireland, and not in California. In addition, depending on the domestic legislation applicable to the beneficiaries, the tax may be paid where the beneficiaries are located and receive payments.

This principle is of great importance for DIFC and ADGM trusts due to the desire of the trustees and beneficiaries to maintain the UAE tax regime with respect to income and distributions. If a DIFC or ADGM trust eventually becomes a resident of a taxable jurisdiction such as the UK or the USA, then the desired status in the UAE may be lost.

The best scenario for a DIFC or ADGM trust is the presence of one or more UAE citizens (provided that they intend to remain residents of the UAE) or corporations or foundations established in the UAE as trustees. This ensures that even if the beneficiaries of the trust are not residents of the UAE, the trust can continue to receive income and accumulate capital without being subject to taxation.

For foundations, it is somewhat easier to determine the place of residence since the foundation is a legal entity. However, if a person who is not a resident of the UAE exercises control over the fund, this jurisdiction may consider itself the residence of the fund.

Who can act as a proxy?

The presence of a trustee resident in the UAE does not mean that the corporation should be created specifically to act as a trustee. There are many professional corporate trustees in the UAE who provide stability and good governance. By definition, the trustees have fiduciary duties towards the beneficiaries, but must also respect the wishes of the founder, which are usually set out in the trust document. Very often, trusts also appoint a defender with the authority to advise or replace the trustees. This is especially important in the case of discretionary trusts, when the trustee determines which payments to make to the beneficiaries.

What is crucial when choosing a trustee is good communication with the beneficiaries and the defender (if any) and maintaining consistent management and permanent residence.

Unlike the broad powers often granted to the trustees of the trust, the founder of the foundation can provide very detailed instructions that the Foundation Board is required to follow, which makes the foundation an interesting option for some individuals.

How long has the trust been in existence?

Many people have heard about the famous 21-year rule, or, as lawyers call it, the rule against indefinite periods. The 21-year rule is newer than trusts – it originated from court cases heard in England in the 15th and 16th centuries, where its purpose was to limit the ability of the founder to keep assets in the trust indefinitely after death. The application of this rule has been excluded in both the DIFC Law and the ADGM Law.

Many jurisdictions have incorporated the 21-year rule into their tax laws, which has led to an estimated capital gain of the trust's assets on the 21st anniversary of its existence. As a rule, the trustees plan this by distributing funds before the anniversary. However, in the UAE, where trusts are not taxed, there are no such restrictions, so a trust in the UAE does not require asset allocation before its 21st anniversary to avoid taxes.