Living in a foreign country can come with a host of challenges. Foreign people Living in Japan know this to be especially true. For many people, tax laws can be among the most difficult challenges to navigate, but if you’re from a common-law country such as the U.K., the U.S., or Australia, tax issues become even more difficult. One aspect that stands out as particularly challenging for foreign residents in Japan is the issue of trusts. If you are somehow involved in a trust from a common law country, you may be in trouble.
What Is a Trust?
A trust is a contract that involves three parties: the settlor, trustee, and beneficiary. The settlor transfers ownership of their assets (known as property) to the trustee, who holds the legal title to the property but not for their own benefit. Instead, the trustee holds the title for the benefit of the beneficiaries, as determined by the structure of the trust. Most trusts can be broadly categorized into two groups:
- -Living Trusts: Also known as inter-vivos trusts, these trusts are established while the settlor is still alive.
- -Testamentary Trusts: these are created in a person’s will and become active only after their death
Within these two groups, there are many different types of trusts. Each type serves a specific purpose and has distinct attributes that make it useful in certain circumstances.
What Are the Benefits of Trusts?
Personal trusts have become popular for affluent people in common-law countries. A trust can provide a number of benefits for individuals who want to protect their assets. Such benefits include:
- –Asset protection: Trusts can protect assets from creditors, bankruptcy, and lawsuits.
- –Estate planning: Trusts can help individuals plan for the distribution of their assets after death, reducing the tax burden on their estate.
- -Privacy: Trusts can be structured to keep the ownership and distribution of assets confidential.
- –Control: Trusts allow individuals to have control over how their assets are managed and distributed, even after their death.
- –Flexibility: Trusts can be customized to fit the unique needs and goals of each individual.
- –Continuity: Trusts can provide for the continuous management of assets, even after the death of the Settlor.
- –Special needs planning: Trusts can be established to provide for the financial well-being of a family member with special needs.
Trusts can be a useful tool for estate planning and asset protection. Unfortunately, this utility often does not extend to people in Japan. In fact, being involved in a common law trust can cause significant problems.
Why Are Trusts Problematic for People Living in Japan?
Trusts are a legal structure governed by the common law system. In contrast, Japan operates under a civil law system and does not recognize trusts as valid legal entities. Trusts are technically recognized in Japan, but there are significant differences between Japanese trusts and common law trusts due to differences in legal systems.
Personal trusts are not widely used in Japan, as wills are typically used for estate planning purposes. When they are used, the terms are standardized and simplistic, rendering the assets involved either as gifts or taxable income. There is no separation between the “legal owner” and the “beneficial owner” for the purpose of Japanese tax. This creates two nightmare scenarios:
- 1) Gift Tax
If assets are transferred into a trust for which you are a listed beneficiary, the Japanese NTA will look upon the transfer as a “gift” to you, the beneficiary. These assets would then be subject to Japan’s significant gift tax rates. These taxes can claim as much as 55% of the value of the transferred asset.
- 2) Income, Dividend, and Capital Gains Tax
As the beneficial owner of trust assets, any traditionally taxable event occurring inside the trust, despite probably being tax-exempt in the country where the trust is domiciled, will be taxable for the purpose of Japanese tax. The result is that any investment income, dividends, or capital gains arising from distributions or asset sales within the trust will create a tax obligation for the beneficiary in the same way it would have done had they owned the assets personally here in Japan. In other words, the tax protections that a trust would typically provide are destroyed.
How to Deal with Foreign Trusts if You Are Living in Japan
If you are setting up a trust in a common law country, it is crucial to understand all of the potential legal implications of trying to manage a trust while living in Japan. If you are already connected to a foreign trust, you may already be facing the challenges that come with a conflict of law and are probably in a non-compliant position, which needs to be fixed. Either way, you should know all of your options so that you can find a way to protect your assets without (more) legal and tax risk.
A financial advisor can provide valuable advice on the tax implications of managing a trust from Japan and help you navigate the complex legal landscape. An experienced advisor can provide a better alternative through which to protect investments, and help those connected to foreign trusts manage their assets in a way that is tax efficient and compliant with Japanese rules. Don’t put your family’s property at risk of excessive taxation. Speaking to an expert now could save you a world of frustration.