crowther exlains the tax and legal position of investors in various investment structures
Increasingly, investment managers (whether providing execution-only, advisory or discretionary services) insist that investors hold their investment portfolios through the investment manager's nominee company rather than in certificated form. But what exactly is the legal and tax position of such an arrangement and is it a time bomb waiting to explode?
The acts of an investment manager in respect of an investment portfolio held by themselves as nominee are treated as the acts of the investor, the principal. As nominee, the investment manager is a mere passive repository of the portfolio with nothing to do except obey the principal who retains full equitable ownership. All income and gains arising on the portfolio are the principal's for income and capital gains tax purposes and the portfolio is the principal's for wealth tax/estate duty/inheritance tax purposes.
The split between legal and beneficial ownership of an asset occurs in its most elementary form where the nominee has a legal title on behalf of the principal. The nominee can give good legal title and third parties are not bound to inquire into the beneficial ownership of the asset in question. This is particularly so with regard to the bon-fide purchaser for value whose favoured position in this and other respects has led to them being labelled equity's darling.
Third parties who have not given value are more exposed. If the nominee's behaviour in transferring the asset to them represents a breach of trust then the true beneficial owner can try to trace the asset in question into the third-party's hands. As the third party has not given value, they are labelled a volunteer and equity will not assist a volunteer, which means that equity will cheerfully see the third party deprived of the asset they received in favour of the true beneficial owner.
On the principal's death the nominee holds as bare trustee for either the executor, if there is a will, or for heirs at law if there is no will. In jurisdictions where the concept of executorship is unknown or ill-developed, the nominee may be holding for the beneficiaries under the will. The problem for the nominee is to ascertain exactly who the new principal is and whose instructions they should take in respect of the investments for which they are nominee.
In the legal systems of the developed world there is a broad consensus that a deceased's movable property falls to be distributed according to the rules of their personal law. That personal law may be defined by reference to the relevant connecting factors of nationality, residence or, in the common law world, domicile. Individuals with international associations may satisfy several, or no, such tests with regard to the establishing of their personal law. In these circumstances, complex rules of private international law come into play and there will be delay and expense before the appropriate law can be determined which will govern the validity of any wills and the distribution of the estate.
Another problem can be that a testator's moveable estate will be governed by the relevant connecting factors at the time of death rather than those at the will-making date. Thus the effect of the Will may well change if the testator subsequently changes domicile, habitual residence or nationality or the location of assets.
As a result, a nominee who agrees to transfer securities on the instructions of an executor only on sight of the deceased's will and death certificate could be putting themselves in a difficult position and would be exposed if another executor appeared with another will and an official grant of probate.
There are various ways around these quandaries all of which involve some degree of alienation of the property from the principal during his lifetime:
• The use of 'thin trusts'.
• Specific instructions in the nominee agreement.
• The use of offshore holding companies.
• The use of trusts.
A nominee agreement can be drafted to make provision for the transfer of beneficial ownership of an asset after the death of the original principal so long as it is a properly constituted trust when it will be an inter vivos disposition and remove the asset from the principal's estate. The agreement must make provision for the principal to enjoy an interest during their life and clearly identify the beneficiaries who should take over after death.
Such a trust would be in the form of short life interest trust for the principal with a power to appoint capital during their lifetime and with specific named individuals to become beneficiaries after the principal's death. Any doubt arising as to the identity of the post-death beneficiaries will undermine the validity of the agreement as a trust and create the danger that it would be seen as a quasi- testamentary disposition, i.e. a quasi-will. Since there are strict legal requirements in order for a will to be valid the agreement may prove invalid as a will and so fail completely to achieve its objective. What is worse the nominee may find that they have been guilty of intermeddling with the estate, which can have serious consequences.
The use of an offshore holding company to hold international assets does not itself avoid probate but may well limit the requirement for probate to the transfer of the shares in the holding company in the territory in which the company is registered. However, since probate is required only in respect of the shares in the holding company and not in respect of the underlying portfolio, the nominee is wholly "off the probate hook" since they can continue to take directions from the directors of the company. The death of the beneficial owner of the company does not affect who the principal is as far as the nominee is concerned.
A will executed under the law of the offshore centre where the offshore company is registered should be put in place by the individual so that probate can be taken out by the executors in the centre on the individual's death and the shares in the offshore company transferred accordingly. Depending upon the connecting factors of the individual, it may be that forced heirship rules and inheritance tax/estate duties apply and again it will be important for the individual to ascertain exactly what their position is vis a vis the territories they are connected to before entering into these arrangements.
If the shares in the offshore company were held by a trust then probate can be avoided altogether. When the original owner dies, the executors appointed under the will would need to apply for probate in the centre and once this had been granted then the shares in the original beneficial owner's name would be transferred into the names of his legatees under the will. The only effect on the nominee would be that a new arrangement might have to be set up in respect of any advice to be taken from the new beneficial owner(s), which would obviously be subject to the confirmation of the directors of the offshore company.
Rather than employing any of the above solutions the view can be taken that by transferring investments to a nominee the principal has created a new asset in the form of a chose in action, or a right, against the nominee rather than the securities themselves and that it would be sufficient for him to execute a Jersey will covering the disposition of this chose in action. Whether or not this view is correct may, ultimately, be a matter for the offshore centre's courts, but great caution should be exercised in this respect in the meantime.
The increasing use of nominee arrangements for investment management may well tempt individuals to hide behind the nominee's name. This would be yet another example of pushing the use of an ownership vehicle beyond its proper limits. However, in the case of the use of a nominee it may well be not only the individual and their heirs but also the nominee who could be storing up trouble for themselves.
Nominee arrangements can speed up trading and may become an essential requirement for securities trading. However, many quoted companies refuse to look behind the nominee and consequently deny the perks associated with being a shareholder to the beneficial owner. An increasingly attractive alternative to using a nominee is for the investor to become a sponsored member of Crest (there are over 20,000 members compared to 1,000 in 1997) but this too can have its drawbacks since it excludes investment in some UK and many foreign shares.
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