Because of its wealth protection features and favourable tax environment, trusts have become one of the most popular tools for family wealth planning. However, it matters what assets the settlor places in the trust– a mistake could easily undermine the favourable tax treatment of the trust.
A trust can fulfil several functions at the same time. On the one hand, it can shield the assets of a family or individual from the risks to which they are exposed (whether as managing director, owner or individual). On the other hand, it is also useful in inheritance and estate transfer situations: it helps to avoid some of the inheritance law restrictions imposed by the Civil Code (such as the allocation of a forced share), and can also resolve the deadlock created in the operation of a company by the delay in the probate procedure.
Trusts can also serve a number of tax purposes. Firstly, the assets placed in trust can obtain a tax-free step-up in their value at the time of transfer, so if they are subsequently sold by the trust, the owner or beneficiary will not incur any tax liability. Secondly, although the trust is basically taxed as a “standard limited liability company”, it can be made fully tax-exempt. As long as the trust functions as a kind of financial holding and realises financial income (e.g. receives dividends from a subsidiary, interest or capital gains from securities, or derives income from cryptocurrencies) only, the profits from its operations are fully tax-exempt. This is a distinct advantage of the trust over entities operating in the form of a company, as the latter only enjoy exemption from tax on the realisation of dividend income and, subject to certain administrative conditions, capital gains.
What happens if you put property in trust?
In general, the settlor wishes to transfer all or a substantial part of his assets to the trust. In more than one case, these assets include real estate properties or even a substantial property portfolio. However, putting property in trust may entail serious tax disadvantages.
Profit from the property (for example rent income or even capital gains from the sale of the property) is not regarded as financial income. Therefore, this income is not eligible for the tax exemption mentioned above. In addition, in such a case, not only the income from the property becomes taxable, but it also entails the tax liability of the profits from all other assets placed in the trust. Thus, if the trust has a financial profit of 950 units (which would be tax-free in itself), but also has rent income of 50 units, the latter income will make the whole of the 1,000 units of profits taxable.
How to avoid a tax disadvantage
The simplest way to deal with the above tax problem is, for the settlor, to transfer the company owning the property to the trust (i.e. to “package” the property into a company) rather than the property itself. In this case the trust will not receive rent income directly, but will only receive dividend income from the company, which remains tax-exempt. However, the disadvantage of this solution is that the income from the property will be subject to 9% corporate tax (and possibly also to local business tax) at the level of the company, and if the trust distributes this asset to the beneficiaries, they will pay an additional 15% personal income tax. In addition, if the property is not owned by a company already, "packaging it into a company" may also come with a tax obligation.
There is also the possibility that the individual settlor does not put the property in trust but holds on to it as an individual. The income from the property is taxed favourably for individuals – rent income is subject to 15% personal income tax, and the tax liability on capital gains derived from the appreciation of the property can be avoided altogether if the property is sold after 5 years. However, the extent to which such a solution can secure the settlor’s asset protection objectives needs to be considered.