Recognition of Foreign Trusts in Ukraine and Use of Trust Structures by Wealthy Ukrainians
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The international tax planning of Ukrainian business is rather straightforward due to a degree of inexperience among Ukrainian tax and other interested authorities in relation to the application of international tax concepts and practice. It is common practice for Ukrainian business to use holding, trading, financing or licensing companies registered in countries with appropriate tax treaties which enabled a high level of confidentiality through the nominee relationship arrangement and efficient tax planning for foreign structures. However, the OECD’s BEPS (anti-tax avoidance) and CRS (automatic exchange of information) trends lead to transparency and push offshore business owners to take all required measures to assure transparency of their structure. For example, subject to new changes in Ukrainian legislation all Ukrainian legal entities and banks are required to disclose publicly information about their ultimate beneficial owner (UBO).
Earlier, wealth planning was not very popular among wealthy Ukrainian families because most concepts and instruments were quite complex and unknown. Also, traditionally, confidentiality and asset protection based on using offshore jurisdictions were simple and inexpensive. However, the beneficiary owners of business structures are getting older and interest in succession planning and using trusts is rising among Ukrainian high-net-worth individuals (HNWIs). In Russia this trend started a couple of years ago and is now very popular among HNWIs.
Notwithstanding that foreign trusts are used by Ukrainians in practice, analysis of the legal consequences of such practice has received little attention from legal practitioners. For example, it is a real life scenario when upon the death of Ukrainian businessman, his widow and children bring a lawsuit against the child of his first marriage in a Ukrainian court and claim that the setting up of the offshore trust with such child as the sole beneficiary violates the forced heirship provisions of Ukrainian civil law. 1 This is no easy case for a Ukrainian judge because Ukraine has not ratified the Hague Convention on the Law Applicable to Trusts and on their Recognition of 1 July 1985 (the Hague Convention).2 So, the Common Law concept of a “trust” does not exist formally in Ukrainian legislation. Also, there is no judicial practice of the Supreme Court of Ukraine how courts would resolve such cases regarding trusts.
The Possibility of Recognition of Foreign Trusts in Ukraine
Ukrainian civil law only has the concept of “estate administration” 3 which is often (erroneously) translated into English as “trust”. However, this concept and Anglo-Saxon common law trusts have differing natures and are used for different practical purposes. For example, an estate administrator cannot dispose of the estate without the owner’s consent and this agreement automatically terminates with the owner’s death. So, these provisions of Ukrainian civil law effectively prevent the setupping of a testamentary trust involving assets located in Ukraine under domestic law.
In accordance with the provisions of the Act of Ukraine On Private International Law (the Act), the determining of the term “trust” can be made by Ukrainian courts and legal practitioners on the basis of foreign law. 4 Taking into account the different definitions of the “trust” amongst the various jurisdictions, the concept in Article 2 of the Hague Convention is the most appropriate. Thus, a trust has the following characteristics: the assets constitute a separate fund and are not a part of the trustee’s own estate; title to the trust assets stands in the name of the trustee or in the name of another person on behalf of the trustee; the trustee has the power and the duty, in respect of which he is accountable, to manage, employ or dispose of the assets in accordance with the terms of the trust and the special duties imposed upon him by law.
In addition, the Act allows for the application of foreign law to the relations with the participation of Ukrainian persons complicated by a foreign element5, provided that its application does not contradict the so-called “mandatory norms” of Ukrainian legislation6 or public order in Ukraine7. Consequently, despite the absence of the concept of “trust” under applicable laws of Ukraine, a foreign trust where the trustee or the beneficiary or the assets are located outside of Ukraine as a legal “relation complicated by a foreign element”, shall be subject to the choice-of-law rules of the Act and can be recognized in Ukraine. 8
Forced Heirship Provisions as Mandatory Rules
The provisions of Article 14 para 1 of the Act may effectively impede the recognition of foreign trusts in Ukraine when the conditions of such trust would interfere with the mandatory rules of Ukrainian legislation. In this case, Ukrainian courts should determine on a case-by-case basis whether certain provisions shall be considered to be “mandatory”. For example, Ukrainian civil law states9 that some categories of heirs-at-law have the right to succession irrespective of the will. Such mandatory heirs inherit half of the shares in the decedent’s estate that would have belonged to them in case of by-law succession.
So, it is most likely that these forced heirship provisions will be recognized as “mandatory” rules and Ukrainian courts would refuse to apply the foreign law governing the trust and conclude that the share of the assets received by the beneficiary of the trust which corresponds to the mandatory share of mandatory heirs still constitutes part of the testator’s estate. Consequently, the beneficiary may be required to return to the mandatory heirs the respective parts of these assets or to repay them its value.
Family Agreement and Spousal Consent
Ukrainian family law10 provides that spouses, a child’s parents, other family members and relatives whose relations are governed by the Family Code of Ukraine may regulate relations between them upon agreement unless this is not inconsistent with the provisions of Ukrainian laws and morals in society.
If the executor of the trust is married and lives with his/her spouse in Ukraine and the assets which he/she intends to transfer to a trust have been acquired during the marriage, Ukrainian family law requires notarized spousal consent for alienation of family assets in certain cases. 11 Since any transfer of assets into a trust shall be viewed as their “alienation”, these rules may serve as grounds for challenging these transfers in such cases where the spouse was not aware of the creation of a trust.
Public Order of Ukraine
Under the Act a provision of foreign law shall not be applied when the consequences of its application would openly contradict the fundamentals of public order of Ukraine. In such case the respective provisions of Ukrainian law shall be applied if necessary.12 Decree No.12 of 24 December 1999 of the Plenum of the Supreme Court of Ukraine specifies that public order should be understood as the legal order of the state, the determining principles and basis, as being fundamentals of the existing state order, and connected with its independence, integrity, inviolability, main constitutional rights, freedoms, guarantees, etc. Thus, the refusal to apply a provision of foreign law cannot be justified solely by the differences of their respective legal systems. So, the absence of the concept of “trust” in Ukrainian legislation should not be used to refuse their recognition on the basis of the public order clause.
In summing up, trusts may be recognized by Ukrainian courts in case of a possible dispute but the appropriate case law in respect of trusts is absent. So, direct contribution of Ukrainian assets to a foreign trust, especially if the change of ownership requires state registration, may be prone to attack. It is recommended to transfer such assets to a trust via an intermediate holding company registered in the countries with appropriate tax treaties.
It may also cause problems in Ukrainian courts with avoiding forced heirship provisions as mandatory rules. In this case, prior to the creation of a trust all the members of a family and mandatory heirs have to compile a written and notarized family agreement and consent to the setting up of such a trust and the legal waiving of their right to file a claim with a court based on the above forced heirship provisions in future after the death of the executor.
Structuring business assets using trusts with a clear UBO can help Ukrainian business to become more transparent for an IPO or other corporate restructuring or seek funding from Western financial institutions where a standard part of the compliance is the confirmation of legal ownership, as evidenced by adequate legal documentation.
Where assets are held personally by Ukrainian HNWIs, on the death of the relevant individual, forced heirship provisions as they apply in Ukraine will dictate the devolution of the assets. Where assets consist of shares in an underlying business this may create succession and management issues for businesses that have been built over a lifetime. Thus, a properly settled trust structure may help to protect the interest of the heirs and allow for a business to continue without unnecessary disruption because it is not formal succession but merely changes the person who controls the underlying companies and does not require wills. Furthermore, such a structure may help to protect assets from potential creditors and avoid inheritance tax. A trust would also be an answer to potential Ukrainian anti-tax avoidance rules similar to current Russian CFC rules.
2 Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition, available at http://www.hcch.net/index_en.php?act=conventions.pdf&cid=59.
3 Article 1029 of the Civil Code of Ukraine
4 Articles 2, 4 and 8 of the Act On Private International Law.
5 Articles 2 and 4 of the Act On Private International Law.
6 Article 14 of the Act On Private International Law.
7 Article 12 of the Act On Private International Law.
8 Articles 2, 4 and 27 of the Act On Private International Law.
9 Article 1241 of the Civil Code of Ukraine.
10 Article 9 para 1 of the Family Code of Ukraine.
11 Article 65 of the Family Code of Ukraine.
12 Article 12 Part 1 of the Act On Private International Law.