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More About Living Trusts

(Article published in the Feb 1, 2006 issue of Manila Standard Today)

           As a legal tool, the most notable characteristic of the trust device is its utmost flexibility and consequent susceptibility to be molded according to the specific needs of particular users.  An English writer, Frederick William Maitland, is said to have written long ago, that trust “is an institute of great elasticity and generality…”  Austin Wakeman Scott, reporter on trusts for the American Law Institute, for his part says that “the purposes for which trusts can be created are as unlimited as the imagination of lawyers.”  Assuming you grant that lawyers do have great imagination, that is saying a mouthful about the flexibility of the trust device.

           But this defining feature of trust is also what makes it hard to define a trust.  And none illustrates this better than the current array of differing definitions of a “living trust”  in legal literature and regulatory issuances.

 Standard American reference materials on trust such as the multi-volume works of above-named Harvard Professor Austin V. Scott or of George Gleason Bogert of the University of Chicago as well as legal encyclopedias like Corpus Juris Secondum and American Jurisprudence 2d, uniformly refer to “living trusts” as a specie of trusts that is contrasted with “testamentary trusts”.  These authorities teach that trusts are always created through a conveyance of property; but, whether one is a “living” or a “testamentary” trust depends on when the conveyance takes effect.

              If the conveyance in trust is intended to take effect upon the death of the trustor (at times also called the “settlor”, or, in tax law, “grantor”), then the trust created is called “testamentary”.  “Testamentary” because the only act that the law allows to be effective only upon the actor’s death is called, and must be in a document called, a “will” or a “testament”.  In fact, present lawyers have fallen into the habit of calling the instrument memorializing such act as “Will and Testament”.

       But if the conveyance in trust is intended to take effect while the trustor is still living, then the trust is called, by its latin name, an “inter vivos” trust, meaning a trust effective among the living, or, in English, a “living trust”.  Obviously “living” does not modify “trust”, but instead refers to the state of being alive on the part of the trustor. 

 But even Americans do not strictly follow this trust law definition. Scott, in his Abridgement of the Law on Trusts, which is his one volume summary of his larger work, noted that “in recent years it has become quite common to create a trust inter vivos for the benefit of the settler himself for life with remainder to others on his death.  Trust companies have been quite active in suggesting the creation of such trusts, which they speak of as ‘living trusts’.

 Thus, while trust law gives “living trusts” coverage of any trust effective upon the settlor’s lifetime, trust business usage confined its scope to one where initial beneficiary is the settler himself and the rest of the trust’s beneficiaries step up upon his death.  This American trust practice’s meaning of “living trust” found its way in the Philippines in the early 90s when a Filipino lawyer, who, if I am not mistaken, was also a member of the Bar in California, sought a ruling from the Bureau of Internal Revenue on his own living trust.

 This lawyer and his wife were residents of Los Angeles, California, and, had an estate plan in the United States which consisted of a Pour-Over Will and a Revocable Inter Vivos Trust.  A “pour-over” will is one where the residue, after payment of taxes and debts and distribution of the estate to the heirs, is turned over by the executor (hence the picturesque name “pour-over”) to a previously existing trust.

 This previously existing trust that the lawyer and his wife created had himself and his wife as trustees and beneficiaries at the same time for as long as they lived, and, the trust corpus, upon the death of the survivor of them, was then to be distributed to named beneficiaries.  This was called their Living Trust.

 The question they posed to the BIR was whether the title over a certain piece of land that they held in their names in the Philippines could be transferred to their names as trustees of their Living Trust (in effect, they transferred to themselves as trustees what they owned on their own) without payment of the capital gains tax and the documentary stamp tax.

 The Bureau correctly noted that the change in the name of the title holder (from the names of the spouses as outright owners to the same names but this time as trustees) involved no actual transfer of the property.  Therefore, it ruled, in Revenue Ruling No. 086-92 issued on 19 March 1992, that no capital gains tax was due on the “transfer”.  Neither did the transfer attract the documentary stamp tax.

 The Bureau did not articulate why it conceded that there was no actual transfer of property when title was changed from the names of the spouses outright into their names as trustees.  But since the then Commissioner who issued the ruling was Jose U. Ong,  himself a successful estate planning practitioner prior his recruitment in the government service, I take it that he recognized the “living trust”, where for life the settlers were the trustees and beneficiaries at the same time, as a transfer described in Section 85(B) of the National Internal Revenue Code. 

 That section includes the interest in that trust in the settlor’s (or grantor’s) gross estate and thus, in a manner of speaking, does not consider the living trust of that kind to have involved a real transfer of property for purposes of the estate tax.  Hence, no capital gains tax and documentary taxes are due since no transfer was recognized by the estate tax law.

 Be that as it may, what is apropos to our subject is that the BIR itself had, in Rev. Ruling No. 086-92, accepted a definition of “living trust” that was at variance with strict trust law.

 And the BIR is not alone.  In its Memorandum dated 16 October 1990, which provided the current Chart of Accounts of trust entities, the Bangko Sentral ng Pilipinas defined a “living trust” as “a trust created by Agreement.  Under a living trust, the trustor creates a separate trust estate out of his general estate, to be managed by the trustee, for the benefit of the trustor and/or third person(s).”  We note two significant departures from main stream trust law and trust business practice, albeit American, as described above.

 First, the mode of creation of a living trust under the BSP definition is apparently by “agreement” as distinguished from by will.  This is not always the case as illustrated by Revenue Ruling No. 086-92.  An “agreement” involves two parties, different from each other.  The living trust in Revenue Ruling No. 086-92 had the same spouses as transferors and transferees.

 And second, the beneficiaries of a BSP living trust is “the trustor and/or third persons(s).”  The use of the shorthand  phrase “and/or” is, to say the least, confusing.  It suggests that a living trust may have only third persons as beneficiaries.  As described by Scott and illustrated in Revenue Ruling No. 086-92, the current usage of “living trust” in trust business practice requires a two tier beneficiary structure.  The first tier is always the trustor (and spouse, if any); the second is always  third person(s) because the second tier steps up only after the first dies.

 The point I am making is that the phrase “living trust” is notoriously imprecise in content. Authorities on trust law, the Bureau of Internal Revenue, and the Bangko Sentral ng Pilipinas would not necessarily mean the same thing in their use of exactly the same words.

 To minimize cheating in the eternal game of regulator and regulated, the first important step, I suggest, is to return to the traditional labels of “testamentary” versus “inter vivos” trusts.  The latter concept can then be further refined by an enumeration of its various categories useful and relevant to BSP’s concern to separate the true trusts from the deposits masquerading as trusts.  A later article will be devoted in this column to that endeavor.