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The third man in the trust ring

(Article published in the Feb 15, 2006 issue of Manila Standard Today)

        It was a frothy head of black beer expertly poured by the bartender of the Top of the City in a frozen mug bearing the Icelandic “cheers”, “skál!” that made me say, three columns back, that what was going on between the Bangko Sentral ng Pilipinas (BSP) and the trust entities was a cat-and-mouse game.  Of course, that was an over-simplification.  The sober and somber truth is that there is a third player in game, more significant in role and rule than the other two: the bank client.

 It would take a multi-disciplinary approach, far beyond my undisciplined aptitude, to provide a thorough profile of the Filipino as bank trust client and how his predilections have shaped the configuration of Philippine law and regulation; I could, however, contribute to the endeavor a few observations and conclusions culled from the limited  confines of my experience with various trustors, here and abroad, for the last 35 or so years.

 Bank clients setting up trusts may be grouped into two classes based on their motivation for entering into the arrangement.  The first category consists of those who consider the trust arrangement as primarily a way, among many, of their parceling out their respective estates to different persons or entities.  Distribution ( also referred to in common law jurisdictions as “settlement”) of their estates in favor of their loved ones was in the long history of trusts the most common motivation of trustors, and it is for this reason that trustors are still in legal literature referred to as “settlors.”

 The second is composed of those who view a trust primarily as a vehicle for their investible funds, i.e. funds not needed for their personal maintenance and support nor for the conduct of their profession or business and hence available for placement in financial instruments, hard assets and other areas of investment.  Thus, members of this group are most demanding on questions of safety of capital, rate of return, portfolio risk, and similar issues.  It is in concession of this intent of their clientele that banks sometimes refer, quite oxymoronically, to funds placed in trust with them as “trust products.”










 In varying degrees, most bank clients want the best of all worlds when they set up trusts.  Thus, they want the properties they put in trust to enjoy the advantageous tax treatment given by law to property separated from the mass of their own holdings but they desire to continue benefiting from the properties as if they were still the owners.  They want to be formally known to have transferred property to the trustee but they try to retain, if not actually exercise, control over the activities of the trust.  Finally, they want to share in the upside profits of the trust’s placements but expect the trustee bank to be responsible for business losses should the placements turn sour.

 The Bangko Sentral is presently flabbergasted at apparently a significant number of trust entities which continue, despite categorical mandates from the regulations, to be either unable or unwilling to insist on their trust clients’ taking all to themselves the both the risks and rewards of their trusts’ investments. As a result, they surreptitiously take on some of the risks themselves.  Since methods of doing this are, by definition, underground like geological faults beneath our feet, the magnitude of the exposure of the banking system to the risk of adverse tectonic movements below the surface of reported financial statements  is beyond the BSP’s ability to calculate and prepare for.  Oh would that BSP Deputy Governor Nesting Espenilla had a powerful satellite imaging technology that can expose the moving plates hidden from view by the mountains of data reported to the BSP daily and warn of financial disasters before they occur!

 There is, however, a less high-tech way of taming the trustor and thereby easing the pressure on the trust entities to be aggressively “innovative” in meeting the demands of their clients. This is the approach taken by the tax authorities in handling trustors who want to appear, in order to avoid paying the income and estate taxes, to have parted with their property and at the same time in fact to enjoy its benefits like an owner. This approach is found in Chapter X, Sections 60 to 64, of Title II on the income tax and Chapter I, Section 85, of Title III on the estate tax.

 The provisions of the income tax and of the estate tax on trusts are not completely coordinated in some details, but the major thrusts are in the same direction.  The fundamental approach is not to declare the suspect arrangement as a non-trust but to simply deny to these dubious arrangements the benefits accorded to clearly bona-fide ones. 

 For example, a trust is supposed to require a transfer of property from the trustor to the trustee.  That element of transfer, however, is clearly diluted when a proviso is attached giving the trustor the right to revest the title to himself.  The response of Section 63 is, without saying that no trust was created, to require that the income be included in the gross income of the trustor for purposes of computing his gross income.  At the same time, Section 85(C)(1), also without saying that the transfer in trust was not valid, responds by including the “transferred” property in the gross estate of the decedent-trustor.

 The same posture is taken by Section 64 and Section 85(B) with respect to trusts whose income is either to be distributed or accumulated for the benefit of the trustor.  Secton 64, despite the transfer in trust over the property, attributes the income to the trustor.  And, despite said transfer, Section 85(B) in effect, for tax purposes, “transfers” back the trust corpus to the trustor.  In both cases, the trust is not invalidated; but the attempt to spare the trustor from liability for the income tax and estate tax (and at the same time create a situation that keeps the trustor owner-like) is nevertheless frustrated.

 The BSP, I submit, would do well to take the approach of the tax authorities.  In fact, it did follow that procedure partially in Sec.X407 of the Manual of Regulations for Bank when it enumerated characteristics of an arrangement that would make it a debt rather than a trust.

 It appears to me, however, that the regulation overstepped  its limits when it declared those arrangements “non-trust.”  In the first place, only the courts are legally competent to say which specific arrangement is a trust or not.  But, in the more practical realm, the declaration derailed the dialogue between the regular and the banks into a debate on what is and what is not a trust and distracted attention from the serious risk that debts posing as trusts were exposing the banking system to.

 In the current issue of “living trusts”, the more pragmatic approach is to totally prescind from saying whether an arrangement is a living trust or not.  Instead, the banks should be given a listing of what would make an arrangement, regardless of what it actually is or legally called, subject to reserves and treated like a debt.  In other words, the BSP should simply say that if an arrangement looks like a duck, walks like a duck and quakes like a duck, it is going to be roasted like a peking duck. And irrespective of whether it was raised in Peking or Ongpin, it’s a dead duck.

 

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