[Congressional Record Volume 141, Number 146 (Tuesday, September 19, 1995)]
[Extensions of Remarks]
[Pages E1804-E1806]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                             FOREIGN TRUSTS

                                 ______


                            HON. SAM GIBBONS

                               of florida

                    in the house of representatives

                      Tuesday, September 19, 1995

  Mr. GIBBONS. Mr. Speaker, I am introducing legislation today to 
prevent avoidance of our tax laws by individuals transferring their 
assets to foreign trusts. I am introducing this legislation because it 
responds to a real and growing abuse of our tax laws.
  The legislation that I am introducing today includes several 
provisions similar to proposals recommended by the President in his 
budget submission for fiscal year 1996. My proposal contains 
substantial changes to the proposals recommended by the President. 
These changes are largely in response to concerns raised by tax 
practitioners. In particular, I would like to thank the New York Bar 
Association for its thoughtful analysis of the President's foreign 
trust proposals. Many of their recommendations have been incorporated 
into the legislation that I am introducing today. Although I have made 
substantial revisions to the original Treasury proposal, the Treasury 
has indicated that it would support my bill as a reasonable approach to 
the problem of tax evasion through foreign trusts.
  Recently, we had a long debate over provisions designed to prevent 
avoidance of our tax laws by American citizens renouncing their 
allegiance to this country. During that debate, I became aware that 
many other wealthy individuals, while retaining their citizenship in 
this country, are abusing our tax laws by hiding their assets in 
offshore trusts or other accounts located in tax havens with bank 
secrecy laws designed to facilitate tax evasion. I feel that these 
individuals are worse than the expatriates because they are renouncing 
their responsibilities to this country while retaining the benefits of 
citizenship.
  Mr. Speaker, there is ample evidence that trusts and other accounts 
in tax havens are fast becoming a major vehicle for abuse of our tax 
system. In the Cayman Islands alone, $440 billion are on deposit with 
over 60 percent of this money estimated to be from United States 
sources (Barron's, January 4, 1993, pg. 14). Barron's estimates that 
there is more American money on deposit in the Cayman Islands than in 
all the commercial banks in California. In addition, Luxembourg has 
$200 billion on deposit from United States sources and the Bahamas has 
$180 billion from United States sources (New York Times, October 29, 
1989). Legal experts outside the United States told the Washington Post 
(August 7, 1993) that they were getting a 100-percent increase in the 
business of offshore transfers every 6 months. An article in the 
Washington Times (November 7, 1994) quoted a promoter of these schemes 
as stating ``only fools pay taxes in the United States.'' During the 
debate on the expatriate issue, there were constant assertions that the 
problem was neither large nor growing. That argument was dubious in the 
context of the expatriate issue but would clearly be erroneous in the 
context of foreign trusts. There is no question that the use of 
foreign trusts for tax avoidance is a problem that is both large and 
growing.

  U.S. taxpayers are required to file annual information returns on 
trusts of which they are the grantor showing the aggregate amount of 
assets in such trusts. However, the rate of noncompliance with these 
requirements is staggering. The IRS estimates that in 1993 only $1.5 
billion of foreign trust assets were 

[[Page E1805]]
reported. Treasury estimates that tens of billions of dollars of assets 
could easily be contained in foreign trusts created by U.S. persons. It 
appears to me that the rate of noncompliance exceeds 85 percent. While 
no legislation can ensure compliance by everyone, the Treasury 
Department estimates that my legislation would result in $3.4 billion 
in additional revenues over 10 years.
  Many of these trusts are asset protection trusts established to avoid 
our tort laws rather than our tax laws. One promoter of asset 
protection trusts claims to have transferred over $4 billion to 
offshore trusts. Although these trusts may not be established for tax 
avoidance, their creators quickly realize that there is no third-party 
reporting to the Internal Revenue Service and they conveniently fail to 
report the income as required. Although I question the use of these 
trusts for what is in effect self-help tort reform, my legislation will 
not stop the use of these trusts for asset protection but will ensure 
proper payment of tax on the income from these trusts.
  Mr. Speaker, I hope that the legislation that I am introducing today 
will be considered on a bipartisan basis. Neither party benefits when 
the public perceives that our tax laws can easily be evaded by wealthy 
individuals through devices such as expatriation or transfers to 
foreign trusts. We should be united in our efforts to ensure that there 
is maximum compliance with our laws. I am troubled by the fact that the 
Republican efforts to eliminate so-called waste, fraud, and abuse seem 
to be limited to programs for the poor and middle class. The 
Republicans decry the error rates in welfare programs and the earned 
income tax credit but do not seem to be bothered when wealthy 
individuals avoid tax through foreign trusts in tax havens.
  Mr. Speaker, the bill that I am introducing today responds to the 
problem of tax avoidance through the use of foreign trusts in four 
ways. First, the bill modifies the current law reporting requirements 
by increasing the penalties for noncompliance, by providing the 
Internal Revenue Service with access to information to appropriately 
tax the income of foreign trusts, and by requiring reporting of trust 
distributions and large foreign gifts. Second, the bill modifies the 
grantor trust rules to prevent U.S. grantors from avoiding the 
provisions requiring current taxation of trust income and to prevent 
the manipulation of the grantor trust rules by foreign grantors. Third, 
the bill prevents the use of foreign nongrantor trusts for tax 
avoidance by modifying the interest charge on accumulation 
distributions and by treating use of trust property as a constructive 
distribution. Finally, the bill provides objective criteria for 
determining the residence of trusts and estates and clarifies the 
treatment of trust migrations under current law. Following is a brief 
technical description of these provisions.

                       I. Reporting Requirements.


                            a. present law.

       Under current law, any U.S. person who creates a foreign 
     trust or transfers property to a foreign trust is required to 
     report that event to the Internal Revenue Service. Also, any 
     U.S. person who is subject to tax under the grantor trust 
     rules by reason of being the grantor of a foreign trust is 
     required to file an annual information return. Civil 
     penalties not to exceed $1,000 are imposed for failures to 
     comply with these reporting requirements.


                         b. reasons for change.

       Compliance with the existing reporting requirements is 
     minimal. Also, many foreign trusts are established in tax 
     havens with strict secrecy laws. As a result, the IRS is 
     often unsuccessful when attempting to verify the income 
     earned by foreign trusts.


                        c. description of bill.

       The bill makes the following changes to the reporting 
     requirements applicable to foreign trusts:
       1. First, the bill increases the penalty for failure to 
     comply with the current law requirement to notify the 
     Internal Revenue Service when transferring assets to a 
     foreign trust. The penalty for failing to comply with this 
     requirement would be increased to 35 percent of the value of 
     the property involved. The penalty would be increased in the 
     case of failures that continue after notification by the 
     Internal Revenue Service.
       2. Second, the bill makes a U.S. grantor of a foreign trust 
     responsible for ensuring that the trust files annual 
     information returns. The U.S. grantor would be liable for 
     penalties in the case of noncompliance.
       The bill also ensures that the Internal Revenue Service 
     will have adequate access to information to determine the 
     proper tax treatment of U.S. grantors of foreign trusts by 
     requiring foreign trusts with U.S. grantors to have an agent 
     in the United States to accept service of process. This 
     provision is similar to a current law provision requiring 
     foreign corporations with U.S. subsidiaries to have U.S. 
     agents.
       3. Third, the bill requires U.S. beneficiaries of foreign 
     trusts (including grantor trusts) to report distributions 
     from those trusts and be able to obtain sufficient records to 
     determine the appropriate tax treatment of the distributions.
       The bill would also require U.S. persons to report gifts or 
     bequests from foreign sources in excess of $10,000.

                        II. Grantor Trust Rules


                             a. present law

       Under current law, existence of a trust is disregarded 
     where the grantor or other person holds certain powers over 
     the trust assets. These rules, called the grantor trust 
     rules, result in the grantor or other person being subject to 
     current taxation on the income of the trust. These rules are 
     anti-abuse rules designed to prevent to prevent shifting of 
     income to beneficiaries likely to be taxed at lower rates.
       In order to prevent tax avoidance by transfers by U.S. 
     persons to foreign trusts, section 679 requires income from 
     assets transferred to foreign trusts to be currently taxed in 
     the income of the transferor even though he has no powers 
     over the trust assets.


                          b. reason for change

       Taxpayers have avoided the application of section 679 by 
     structuring transfers to foreign trusts as sales in exchange 
     for trust notes. Also, foreign persons becoming residents of 
     the United States often avoid section 679 by transferring 
     their assets to a foreign trust before becoming a U.S. 
     resident.
       Under existing grantor trust rules, a foreign grantor can 
     establish a trust for the benefit of U.S. beneficiaries and 
     avoid tax on the income paid to the U.S. beneficiaries by 
     retaining certain powers over the trust assets. The retention 
     of limited administrative powers is sufficient for this 
     result.


                         c. description of bill

       The bill makes the following changes to section 679 which 
     requires U.S. transferors to be taxed on the income of 
     foreign trusts:
       1. In determining whether a transfer qualifies for the 
     current law exception for sales at fair market value, debt 
     obligations of the trust or related parties will be 
     disregarded.
       2. A foreign person who becomes a U.S. resident will be 
     subject to tax under section 679 on the income of property 
     transferred to a foreign trust within 5 years of becoming a 
     U.S. resident.
       (3) If a domestic trust becomes a foreign trust during the 
     lifetime of a U.S. grantor, the grantor will be subject to 
     tax under section 679 on the income of the foreign trust.
       The bill provides that the grantor trust rules apply only 
     to the extent they result in current taxation of a U.S. 
     person. This provision would not apply in the case of 
     revocable trusts, investment trusts, trusts established to 
     pay compensation, and certain existing trusts. This provision 
     also would not apply where the grantor is a controlled 
     foreign corporation, personal holding company, or passive 
     foreign investment company.

          III. U.S. Beneficiaries of Foreign Nongrantor Trusts


                             a. current law

     1. Accumulation distributions
       A U.S. beneficiary of a foreign trust which is not a 
     grantor trust is taxed on the income of the foreign trust 
     only when it is distributed. If the trust accumulates income 
     and then distributes the accumulated income, there is an 
     interest charge imposed on the beneficiary to eliminate the 
     benefit of the tax deferral. The interest charge is based on 
     a 6-percent rate with no compounding and the distribution is 
     allocated to the earliest years with undistributed income.
     2. Use of trust property
       Under current law, taxpayers may assert that use of trust 
     property by a beneficiary does not result in an amount being 
     treated as constructively distributed to the beneficiary.


                         b. reasons for change

     1. Accumulation distributions
       To effectively eliminate the benefit of the tax deferral in 
     the case of accumulation distributions, the interest charge 
     should be based on market rates with compounding.
     2. Use of trust property
       If a corporation makes corporate assets available for 
     personal use by a shareholder, the shareholder is treated as 
     receiving a corporate distribution equal to the fair market 
     value of that use. In the case of domestic trusts, the 
     absence of such a rule affects only which person is liable 
     for the tax but not the amount of income subject to tax. 
     However, the absence of such a rule in the case of foreign 
     trusts can result in U.S. beneficiaries enjoying the use of 
     trust income without any tax.


                         c. description of bill

     1. Accumulation distributions
       For periods after December 31, 1995, the interest charge on 
     accumulation distributions would be computed using the rate 
     and method applicable to tax underpayments. Also, for 
     purposes of computing the interest charge, the accumulation 
     distribution would be allocated proportionately among the 
     prior trust years with undistributed income rather than to 
     the earliest of such years.
     2. Use of trust property
       The bill treats a loan of cash or marketable securities to 
     a U.S. beneficiary as a constructive distribution. The bill 
     also treats other uses of trust property as constructive 
     distributions in an amount equal to the rental value of the 
     property

                        IV. RESIDENCE OF TRUSTS


                             a. present law

       The Internal Revenue Code does not contain objective 
     criteria for determining whether an estate or trust is 
     domestic or foreign. Court cases and rulings have applied a 

[[Page E1806]]
     variety of factors in determining the residence of an estate or trust. 
     Also, the treatment of trust migrations under current law is 
     unclear.


                         b. reasons for change

       Because the tax treatment of an estate or trust depends on 
     its residence, it is appropriate to provide objective 
     criteria for this determination.


                         c. description of bill

       The bill would provide that an estate or trust would be 
     treated as domestic if a domestic court exercises primary 
     supervision over its administration and one or more U.S. 
     fiduciaries have the authority to control all substantial 
     decisions of the trust. In other cases the estate or trust 
     would be treated as foreign.
       The bill would also provide that, when a domestic trust 
     becomes a foreign trust, the trust would be treated as having 
     made a transfer for purposes of section 1491 of the Code.

                          ____________________