Background – Everything Was Considered Except the Settlor’s Death
A Liechtenstein foundation, established by a settlor resident in Switzerland. The structure is straightforward: the settlor has reserved extensive rights for himself, including revocation, amendment of the by-laws, designation of beneficiaries and changes to the foundation board. For tax purposes, the foundation is therefore qualified as transparent: its assets are attributed to the settlor, and in Liechtenstein the foundation itself is subject only to the minimum income tax. The beneficiaries, his children resident in Switzerland and Germany, are to receive fixed annual distributions from the settlor’s death onwards.
So far, this is a set of facts many trustees will recognise in a similar form. As long as the settlor is alive, the structure works as intended. But what happens when he dies?
The Catch – A Foreseeable Event That No One Planned For Can Overturn the Tax Qualifcation
With the settlor’s death, his reserved rights lapse without replacement. The question this raises is fundamental: does the foundation remain transparent for tax purposes, or does it become opaque?
The answer has significant consequences. If the foundation is qualified as opaque, the foundation’s assets are no longer attributed to the settlor (or his estate), but to the foundation itself. In the worst case, the tax authorities in the settlor´s country of residence treat the transition as an event subject to inheritance tax, with tax rates that, depending on the jurisdiction, degree of kinship and allowances, potentially reaching as high as 40 per cent of the foundation’s assets.
At the same time, a change in status alters the ongoing taxation of the beneficiaries: what was previously considered a distribution from transparent assets may be qualified differently under an opaque regime, with consequences for the beneficiaries’ income tax in their respective countries of residence.
Our Approach – Subsequent Clarification Restored Transparency
In this specific case, the question was only raised after the settlor’s death, in other words at the worst possible moment. Nevertheless, a solution was found: through a careful analysis of the by-laws, the actual circumstances and the relevant case law, it could be demonstrated that the foundation was still to be qualified as transparent after the settlor’s death. A corresponding application was submitted to the competent tax administration and accepted.
Inheritance tax was thus avoided. The outcome was right, but the path to it was more laborious and uncertain than it needed to be. Had the qualification been reviewed during the settlor’s lifetime and secured by a ruling, the situation for everyone involved (foundation, beneficiaries and trustee) would have been considerably more comfortable and less costly.
The Role of the Trustee and Their Responsibility
One could argue that the tax qualification of the foundation after the settlor’s death is primarily a matter for the beneficiaries and their advisers. That is true, but only in part. As a governing body of the foundation, the trustee is the one who knows the facts earliest: he knows which rights the settlor holds, how the by-laws are worded and when circumstances change. If he fails to recognise the tax risk or to escalate it in time, this can come back to him: as a liability risk towards the foundation and the beneficiaries, as a reputational risk towards the client, and in the worst case as the loss of the mandate.
The decisive point: the window in which action can be taken closes with the settlor’s death. A subsequent solution is not ruled out, but it is considerably more difficult than proactive clarification and certainty through a ruling. Anyone who only reacts after the settlor´s death has already missed the best option.
The Early Warning Signal
The trigger is not the death itself, but any foreseeable change concerning the settlor: advancing age, illness, upcoming succession planning, but also an amendment to the by-laws or the revocation of individual rights. These are all moments when the trustee should pause and ask one question:
Has the tax qualification of this foundation been clarified for the event of death, and has it been secured?
If the answer is not clearly yes, this is the moment to bring in tax specialists, not after the
settlor´s death.
A foundation’s tax status does not last forever; it can be overturned by events and changes in the foundation’s structure. The trustee is in the best position to address such events proactively, but also bears the responsibility for doing so.
What Has Really Changed
Inheritance tax was avoided. For the trustee, however, the case meant even more: a topic that was previously not on the radar is now an integral part of mandate management. The question of tax qualification in the event of death is now raised proactively, during the settlor’s lifetime, not afterwards.
Or as the trustee put it:
We knew the foundation was well set up. But we weren’t aware that the settler’s death could change so much from a tax perspective. Today the situation has been clarified, and we have the certainty we didn’t have before.
Key Points at a Glance:
- The settlor’s death can fundamentally change a foundation’s tax qualification, with inheritance tax consequences potentially reaching as high as 40 per cent.
- The window for a proactive solution closes after the settlor´s death; an advance ruling is simpler, cheaper and more secure than subsequent clarification.
- The trustee is the first to recognise the need for action, and by escalating in time and protects the client and themselves.
- The early warning signal is not the death, but any foreseeable change concerning the settler: age, illness, succession planning.
About the Author
Franz Wegscheider specialises in cross-border tax advice with a focus on Liechtenstein, Germany and Switzerland. A particular focus of his work is the tax support of foundations and trusts, from establishment and ongoing management through to succession planning. His aim is to identify tax risks at an early stage and develop solutions that are sustainable in the long term and legally sound.
