Another Panamanian Foundation Link
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I. BRIEF OVERVIEW
The Panamanian Foundation of Private Interest, passed into law by the Panamanian legislature as Law No. 25 of June 12, 1995, is a legal entity that was developed based on the Private Interest Foundation models from three different jurisdictions including the Principality of Liechtenstein, Switzerland, and Luxembourg. The Panamanian Government carefully designed the Panama Private Interest Foundation with the intentions of creating a more modern, more flexible, and more affordable estate-planning vehicle for people from around the globe. Since becoming law in Panama in 1995, many financial planners, both domestic and international, have begun incorporating Panamanian Foundations into planning and estate structures as a means of increased asset protection and confidentiality for assets based in the U.S. and other jurisdictions.
There is no ready definition acceptable to U.S. persons that describes with clarity what a Panamanian Foundation is. It can be best described however, as what it is not. It is not a trust, revocable or irrevocable, domestic or foreign. Neither is it a corporation, either for-profit or charitable. It is not a “private foundation” as defined pursuant to Internal Revenue Code, Section 509(a), (an organization funded by contributors unrelated to its purpose and which makes grants to organizations that conduct charitable activities), not performing the activities itself). The Private Foundation may be defined as a legal entity that, in simplistic terms, connects two operations: 1) a donation plus a trust, with, 2) formation of a legal entity similar to a corporation pursuant to Panamanian law. It is, however, an entity that may qualifiy as sui juris (i.e., it can own and hold title to property in its name and can sue and be sued). In other words, the Foundation is considered a legal person whose existence and identity are entirely separate from that of its founder or of any other person; consequently, the legal identity and property, including real estate, of a Foundation are separate and independent from those of any Founder or any other person. Putting it another way, the dual nature of the entity, (i.e., a trust and a corporation), allows the beneficial aspect of each hybrid part to work to the benefit of the entity as a whole. As an example, its trust nature would allow it to manage bank and securities accounts, distribute present and future income as well as effect transactions on a stock market. Its corporate nature allows it to be a holding vehicle of subsidiary companies, to control and exercise the rights of shareholders and to own real property it its own name. It gains “its life” or legal recognition as an entity through the filing of a Foundation Charter (analogous to Articles of Incorporation for corporations) in the Panamanian Public Registry (Oficina de Registro Publico de Panama).
A Private Interest Foundationbrings balance to your offshore structure - It is the essential part that creates a more substantial and protective entity of your offshore presence - Used in harmony with other established entities (corporations, trusts, partnerships, holding companies, etc.) asset and estate planning are given a more stronger arm with the use of Panamanian Foundations.
II. BENEFITS
There are no minimal capitalization requirements. Although under Panamanian law the stipulated amount found in most charters of US$10,000 , a Foundation can be capitalized with any amount of cash and/or property.
¨ The assets placed in the Foundation are not subject to attack by beneficiaries, creditors, third parties and cannot be seized, attached or encumbered.
¨ There are two types of Foundations: Irrevocable and Revocable; virtually all foundations created from a U.S. perspective are irrevocable.
¨ The parties to the Foundation may form a Supervisory Committee or “Protector” which operates as the “watchdog” of the managing committee of the entity on behalf of the Founder.
¨ The Foundation is similar to a corporation to the extent that its duration is perpetual; however, there are no shareholders, officers or directors to a Foundation.
¨ Used in harmony with other established entities (corporations, trusts, partnerships, holding companies, etc.) asset and estate planning are given a more stronger arm with the use of Panamanian Foundations.
¨ As of the preparation date of this summary (November, 2003), the U.S. Internal Revenue Service has not specified Foundations of Private Interests as an entity to which reporting requirements for interests, income, establishment or beneficial ownership are mandated. Needless to say however that in an appropriate case, the service will argue that, by analogy, U.S. persons must report (on forms yet to be designated) their involvement with foundations in the same manner that involvement in other foreign entities require . From a planning aspect for those desiring non-reporting criteria, creative structuring should strive to minimize U.S. contacts with the foundation.
III. FORMATION AND ORGANIZATIONAL STRUCTURE
The following elements that form the foundation and its structure are as follows:
¨ THE FOUNDER – may be a natural person or entity that gives that is deemed the creator of the foundation and who provides the corpus (patrimony) for the entity through the charter documents and for the benefit of third-party beneficiaries or for his/her own advantage. From a U.S. planning perspective, it is advisable for a non –resident alien to be the founder of the entity due to the reporting requirements established by the Service for the establishment of and transfer of assets to a foreign entity. The U.S. person (technically referred to as the “Fundor”) provides the corpus (patrimony) for the Foundor in order to establish the foundation.
¨ THE PATRIMONY – (or, in U.S. terms, the “corpus”) the assets that the Foundation receives, manages and administers through the Foundation Council. It may be in cash, in kind, hard assets, securities or other items of value. It is not necessary for the assets to be transferred at the moment the foundation is constituted – it may be capitalized in the future.
¨ THE BENEFICIARY – may be natural persons or an entity and may also be the Founder or Fundor, although not recommended in the case of U.S. persons. The beneficiary(ies) need not be identified at the time of the initiation of the foundation and may be determined in a later publication but, under all circumstances, must be determined at some point. This is important in the case of U.S. persons with respect to gift tax issues in that the tax is not imposed upon incompleted (inchoate) gifts . Based on case law precedents in the U.S., gifts intended to beneficial interests are not completed if the beneficial holders are not yet named or if the Founder (Grantor) reserves the right to modify, change and/or remove beneficiaries. Creative planning through professional advisors would be instrumental in these types of strategies.
The foundation is not intended as a means of transferring or conveying property but as a means of conserving, managing and enjoying the assets. As such, the beneficiaries shall effectively be the title holders or owners of the assets in the foundations upon its termination or upon the occurrence of a stated event or date referred in the charter.
¨ THE ARTICLES OF INCORPORATION (CHARTER) – are the constitution clauses or articles propounded for the existence of the foundation. Panamanian law requires that the document must be registered by a Notary (Notario Publico) in Panama or a Panamanian Consul abroad, then registered in the public records as referred previously. The document must contain the basic clauses for the existence of the entity as are described in Article 5 of Law No. 25 and must also minimally state the following in any language using the Latin alphabet:
- the establishment of patrimony;
- appointment of at least three (3) initial members of the Foundation Council;
- the domicile of the foundation;
- the appointment of a Resident Agent in Panama who countersigns all acts;
- a listing of the foundation’s purposes;
- a designation or listing of beneficiaries;
- reservation of the right to modify the Articles of Incorporation;
- the duration of the foundation and causes for the foundation’s termination;
- rules, if any, for the return of the assets.
¨ THE FOUNDATION COUNCIL – is the main body of the entity and is obligated to act pursuant to the mandates as stated in the Articles, among which include the administration and management of the assets of the foundation, complying with the objectives of the foundation, preparing of an accounting at least annually for the benefit of the beneficiaries, represent and defend the interests of the foundation against third parties and to act with reasonable business prudence. The members of the council, which must initially be at least three (3) members, can be either natural persons or entities, operate in a fiduciary capacity to the Founder and is responsible for all business decisions with respect to the assets. Although not advisable, a U.S. person may serve as a member of the council in order to give the Fundor a sense of control over the transferred assets.
¨ THE BYLAWS – are the means whereby the general clauses of the Articles are developed and is the document whereby the Founder perpetually controls and states his/her will as to what the foundation will do, specifically enumerating the objectives of the foundation. Unlike the Articles which are a public document, the bylaws is not a publicly recorded document and is privately maintained by the Foundation Council, serving thus as the “roadmap” which must be followed by the Council; in short, the intentions of the Founder must be stated with specificity in this private document. Further, it is in the bylaws where the beneficiaries are listed and named, as well as describing the mechanism to implement asset transfer instructions, the management and/or investment policies for the assets, the relationship between the Council and the beneficiaries and the manner in which the distribution of the assets must be established regarding the beneficiaries appointed by the Founder. Because it is not a publicly registered document, the confidentiality and privacy of the Founder’s intentions as well as the mechanics of the foundation are always maintained.
¨ THE SUPERVISORY COMMITTEE (PROTECTOR) – The Foundation Council does not operate in an absolute manner and it may have limitations imposed on it by the Founder through the creation of a Protector or Supervisory Committee. Through this committee which may consist of natural persons or entities, the activities and actions of the Foundation Council may be reviewed and scrutinized as well as act as a “buffer” in disputes between beneficiaries and the Council. More importantly however, it is through this Protector or Committee that a U.S. person could achieve his/her demands for control over the transferred assets. To achieve this objective, U.S. persons are recommended to serve in this capacity. Usually the Fundor’s attorney, accountant, financial advisor, trust company, bank, or other trusted person (even the Fundor him/herself) may serve as Protector or make up the Committee and, are not answerable to the Council for the daily policies of the internal matters of the Foundation. Further powers may be granted to the Protector to provide for the removal of members of the Council.
The activity of serving in a Protector capacity is non-reportable from an IRS standpoint except where the persons are compensated for their services as Protector or Committee member.
IV. U.S. TAX INTERPRETATIONS
Prior to utilizing a foreign entity that is not part of the common law system of the U.S., it is important for a professional advisor of a multinational investor to ensure the entity's characterization under U.S. tax laws.
Although the Panamanian Foundation “smells like a corporation but feels like a trust”, a determination must be made for U.S. taxing purposes as to what it may be classified for taxing purposes. The classification of an entity is not merely determined by what it calls itself; The Internal Revenue Code (“Code”) and Regulations determines and prescribes entity classifications under Federal law and no consideration is given as to whether the entity is recognizable under local law. Accordingly, the classification of whether an entity is domestic or foreign is also determined similarly. Thus, Panamanian Foundations can only be classified as one of the following recognized entities: 1) a trust, 2) as association treated as a corporation, 3) a partnership, or 4) an entity disregarded as separate from its owner.
The above entity classifications apply to “business entities”, defined as any entity recognized for federal tax purposes that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. It would appear that the regulations created a special niche for trusts by excluding it from the definition of business entities in that the traditional uses of trusts were not contemplated for the purposes of business but rather for the purpose of the protection and conservation of property for beneficiaries. However, for purposes of federal taxation, the fact that an entity may be characterized as a trust for local law purposes is not dispositive for the purposes of U.S. income tax treatment.
Under these circumstances, a Panamanian Foundation’s tax status will depend primarily on the entity's purpose and objectives. The actual classification of a Foundation as a trust or corporation is likely to depend on its business purpose as stated in its Articles and as carried out in reality. In effect, the beneficiaries or those persons having powers of attorney over all or a part of the Foundation’s assets may appear more akin to associates conducting a business for profit than to passive beneficiaries and/or to trustees. Otherwise, the Foundation, absent any business entity-type language in its charter, will appear to be a trust for taxing purposes even though it possesses corporate-like characteristics. Accordingly, we adopt the position of Panamanian Foundations being recognized as trusts for tax purposes and in the context of asset preservation and protection for potential beneficiaries, its classification as a trust should be rendered unchallenged.
V. TRANSFER OF REAL PROPERTY TO FOUNDATION
As illustrated earlier, Panamanian Private Interest Foundations are an ideal vehicle for the holding of assets designated for beneficial use and enjoyment. As such, the assets placed within the jurisdiction of the Foundation are afforded protection from attack by creditors, family members, third parties and intended beneficiaries. This makes Foundations the preferred vehicle for the holding of valuable assets such as real estate, appreciated securities and certain types of family businesses.
With respect to real property, the utilization of Private Interest Foundations as owners and holders of the asset may provide certain additional advantages not found in the usual and customary methods of holding real property. Unlike a corporation or trust where one or more individuals or entities may serve as the manager or trustee charged with the conservation of and increase of value of real property assets and where these persons and/or entities may be professionally retained for those purposes, the Founder of the Foundation may implement the right to name a Supervisory Committee or “Protector” to oversee and/or serve as the “watchdog” over the Foundation Council to insure the Founder’s intentions are being served as well as to insure property preservation for the benefit of beneficial owners. This additional layer of management oversight can be critical for the long-term investor of real property or to a family patriarch holding properties intended for the benefit of his children or other beneficiaries.
Foundations are the preferred vehicle for the holding of valuable assets such as real estate, appreciated securities and certain types of family businesses.
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Regarding the mechanics of moving property into a Foundation structure, it is not possible in this writing to describe the methods pertaining to each jurisdiction or country as to the rules for an actual transfer. However, by using the U.S. model which is representative for most industrialized nations, some guidance may be found in that method. Under usual circumstances, the owner of property transfers via deed his/her ownership interest to the Foundation which should have been formed previous to the transfer. This deed of transfer, to be legally effective in most states in the U.S., must be recorded in the office of the county or local recorder of deeds. There will be, in most states in order to complete the transferal process, a requirement to pay state and local transfer taxes (which in some states may be as high as Ten (10%) percent of the value of the property) as well as local recording or documentary taxes (usually expressed either as a percentage of the value of the property or a certain numerator per every amount certain of value, e.g., $3.00 for every $1,000 of transfer value). Additionally, for U.S. property, the owner that transfers for value will be subject to a capital gains tax of Twenty (20%) percent of the transfer value as the transaction would be considered the disposition of a capital asset. There are many strategic methods to perfect a real estate transfer to the Foundation where taxes are mitigated, deferred or avoided outright; these strategies and methods, however, are an entire subject matter to itself and cannot possibly be covered with any detail in this brief exposition. More on this particular topic may be forthcoming.
When the transfer has been perfected, title to the real estate will be registered in the name of the Foundation through the person(s) or entity serving in the capacity of Foundation Council. For example, in a transfer from John Smith to a Private Interest Foundation, the title should read: “The John Smith Foundation of Private Interest, XYZ Co., Ltd., Council and Trustees”. Whomever is the designated signatory within the Foundation Council or, if the Council is an entity, that person will have the legal capacity to bind the Foundation for contracts, notes and other transactions.
VI. MISCELLANEOUS
With respect to the transfer of assets which compromise the patrimony of the foundation, the transfer itself creates a separate and autonomous being to itself and thus removes the assets from the estate of the Fundor/Founder. However, with respect to U.S. persons making transfers, the method and manner of transfer would be determinative as to the successful removal of assets from one’s taxable U.S. estate as well as determining if taxable gifts may result from the transfer.
Pursuant to Panamanian law, the assets or patrimony in the foundation are exempt from Panamanian taxes provided the assets originate from a source outside of the Republic of Panama. With respect to transferred U.S. assets that appreciate, such as stocks or other securities and real estate, normal trading activity with a broker/dealer or arms-length purchaser would result in no imposition of capital gains tax as the asset would enjoy the “safe harbor” of assets being traded offshore not as a U.S. trade or business. However, under most circumstances, the repatriation of assets or income to U.S. beneficiaries or other U.S. persons would result in reportable taxable income to the recipient. The sale of Foundation owned real estate in the U.S. may result in the payment of a 10% tax under FIRPTA (Foreign Interest in Real Property Transactions Act) regulations.
Foundations may produce international advantages such as changes in jurisdiction or change in the registry. Under circumstances specified in either the Articles or the bylaws, the Founder may elect to change the law of the foundation from Panamanian law to one more akin to his/her nationality. Furthermore, the Founder may establish the foundation in Panama but submit the relationship between the Foundation Council, Protector or Supervisory committee and Beneficiaries to the law of another jurisdiction, e.g., Bahamanian, Swiss, etc., in order to better facilitate dispute resolutions. Again, this provision must be either in the Articles or bylaws.
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A Panamanian Foundations of Private Interests may be viewed as a 'Will' for your beneficiaries with the added advantage that it provides protection against capital gains and Inheritance taxes -
V. CLOSING SUMMARY
Panamanian Foundations, when property planned and utilized, are excellent adjuncts to existing estate and/or business structure plans for both U.S. and non-resident persons. However, it must be emphasized that foundations are not the panacea to all offshore planning concerns and absolutely should not to considered by U.S. persons as their primary planning vehicle for removing assets from the domain of the U.S. Used in tandem and in harmony with other recognized planning vehicles (i.e., trusts, IBC’s, limited partnerships, etc.), foundations present a formidable protection tool for hard earned assets as well as providing a means for transitioning assets from one generation to the next as per the wishes of the Founder. Although there may be some estate and gift tax benefits to the use of foundations by U.S. persons if planned and structured properly as well as the potential for minimal reporting, foundations will in no way reduce, avoid nor affect the income taxes of U.S. persons. It may defer income taxation (again, with proper planning) with respect to and until the ultimate repatriation of assets back to U.S. hands and, in the case of appreciated securities, may defer capital gains taxation; otherwise, foundations cannot be viewed as a pure tax-planning device.
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