EXPERT VIEW: Ultimate Trust: Fiduciary Structures For Family Art Collections - Part 1

Randall Willette and Matt Litten Fine Art Wealth Management and Collas Crill Trust 18 December 2014

EXPERT VIEW: Ultimate Trust: Fiduciary Structures For Family Art Collections - Part 1

This is the first part of a feature on fiduciary structures for family art collections, written by Randall Willette of Fine Art Wealth Management and Matt Litten of Collas Crill Trust.

This is the first half of a feature, drawn from an abstract from a new White Paper on Fiduciary Structures for Family Art Collections. It is written by Randall Willette of Fine Art Wealth Management (also a member of WealthBriefing’s editorial advisory board) and Matt Litten of Collas Crill Trust. They consider the key issues facing sophisticated art collectors who seek to establish fiduciary structures - such as trusts and foundations - for the long-term protection and management of family art collections. As ever, the editors of this news service invite readers to respond with their own views.

A new generation of wealth is emerging, for which art is increasingly becoming an important component of their overall tax and estate planning to put under the care of trust and estate practitioners. A growing number of wealthy families are art lovers, own collections or actively buy and sell in the art market. They require someone who shares and understands their passion for art and appreciates the pleasure of investing in art of high value. A recent report by Deloitte Luxembourg and ArtTactic suggests 76 per cent of those surveyed acquired art and collectibles from an investment viewpoint, up from 53 per cent in 2012.

Globalisation and structural inefficiencies in the art market are driving demand for financial innovation around art assets. Today, a family art collection requires the same strategic planning as other investments and with the help of skilled advice can become an effective working asset, requiring the same standards of asset protection, succession planning and management as with other family wealth. Planning how to transfer a family collection to the next generation can be one of the most critical aspects of building and maintaining a successful art succession plan. Understanding the real value of your collection is important.

Collectors need to consider their art as part of their overall financial and estate plans, especially in relation to other assets, such as real estate or investments. Deciding where the collection may reside after it passes from a family’s control, be it with an institution such as a museum, a family member or a planned sale strategy, is also a key consideration. And, in the light of potential tax and other financial liabilities, deciding on the best strategy early is critical.

Often, the family’s overall financial needs may help to determine the specific vehicle chosen to transfer all or part of a collection from one generation to another. Questions concerning whether children will have the organisational and financial resources to care for a collection and whether there will be sufficient wealth to bequeath an inheritance outside of the collection itself may have to be worked out. It is also essential to put in place a structure to ensure sound future governance. This will avoid potential family disputes, including questions as which family members will enjoy certain pieces of art after the death of the collector.

Regardless of whether the children have an interest in a family collection, decisions about any disposal can be emotional. One key to making sure a collection does not damage family harmony is to work toward open communication and look for creative ways to include family members in the decision-making process. A suitable governance structure, including a shared family vision, can be constructed and embedded into the chosen fiduciary structure.

Art ownership through a fiduciary structure can offer significant advantages over direct ownership, in terms of preservation of wealth generally and in particular in relation to art collections. The wide range of fiduciary structures available and the huge flexibility which careful drafting can incorporate into the governing documentation for structures means they can be tailored to the needs of each particular family and their collections.

Once a collector’s long-term objectives have been understood, the most appropriate fiduciary structure can then be identified. The relevant specialists such as art wealth consultants, valuers and restorers will also be identified and appointed to formulate the most appropriate art investment and collection care strategies.

In the short-term, the simplicity of direct art ownership may have a number of advantages - notably the absence of trustee fees. However, there are a number of long-term issues that collectors should consider, where trust structures can be of considerable benefit. These include:

Succession planning
• Is the collection to be kept intact after the death of the owner? Can the owner ensure that only certain family members benefit from specific works?
• Are there any forced heirship concerns in the country where the collector resides? If so, art works might need to be sold upon death to satisfy fractional shares of heirs.

Asset protection
• Is the artwork protected from divorce or potential family disputes?
• Is the artwork protected against unwarranted claims e.g. hostile third parties?

• Possible estate / death taxes - which may require a “fire sale” of the artwork.
• Lifetime taxes e.g. capital gains on sale of artwork.

• Can any philanthropic / charitable endeavours with the artwork be continued after the owner’s death?

• Does direct art ownership cause concerns around client visibility and/or security – for example high-profile individuals and families?

The use of fiduciary structures can assist collectors with some or all of these issues. It is essential to ensure that objectives for the trust are fully discussed at the outset with collectors. Fiduciary structures may be difficult and costly to unwind at a later stage, particularly if there has been any tax planning involved.

Types of fiduciary structure
The strong rise in art prices in recent years has caused many trustees to re-evaluate the best type of trust or fiduciary structure in which family art collections should be held. Art is a challenging asset on a number of levels, requiring careful planning at the outset, and significant ongoing care and maintenance. Historically, works of art and other ‘treasure’ assets would likely be held in a standard discretionary trust structure, forming a relatively small proportion of overall trust assets – held alongside more conventional classes such as marketable securities and real estate. However, with trustees having duties under trust law to act prudently by diversifying assets and preserving capital then owning generally illiquid - and possibly increasingly valuable - works of art through conventional structures poses increased and unwarranted risk to the trustee. At the opposite end, there is also the danger that particular artists and/or works themselves might simply fall out of favour with the art market, thus diminishing their value.

Also, fiduciaries need to consider the cost of ongoing collection care - for example, restorers. Potential family disputes concerning certain art pieces are a possibility e.g. should the work continue to be held, or perhaps sold and funds distributed to the trust beneficiaries? Family members may have differing views on certain art pieces, leaving the trustee in a difficult situation.

Fiduciary structures have evolved significantly in the past 15 years to allow higher-risk assets to be held with reduced risk to professional fiduciaries. Subject to professional advice, family members, or their family offices, can retain certain investment powers when it comes to choosing which works of art are bought, sold or held by the structure.

The types of structure most appropriate for dedicated art collections now include:

i) Reserved powers trusts
This is where the trustee retains legal ownership of the artwork in the trust, but the donor is given power to select and manage the artwork - e.g. deciding when certain works should be sold. Care must be taken to ensure that the extent of the powers retained by the donor will not cause legal and taxation issues in their own country of residence e.g. risk of “sham” or co-trusteeship.

ii) Private trust company
The donor can form his/her own, exclusive, trust company to administer the family trusts, supported by a professional trust company. The PTC will be incorporated and administered in an international finance centre. Typically, the donor along with certain family members and professional advisors will constitute the Board of Directors of a PTC, along with a professional fiduciary company which will add its expertise, and undertake the day-to-day administration, accounting and corporate secretarial matters.

The PTC will in turn act as the trustee to various family trusts, which may hold higher-risk assets according to the family’s risk tolerance, which will be well-known to most board members.

As the PTC will have its own shares, then for succession planning purposes, these will often be held by a purpose trust, where the sole intention (‘purpose’) will be to hold the shares. As there are no beneficiaries of the purpose trust, then for accountability reasons an independent “enforcer” will be appointed - to oversee the trustee.

iii) Private trust foundation (PTF)
This is very similar to a PTC, except that the foundation itself (rather than a company) will act as trustee to the various family trusts. This structure is simpler, as the “orphan” nature of the foundation means no shares are issued (compared to a PTC). Some jurisdictions will require a professional fiduciary to be one of the councillors. As the foundation will have no beneficiaries - and its purpose will only be to act as trustee, then an independent “guardian” will need to be appointed (similar to the “enforcer” role, to ensure the PTF fulfils its purpose).

iv) Foundations
A foundation is quasi-corporate in nature, and may appeal particularly to clients from civil law jurisdiction where the trust concept is not as well known or understood. As with a PTC, the client, the family members, advisors and a professional fiduciary can be appointed as councillors to manage all the affairs of the foundation. Foundations can own higher-risk assets - as like a company, the foundation enjoys separate legal personality and will own assets itself. As such, the beneficiaries will therefore have no rights over the assets; this contrasts with the beneficiaries’ property rights over a trust and the trustee’s overarching duty to act prudently in their interests.

v) Purpose trusts/Hybrid trusts
A purpose trust has no beneficiaries, but instead one or more “purposes” - such as holding designated works of art, or for a philanthropic mission. These trusts can be established to last into perpetuity and are particularly useful for keeping collections together for enjoyment by future generations. As the purpose of the trust is to hold the artwork and nothing else, the trustee cannot be held liable for non-diversification of assets. These purposes can also be combined with a physical class of beneficiaries to create a “hybrid” trust, where family members can benefit from the trust e.g. to enjoy the artwork.

Use of SPVs
Whichever type of structure is chosen, one advisory point is to consider holding the artwork itself in one of more companies or special purpose vehicles (SPVs) - the shares of which can then be held by a foundation, purpose trust etc. This is often done for a number of reasons - including ensuring legitimate confidentiality, and for the SPV to act as a “firewall” in the event there is some difficulty with the artwork itself (e.g. provenance), so that the assets in the parent entity are not put at risk from potential claims. Also, a corporate structure generally facilitates transactions such as lending.

Integrating the client / family office - selection of art pieces In all the above structures, donors and/or their family offices can be integrated into fiduciary structures for the purpose of making decisions as to which pieces of art are bought and sold. For example, this can be achieved either by them sitting on the PTC Board / Foundation Council, or creating an advisory body to the structure. Relevant legal and tax advice may be required, depending on the proposed form of  decision-making body and the intended location for it to make art investment decisions. This is to ensure the tax residency of the fiduciary structure remains in the chosen trust jurisdiction.

Key consideration in selecting a trust jurisdiction
A collector wishing to establish a fiduciary structure should give consideration to choosing the most appropriate jurisdiction for the administration - and long-term protection - of trust structures to hold their art wealth. Most often, this choice will be guided by professional advisors and will take into account the attributes of fiduciary companies themselves. The following points should however be borne in mind:

• Local taxation - Ensuring there is zero taxation of the proposed structure and its Beneficiaries in the chosen jurisdiction itself, as well as no exchange or currency controls.

• Quality of laws - Comfort in the robustness and flexibility of laws (e.g. trust / company laws) which uphold the interests of beneficiaries and provide “firewalls” against unwarranted claims by hostile parties.

• Dispute resolution - Experience and quality of the court system in resolving disputes. This is a strong attribute for long-established international trust jurisdictions, compared to newer finance centres, where the courts may be relatively untested.

Some jurisdictions such as Guernsey, Jersey and other UK Overseas Territories provide for an ultimate right of appeal to the Judicial Committee of The Privy Council in the UK. This can add significant comfort for HNWIs who are establishing structures.

• Regulatory environment - Checking whether a jurisdiction regulates its fiduciary service providers, and if so, to what extent. Sound regulatory regimes will often include capital adequacy tests for service providers, “fit and proper” criteria for trust directors, and codes of best practice for fiduciaries to uphold the interests of clients.

• ‘Secrecy’ jurisdictions - As the global drive towards tax transparency continues, it may become increasingly difficult for certain “secrecy” jurisdictions to administer trusts and handle incoming / outgoing payments with global financial institutions - if those jurisdictions are not committed to standards including FATCA and the future OECD “Common Reporting Standard”, which are being introduced to combat tax evasion.

Issues to consider in selecting a fiduciary
Selecting the right fiduciary requires taking into account the unique financial needs of heirs and other beneficiaries and the nature of the assets involved. The potential problems and pitfalls facing collectors and owners of art are numerous and need careful consideration in order to ensure the best results for the collection, the collector and potential beneficiaries of the art.

Key considerations in selecting a fiduciary specialist for art assets include the following:

• Does the fiduciary have experience of holding and working with art, and the ability to implement regular collection care and periodic valuations?

• What is the fiduciary’s project management expertise - to coordinate with various art
specialists, such as insurers and restorers?

• What fee charging basis does the fiduciary propose e.g. time spent, fixed fee, or an asset value-based fee? Will this be appropriate to the size, complexity and risk for the collection and the donor’s objectives?

• Does the fiduciary have experience of managing potential conflicts between the interests of  different family members, with the ability to remain impartial and to uphold the donor’s overall objectives for the collection?

These questions may have a major bearing on the ultimate trust specialist to be used. In the case of a significant private family collection, an art succession planner can offer useful guidance to collecting families as well as serving as a reassuring check on the powers of trustees.

This note is a summary of the subject and is provided for information only. It does not purport to give specific trust advice, and before acting, further advice should always be sought. Whilst every care has been taken in producing this note neither the author nor Collas Crill Trust Limited or Fine Wealth Management shall be liable for any errors, misprint or misinterpretation of any of the matters set out in it.


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