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Cook Islands Trusts: Prudent Planning or Tools for Scoundrels?

By Robert J. Mintz, J.D., LL.M (taxation)

In addition to the issues with Cook Islands Trusts discussed in this article, several recent developments with foreign trust and bank account reporting should be addressed.

Citizens and residents of the U.S are required to report and pay taxes on their world wide income. While domestic financial institutions provide 1099’s to the IRS with customer names and account income each year, offshore banks did not provide this information. Although U.S taxpayers are required to voluntarily report income from foreign earnings, many failed to do so. A vast and virtually impenetrable offshore financial industry developed in these no tax jurisdictions with strict bank secrecy rules. The effect was to allow U.S. taxpayers to avoid payment of U.S. taxes on foreign account income to the estimated tune of $40-$70 billion annually.

After a long history of unsuccessful attempts by the U.S. (and other countries)  to persuade or coerce the offshore havens to supply information on the accounts of particular targeted taxpayers the U.S adopted strict legislation in 2010 which effectively requires all foreign banks to provide account information for all U.S . customers. The key provisions of the Foreign Account Tax Compliance Act (“FATCA”) became effective in 2014 and 2015 and foreign banks and trust companies are implementing necessary reporting systems as required.

The full impact of FATCA on offshore trusts in countries such as the Cook Islands is not yet fully know. Foreign bank account information, including beneficial ownership and income will be reported by the financial institution to the IRS. Trusts which do not hold foreign bank accounts may be subject to similar reporting requirements. However, many trusts which are intended to be treated as U.S trusts for federal tax purposes, may be exempt from the FATCA filing requirements.

In most cases, individuals who have created foreign trusts for asset protection purposes, rather than attempted tax avoidance, will not be affected by the FATCA rules. As discussed below (Are Secret Accounts and Offshore Havens Gone for Good) foreign banks are sometimes reluctant to accept U.S. customers because of FATCA compliance burdens and costs.

The Cook Islands is a popular offshore haven, offering unique asset protection and privacy benefits for wealthy individuals throughout the world. Those with high liability risks, such as physicians, real estate developers and business owners often put assets into Cook Islands Trusts to shield their wealth from potential lawsuits and claims.  At the same time, complaints are growing that these trusts are a favorite of corrupt politicians and other lawbreakers, taking advantage of these laws to hide and protect illegal funds. Are Cook Islands Trusts a legitimate planning technique or an international haven for criminals stashing their gains?

First a little background. In 1989 the Cook Islands, a former Protectorate of New Zealand in the South Pacific, began an effort to diversify its tourist economy and attract a robust financial services industry. New laws were enacted which focused heavily in the area of asset protection. These laws clarified a jumble or age old court cases and conflicting laws in other jurisdictions and created a single clear and detailed legislative scheme which permitted the establishment of trusts intended to shield and protect assets from lawsuits and claims. Through these initial efforts and various modifications and court challenges over the years, it is generally acknowledged that the Cook Islands has the strongest asset protection laws in the world. Assets in the trusts are not disclosed to the Cooks Islands authorities and the law makes it a crime to identify who owns the trusts or to provide any information about them. Judgments from foreign countries are not enforced in the Cook Islands against the trusts established there, assets of the trusts cannot be seized by a creditor, and the trustees are required to maintain strict secrecy regarding the owners and beneficiaries of the trusts. The Government of the Cook Islands has no treaties or mutual assistance agreements (as the Swiss do) which would permit disclosure or cooperation with a foreign creditor or even a government agency in a collection action.

Who Uses Cook Trusts?

According to a recent article in the New York Times, the Cook Islands, as an asset protection haven, has perhaps worked out too well- opening the door to a variety of illegal and questionable activities. (Cook Islands, a Paradise of Untouchable Assets).  The point of the story is that because these trusts have been difficult or impossible to pierce, they have been a magnet for fraud artists and crooks.  Convicted ponzi-schemer R. Allen Stanford and various corrupt government officials from around the world —- used Cook Islands Trusts to protect the proceeds of their activities from defrauded victims and government pursuit. Efforts to recover funds from the Cook Trusts have been largely unsuccessful.

“Even the United States government has had a hard time going up against a Cook trust. In a lawsuit that has dragged on for years, Fannie Mae, a government-sponsored lender, is still waiting to collect on a $10 million judgment against an Oklahoma developer who defaulted on his loans. In legal filings, Fannie Mae says it has collected only $12,000 — and “that is not for lack of trying.” The “clear purpose” of the trust, Fannie Mae’s complaint said, “is to avoid payment of the judgments obtained by Fannie Mae,” efforts that the agency called “brazen.”

Recently released documents of leaked files by the International Consortium of Investigative Journalists provide evidence that Cook Trusts have indeed been used to help shield the assets of many politicians and celebrities throughout the world. How and why these supposedly top secret files ended up in the hands of journalists is a story for another day.  For now, there is no doubt that some significant portion of the wealth of the rich and famous is parked in Cook Trusts.

Although clearly subject to potential abuse, my own experience in establishing and monitoring hundreds of Cook Trusts over the years, is that generally these trusts are set-up to accomplish legal and prudent asset protection goals. Liability risks from operating a business or a professional practice are well known and understood at this point and many individuals sensibly wish to protect accumulated assets from the particular risks of their business.  This can be accomplished in a variety of ways through the use of well known business entities and strategies such as corporations, LLC’s, family limited partnerships, retirement plans, domestic and foreign based trusts. Cook Trusts sometimes play a role as a component of these asset protection and estate plans.

No Tax Evasion Opportunities

One of the reasons that the Cook Islands has not drawn much international attention or attack (as Switzerland has recently) is that the Cook Islands has only a minimal banking presence and cannot function as a tax haven or a center for money laundering or dubious financial transactions.  Unlike the well known and powerful offshore banking centers in Hong Kong, Switzerland, Singapore and the Cayman Islands, Cook Trusts are unlikely to be used by U.S residents for financial crimes, tax evasion or for purposes other than legal asset protection.  The trust companies in the Cook Islands are audited and regulated by the Government and impose strict due diligence requirements concerning a prospective client’s business and financial background before agreeing to act as trustee. Individuals establishing Cook Trusts must comply with U.S tax reporting and filing requirements and under the provisions of FATCA trustees are subject to similar compliance rules.

States Adopt Cook Trust Laws

Because the opportunities for financial crimes and tax evasion are so greatly limited (as opposed to the tax haven countries), the U.S Government and other nations have not demonstrated an interest in persuading or coercing the Cook Islands to change or modify its strict asset protection laws.  In fact, rather than attacking these laws, many U.S. states have adopted similar asset protection rules for their own residents. Noting the popularity, the need and the effectiveness of these laws (and the income potential for financial services), an increasing number of states in the U.S. have enacted their own versions of the Cook Islands trust laws.  Fifteen states, including Ohio, Virginia, Delaware and Nevada permit residents to establish trusts which are intended to shield assets from liability and claims.

Laws which permit some measure of financial privacy and substantial asset protection will always be subject to abuse by individuals’ intent on corrupt or illegal activities. Government limitations on secret business transactions are justified in the fight against terrorism and corruption to the extent that they are narrowly and accurately targeted. However, given the reality of frivolous litigation, the targeting of “Deep Pocket” defendants and the normal liability risks of most business and professional activities, financial privacy and asset protection with Cook Islands Trusts is often a strategic component of sound business planning.

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