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The Trusts and Foundations Are Coming, Sooner or Later

The Trusts and Foundations Are Coming, Sooner or Later

Croatia
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Under the Croatian law, a foundation is a non-profit legal entity without any members, which includes assets permanently intended to serve a generally useful or charitable purpose on its own or through income it generates.

Foundations are distinguished by the areas of activity. In Croatia, there are scholarship, research, social, scientific, developmental, cultural, religious, and political foundations. Croatia does not have a long-lasting tradition of founding corporate foundations, so the establishment of such foundations began only a little more than ten years ago, when certain funds and the power of corporations was accumulated.

Foundations are an important factor in profiling of the civil society since they contribute to the global level of development. Just like trusts, the details of which we cover below, foundations have existed in various societies and cultures since ancient times until today, and they are legally regulated in Croatia.

The purpose of foundations is to help individuals and groups with specific needs, and they represent a way in which wealthier individuals, organizations, companies etc., may contribute to society and its needs (for example, preserving traditions and culture), and often encourage innovations and progress. A part of activities, which were in the domain of the government before, is being taken over by foundations, identifying social problems/needs and connecting them with the available funding in such a way, that they can serve as a supplement to the government’s measures in joint improvement of the common good, but also a way in which prominent individuals or companies influence the social processes, offering solutions for social problems. That way, foundations create and change the market so they can react better on the market. Globally, it is common that founders of companies transfer ownership of that company to a foundation, with the goal of preserving the business, as well as protect the company from poor management, which could lead the company into difficulties, especially by the heirs who are not interested in business development. In that case, a part of the dividend that the company generates is used to pay the heirs, and a part is used for various charitable, cultural, educational, and similar purposes.

In Croatia today, there are just over 200 active foundations, and in the European Union, there are about 110,000 registered foundations (most of them in Hungary, Denmark, Germany, Spain, and Sweden). An interesting fact to point out is that Liechtenstein has almost the same number of foundations as it has people, given that foundations legislation in Liechtenstein in rather flexible and foundations may be similar in purpose as a trust (on which more details below). Restrictive legislation, uninspiring environment for the development of foundations, low level of social capital and low level of citizens’ trust in such a form of aid, may all be highlighted as reasons for the insufficient number of foundations in Croatia. If we focus on corporate foundations, the situation is even worse, since a small number of companies found their own foundations and thus separate their own funds for the support of a generally useful or charitable purpose. One of the brighter examples of corporate foundations is a large local company performing business activities in the areas of real estate, insurance etc. and promotes and encourages innovations and quality in science and arts, encourages talented students and young scientists, protects and promotes Croatian traditions and strengthens ecological consciousness and assists the individuals in need in the Croatian society. In addition to the above-mentioned reasons for the relatively small number of foundations in Croatia, tax regulations are certainly one of the important factors and they have the potential to encourage or discourage the founding of foundations. Although foundations in Croatia act as non-profit organizations and they do not pay corporate tax, if they use their means and activities to support a generally useful or charitable purpose, the question of taxation i.e., tax incentives for the increase of donations to foundations, still arises. Namely, in Croatia, just like in any other country, one of the key questions raised by advocates of foundations, is certainly taxation of individuals and companies with income tax, corporate tax, or similar types of taxes if the assets/income they generate are not retained for their own benefit and expenditure, but they finance the company as a whole. Croatia enables certain tax incentives in that regard (e.g. according to the provisions of the Income Tax Act, donations in kind or financial donations are considered as tax deductible expenses if done domestically for cultural, scientific, educational, healthcare, humanitarian, sports, religious, ecological and other generally useful purposes and if their total amount does not exceed 2% of the total income of the business entity in the last year), however, their diversity, convenience and quality, as well as the entire (not just tax) regulatory framework regarding foundations, are always debatable.

There are different names for foundations around the world, for example, foundation in the USA, stichting in the Netherlands, stiftung in Germany, fondazione in Italy and in Great Britain they are also called trusts. Just as there are different names for foundations, so are their purposes fundamentally different. We explain the mentioned differences, what a trust is and why trusts are coming sooner or later, below.

Trusts are not a new legal institute. On the contrary, trusts were first used back in the Roman times, and in common law systems trusts are well known, well established and commonly used legal instruments for managing assets. However, even civil law systems, a part of which is the Croatian legal system, are moving towards the regulation of trusts, since there is a need for more flexible regulation of family wealth management and preservation through generations, for which inheritance law does not provide an adequate framework. For example, as of October 2020, the Slovakian Ministry of Justice intends to draft a regulation on the establishment of trusts. Similar regulations were already passed in the Czech Republic some years ago, so we hope that the Croatian legislator would also recognize the benefits of such legal regime, in addition to foundations.

But know, we will briefly describe what trusts are. Trust assets are held by the trustee in his own name for the beneficiary of the trust. The assets put in the trust by a founder, who is traditionally not publicly known, are transferred directly to the beneficiary when certain conditions have been met. The trust acts as a protective holding instrument for asset transfer at a future date, often with the goal of preserving family assets. There are many other public and private functions for the trusts, such as for example, charitable giving, divorce settlements, funding of surviving spouse and, perhaps most importantly for these times and the post-pandemic world, for simple asset protection. Also, trusts are sometimes used as investment vehicles, whereby the assets in the trust generate income surpluses and as investment vehicles, whereby the assets in the trust generate income surpluses.

Of course, it is crucial to appoint a capable and professional trustee who will manage the assets effectively.

There are three important persons in trusts – the founder, the person who puts their assets to the trust, the trustee, which is the person who holds and manages the trust, and the beneficiary, in whose favor the assets are held and managed. There can of course be other such as the settlor, the protector etc.

Some important points to pay attention to when establishing trusts are:

  1. A trust must have a contract founding the trust and regulating the functioning of the trust – the trust is usually established only upon the conclusion of this contract and that contract mostly regulates who can appoint the trustee and how this is done, as well as who determines the beneficiary or how to the determine the beneficiary, when the beneficiary receives the assets, and to which amount etc.
  2. Registration (i.e., creation) of the trust – it’s key to know that the assets are not held by a natural or legal person, but by the trustee (or in his name) for the trust itself.

Additionally, we note that Croatia is not a signatory state to the Hague Convention on the Law Applicable to Trusts and on their Recognition (e.g., the Netherlands and Italy are, and just like Croatia, they too are not common law systems). The common problem in the procedure of recognizing trusts, which appears in civil law systems, is therefore the conflict between the principle of legal certainty and protection of third parties on the one hand, and simultaneous protection of the rights of the beneficiaries on the other hand, however, this issue may be resolved with adequate regulation, the adoption of which we support. Apart from adequate regulation, it would be crucial to contact an experienced attorney-at-law and an experienced tax advisor, who have good knowledge of the specific legal and tax regulations. Namely, thanks to their knowledge and experience, advisors play a significant role in deciding on trust establishment and on its location. For example, the key questions posed would be the way in which the assets put in the trust are taxed, tax treatment of the growth of value of the assets, the level of legal protection of the trust assets etc. Without the precise regulation of the legal basis, the rights and obligations between the founder and the trustee, legally meaningful drafts of documentation and clear tax provisions, there is no efficient protection of assets. Considering that many countries have a developed legal institute of trust with clear legal and tax provisions, trust founders often consider the advantages and disadvantages of every location and legal framework before making the decision on founding the trust. Croatia should certainly pay attention to this topic and it should, through development of clear provisions and regulatory framework, try to be one of the interesting locations for founding trusts in Europe and thus for attracting foreign and retaining local capital in the region.

By Matea Gospic Plazina, Partner, Krehic & Partners in cooperation with Deloitte Legal

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