Foundation setup is about control, residence and the next generation

A foundation is the only legal entity that belongs to nobody. It has no shareholders, no members and no owners, because the assets belong to the foundation itself. That is precisely what makes it the strongest vehicle for asset protection and succession planning, and precisely where serious mistakes are made. This article explains how foundations work, which jurisdiction suits which life situation, what contributing assets costs and how distributions are taxed.

What a foundation is, and what it is not.

A foundation comes into being when a founder dedicates assets to a purpose. With the endowment, those assets take on a life of their own and, from that moment, belong to the foundation rather than to the founder. The foundation has organs: a foundation council that administers it, frequently a protector who supervises the council, and beneficiaries who benefit from the foundation's assets. The beneficiaries may be the founder's family, the founder personally or charitable causes.

A foundation is not a company. There are no shares that could be sold, pledged or inherited. The central question in every foundation is therefore how much control the founder gives up over the assets contributed. Everything else follows from the answer.

Transparent or opaque: the question that decides everything.

For tax purposes a foundation is either transparent or opaque. That is not a box ticked at formation. It depends, first, on how the foundation documents are actually drafted and, second, on whether the foundation is then run exactly as those documents provide.

Neither variant is inherently better. They are different designs with different effects, and control is what determines the classification. In one matter we reworked the foundation documents with an Austrian notary over two rounds to secure exactly that outcome: no reserved founder rights, a protector modelled on a supervisory board, and a council that decides by majority. That is craftsmanship, and it determines whether the foundation still holds in ten years' time.

The German and the Austrian perspective.

Germany: attribution and gift tax

Anyone tax resident in Germany needs to know two provisions. The first concerns attribution. Where a family foundation has its seat or its management abroad, its income is attributed to the founder as long as he is subject to unlimited tax liability in Germany, and to the beneficiaries once the founder has died or has left Germany, in each case regardless of whether anything is actually distributed. There is an exception for foundations in the EU or the EEA where it can be shown that the assets can no longer be attributed to the founder legally or in fact, and where an exchange of information exists with the country of establishment. Liechtenstein meets that test; Dubai and the United Arab Emirates do not.

The second provision concerns gift tax, because contributing assets to a foundation is a gift. For a foreign foundation tax class III applies, meaning an allowance of EUR 20,000 followed by tax at 30% to 50%. For a domestic family foundation the so-called tax-class privilege applies instead: the relationship to the most distant beneficiary is examined, and the result is frequently tax class I. This too argues for establishing the foundation after departure, or for doing the arithmetic very carefully beforehand.

Austria: foundation entry tax

Austria levies neither inheritance nor gift tax, but it does levy a foundation entry tax. The rate is 2.5% of the assets contributed where the foreign foundation is comparable to an Austrian private foundation and its documents are disclosed, and 25% where that is not the case. The entire difference therefore lies in the design. In Austria the transparent-or-opaque question is decided through the attribution of income.

Jurisdictions compared.

The decision follows a simple logic: where do you live today, where will you live in five years, and which assets are to go into the foundation? The jurisdiction follows from those three answers.

Liechtenstein in detail

Liechtenstein is the classic foundation jurisdiction for the German-speaking world. As an EEA member it enjoys privileged treatment for founders from Germany and Austria, and its advantages are concrete. The foundation separates the contributed assets legally from the founder and shields them from creditor and liability claims. It is exceptionally well suited to succession planning, because the founder can set out in the foundation deed and the by-statutes exactly how and for what the assets are to be used. Liechtenstein itself levies no inheritance or gift tax, whereas German family foundations are hit by the substitute inheritance tax every 30 years. The country offers political and economic stability with a high degree of legal certainty, and there is no general obligation to publish the founder or the beneficiaries; for private- benefit foundations only limited information is deposited.

The foundation council must have at least two members, one of whom must be a Liechtenstein-licensed trustee or a person of equivalent qualification. Establishment proceeds as follows:

1. 1

   Planning and purpose

   Private purposes such as asset protection and succession, charitable purposes such as education, science, the arts or environmental protection, or a combination of both. The purpose shapes the entire design.

2. 2

   Formation documents

   The foundation deed sets out the name, the purpose and the assets. The statutes govern organisation and administration, the by-statutes govern the beneficiaries, and these are complemented by the rules for the protector and the letter of wishes.

3. 3

   Paying in the foundation capital

   The minimum capital of CHF 30,000 is paid into a bank account in Liechtenstein before registration. Alternatively, assets in kind such as property or securities may be contributed.

4. 4

   Registration or deposit

   For private-benefit foundations only limited particulars are published, in order to preserve discretion.

Contributing assets: where most mistakes are made.

In principle anything can be contributed to a foundation: cash, securities, property, company shares, art and intellectual property. Each of these carries a tax consequence that must be settled before the contribution is made.

Cash and securities

Gift tax or foundation entry tax arises on the value, and for securities carrying unrealised gains, depending on the country, the realisation of those gains may be added.

Property

This is where it becomes expensive, in Germany and in Austria alike, and irrespective of whether the foundation sits at home or abroad. In Germany the classification decides. With an opaque foundation the contribution is a gift, so gift tax arises on the value of the property, mitigated for a German family foundation by the tax-class privilege. With a transparent foundation there is no gift tax, but real estate transfer tax of up to 6.5% applies instead, because the exemption from that tax covers only genuine gifts. One of the two taxes is therefore always payable. In Austria the transfer attracts real estate transfer tax, a supplement of 2.5% that replaces the foundation entry tax, and the land register fee, which together quickly add up to 6% or more. In both countries the rental income remains taxable where the property is located. It is usually wiser to hold the property through a company and to contribute the company shares to the foundation instead.

Company shares: the most expensive trap

If you hold at least 1% of a corporation and transfer those shares to a foreign foundation without consideration, your home country generally loses its right to tax those shares. That is exactly what triggers the exit tax, in Germany and in Austria. The transfer is treated as a sale at market value, and you pay tax on the full increase in value of your company even though you have sold nothing and received nothing. That applies even where you do not emigrate at all. With a domestic foundation this does not happen, because the right to tax remains in the country and only gift tax or foundation entry tax arises. Whether and when you contribute assets, how that interacts with a change of residence and what structure is sensible in between therefore cannot be answered in the abstract. Every contribution must be examined and structured cleanly, or you end up paying two taxes for a single decision. Our article on tax liability after emigration covers the exit tax in detail.

Distributions to the foundation and out of it.

Assume the foundation is in place and holds shares in an operating company, and that company now distributes profits. What happens depends on where the company sits, where the foundation sits and whether it is transparent or opaque. The following statements are deliberately framed as the typical case; the precise withholding rates depend on the treaty in question and on substance requirements.

Dividends from a German GmbH

Paid to a domestic family foundation, the dividend is almost entirely tax-free at foundation level: withholding tax is deducted but credited, leaving a burden of under 1%. Paid to an opaque foreign foundation, Germany withholds 25% plus solidarity surcharge. That can be reduced under a double taxation agreement or by way of a refund under domestic law that brings the rate for foreign corporations down to 15%. Both require the foundation to have substance rather than being merely interposed; a letterbox foundation obtains no relief. There is no treaty with the Emirates, so 15% is the floor there; there is one with Liechtenstein, which with sufficient participation and substance can produce markedly better rates. Paid to a transparent foreign foundation, Germany looks through it and treats the dividend as your own. If you live in Germany, that is your ordinary flat-rate tax. If you live in the Emirates, the full 25% plus surcharge remains, because the refund to 15% is available only to corporations and there is no treaty. The transparent foundation is therefore the most expensive variant in this scenario.

Dividends from an Austrian GmbH

Paid to an Austrian private foundation, the dividend arrives tax-free and without deduction. Paid to an opaque foreign foundation, Austria withholds 27.5%. The position is nonetheless better than in Germany, because Austria has a treaty with the Emirates that provides extensive relief on dividends. To benefit, the foundation must be resident there, produce a certificate of residence, be the beneficial owner of the dividend and demonstrate substance. With a transparent foundation the founder himself counts once again: if he lives in the Emirates the treaty applies to him personally; if he lives in Austria the dividends are simply his own capital income.

Distributions from the foundation to beneficiaries

With a transparent foundation a payment to you is not a distribution but your own money. Payments to other beneficiaries, by contrast, are gifts from you, which means gift tax in Germany according to the degree of kinship and merely a notification to the tax office in Austria. With an opaque foundation the recipient's residence decides. A beneficiary living in the Emirates pays no income tax. A beneficiary living in Germany taxes distributions like dividends at 25% flat-rate tax, and on dissolution of the foundation gift tax may arise in addition. A beneficiary living in Austria pays 27.5% withholding tax.

How a foundation is set up properly.

Here too the sequence is not a detail.

1. 1

   Purpose

   Is the aim succession, asset protection, tax optimisation or family harmony? Usually it is a mixture, but the weighting determines how the foundation is built.

2. 2

   Residence

   Where does the founder live, where do the beneficiaries live, today and in five years? The jurisdiction follows from that.

3. 3

   Control

   How much of it does the founder actually surrender? That decides whether the foundation is transparent or opaque, and from that follows the entire tax treatment.

4. 4

   Arithmetic

   The assets are valued, and the contribution of every single position is modelled: exit tax, gift tax, real estate transfer tax, foundation entry tax. Every consequence is on the table before anything is transferred.

5. 5

   Documents and organs

   Foundation deed, regulations, protector provisions, letter of wishes. Then the organs are appointed, with a council that holds real decision-making power and a protector with real rights of control.

6. 6

   Ongoing operation

   Meetings, minutes, annual accounts, beneficial-owner filings, tax registration and everything else that belongs to it. This part never ends, and it determines whether the foundation is lived the way it reads on paper.

A foundation is not a product. In creating one you decide to release assets from your own control in order to secure them for the next generation. Anyone who means that decision seriously receives an instrument that carries for decades.

Frequently asked questions.