I want to share with you an example from my practice: a case which has to do more with Foreign Trusts rather than anything else but it can be equally applicable to a Corporate situation.
My client was a beneficiary of a Foreign Trust (actually several, but that doesn’t really matter because the one we are talking about here is the one where the problem appeared) and that trust in the language, the actual Trust Agreement… let me go back a little bit; the trust was formed in the United Kingdom so all the documents were in English. I received the Trust Agreement from the Trustee and I reviewed the Trust Agreement and in the Trust Agreement, it says that my client is entitled to ‘all income’; so, income has to be distributed every year.
If income has to be distributed every year for US Tax Purposes, it’s a Simple Trust as apposed to a Complex Trust where a client would be entitled to only a partial income or no income and whether the Trustee has a discretion in distributing that income.
In the UK, those Complex Trusts are known as Discretionary Trusts. At first when I looked at it I thought: ‘Okay, income, income, income distribution. Income is income right?’ But then for some reason I started wondering: ‘Income, is it really Income? What does it mean by Income?’ My experience has taught me to doubt everything and I was right to do that because in the United States ‘income’ means all income: Capital Gains and Ordinary Income, Dividends, whatever – all of that is income.
In the United Kingdom, ‘income’ means really Ordinary Income. Capital Gains is a completely different category. So, in reality my initial conclusion that this trust was a Simple Trust was erroneous.
You ask: Why do we care if it’s a Simple Trust or a Complex Trust? The problem is if it’s a Simple Trust then all of the income including Capital Gains are deemed to be Distributed to the client and the client has to pay taxes on that income on his tax return; whereas, if it’s a Complex Trust then we only count the income to which he is entitled as being distributed. So that ordinary income, in that case was Rental Income to the client and the Capital Gains were kept off the tax returns.
So this is a very good illustration of the Linguistic Uniformity Trap: Doubt Everything!