Blake Bromley of Benefic Lawyers considers the Gates/Buffet ‘Giving Pledge’ and examines how philanthropy and dynastic wealth planning can converge for the benefit of all concerned.
There has been a lot of buzz in wealth management circles lately on the ‘Giving Pledge’ promoted by Bill Gates and Warren Buffet. Gates and Buffett have been touring the globe encouraging wealthy individuals to donate half of their estate to charity when they die. While the greatest response and debate has been in the United States, they have travelled as far afield as China to convince billionaires in a communist country to divest the majority of their estate to philanthropy.
The debate in China surrounding their visit has interested me because for the last five years I have been working with the drafting committee of the Ministry of Civil Affairs on the proposed new Charities Law for China. China is also eager to encourage its new class of extremely wealthy citizens to donate generously to charitable causes. However, the range of charitable causes for which the Chinese government wants private sector support is much narrower than those advocated by Gates and Buffett. China wants limitless funding for natural disasters and emergencies; but is worried about the political impact of private money supporting religious and human rights causes not favoured by the national government. Chinese billionaires are generally astute enough to understand that at this time in the economic and political evolution in China it is not wise to make massive spending commitments to social causes which are opposed by government.
One of the distinguishing features of philanthropy in the United States is the American assumption that it is both wise and virtuous to make the magnitude of one’s philanthropic commitments known to as many people as possible. In China, as in other parts of the world, there is great risk in advertising one’s wealth, even if only by making large public donations. There are many in government, especially in tax offices, who will presume that any sophisticated tax planning involving philanthropic giving is actually an exercise in tax evasion. Many people in the general population assume that accumulated wealth over a certain level must necessarily have been gained by illegal means. Many wealthy people have more to lose from publicising their philanthropy than they have to gain.
Another issue raised by the Gates/Buffett Giving Pledge is whether such a testamentary divestiture of wealth is even legal in civil law jurisdictions. In common law countries like the United States and England, it is generally legally possible to give away one’s entire estate to charity. However, civil law countries have forced heirship laws which generally require that one third go to the spouse and one third to children, leaving only one third available for voluntary distribution by way of bequest. Given these rules, one must question both the feasibility and the wisdom of promoting a charitable giving formula created in common law jurisdictions in civil law countries.
The Giving Pledge is often promoted on the basis that it is harmful to give too large an estate to one’s children. Philanthropy becomes the only reasonable option left to an entrepreneur with a philosophy that precludes giving too much wealth to family. Warren Buffett has given billions of dollars to charitable foundations controlled by his children. I do welcome this money flowing into the sector and believe good is coming from it. However, I want to add a cynical note of caution about the wisdom of “charitable” billionaires who say their children can only be trusted with a small amount of money for their own use -- but can be entrusted with billions of dollars to interfere in the lives of others. It is important to remember that imprudent philanthropy has the potential to do harm as well as good. Philanthropy, if implemented as misguided noblesse oblige can be a form of social zealotry.
Philanthropy is frequently optimised when it is approached as an important component of international wealth management rather than as a means by which to disinherit children. Philanthropy can be a socially beneficial vehicle by which to maintain multi-generational dynastic wealth while shaping the legacy of the family. The effective and tax-efficient use of foundations is a strategic way to maintain wealth through multiple generations. Once wealth has passed into the next generation there are fewer problems in advertising wealth by publicising philanthropy.
The first and most readily understood advantage of philanthropy from a wealth management perspective is the ability to reduce the amount of wealth paid to the domestic tax authorities because of charitable donation deductions. This is particularly true in reducing estate and other taxes at the time of death. While wealth given to a private foundation is no longer available for private benefit and expenses, it does remain under the control of the family. More importantly, it reduces the need for liquid funds to pay taxes and therefore enables the family to avoid selling strategic assets at fire-sale prices to generate cash for the tax authorities. It is possible to give illiquid assets to a private foundation and receive immediate tax benefits for the fair market value of the assets given. It is also possible to purchase those assets back from the foundation at a later time for fair market value at that time should those particular assets play a key strategic role in the family’s wealth management plan.
Most global wealth management programs encourage people to move large amounts of money to low tax jurisdictions. What is frequently not recognised is the extent to which a private foundation provides tax protection from the exit taxes resulting from moving assets or residence offshore. It is possible to calculate the optimum amount of donations and the most tax efficient assets to donate to a domestic foundation to reduce the tax payable when an entrepreneur is moving wealth offshore. Consider the example of a Canadian entrepreneur selling her business in exchange for $100 million of the purchasing company’s publicly traded shares. If she then sells the shares, she would pay $22 million in tax and have $78 million remaining to move offshore. However, if she donated $27 million of the publicly traded shares to her private foundation and sold the remaining shares, her tax would be reduced to $4 million. While she would only have $69 million to take offshore, she would have an additional $27 million in a Canadian foundation. The wealth in the private foundation remains under the control of the donor even if she moves offshore. The money is available for philanthropy back in the community and country in which she made her fortune. With a few extra legal hoops, it is possible to structure things so that the philanthropy is carried out internationally.
When contemplating inter-generational dynastic wealth, it is important to remember that much of the success of future generations will stem from their access to the innovative and powerful leaders in their communities. This access will not result from living an isolated existence on an island paradise with low taxes. The needed contacts will be in the high tax countries in which the original family wealth was made. Charitable donations flowing from private foundations funded when the family moved offshore will provide continued and ever improving access in those communities.
Having millions of dollars in a family foundation in these jurisdictions will enable future generations to acquire the social access which comes from being significant donors to leading academic, research and cultural institutions in a community. More importantly from a wealth management perspective, it enables this access to be “bought” without reducing the personal and investment wealth of the next generation. Having a foundation purchase a premium table at an opera gala and filling it with important leaders in the community who are at arm’s length from the family is one effective and inexpensive way of introducing the next generation to important business and community circles. The money which was set aside in a charitable foundation now returns to assist the family’s wealth creation prospects while at the same time doing good in the community.
At a much more mundane level, a private foundation releases the next generation from many of the informal, but real, costs of moving in the best circles in society and attending the best schools etc. Tuition is the starting cost of sending children to private schools and music academies. Once admitted, there is a constant pressure to donate funds for better equipment or a new building. While a private foundation will not be able to pay tuition, the donations it makes will assist a child in getting accepted into such prestigious institutions and becoming prominently recognised with no additional outlays from personal funds.
When considering the dynastic wealth potential of strategic philanthropy, it is useful to bear in mind that countries which provide the most generous tax benefits for donating to charity usually have the most restrictive rules on investing assets and operating a foundation. For example, the United States has generous tax incentives to donate but then taxes unrelated business income of charities, restricts the percentage of a company that a private foundation can hold indefinitely and has stringent payout requirements to charitable causes as well as an excise tax. All of the rules of the country in which the foundation is located must be understood and complied with if foundations are to be used as part of a strategic plan for dynastic wealth management. The rules against owning companies may be the most problematic for this type of planning.
It is a deeply personal philosophic and even ideological question whether a person should give away the majority of their wealth upon death. The Giving Pledge debate is helpful in encouraging us to think about the issues. However, it seems contrary to the principles of wealth management to develop sophisticated strategies of reducing taxes and even moving assets to low tax jurisdictions if the endgame is to simply give your wealth away.
It seems prudent to assess philanthropic planning on the basis of how it facilitates and enhances multi-generational wealth management rather than just being a mechanism for disinheriting children. Teaching those children how to manage and improve philanthropic grant making and benevolent endeavours is an important goal. The funds in the private foundation cannot be squandered on the living expenses of the next generation but can be a useful means of transmitting values and creating a legacy which is simultaneously charitable and dynastic.
The Giving Pledge should focus less on the percentage of wealth given away and disinheriting children. Instead, it should find a convergence between philanthropy and dynastic wealth by helping future generations revitalise their sources of wealth while engaging in increasing intelligent charitable endeavours.
Blake Bromley, Principal, Benefic Lawyers, Vancouver, Canada