Asia: Tax & Trust Developments Taking Center Stage

Developments in Asia over the last year have been continuous with the biggest generic development relating to the exchange of information.

Asian countries have put their FATCA reporting systems in place (even though not all have yet signed an inter-governmental agreement with the US IRS), and most have now committed to the coming Common Reporting Standard. Indeed, India and Korea have gone one step further and committed to early adoption.

Financial institutions are deeply concerned that countries will impose different procedural requirements, and are therefore intensely lobbying through their industry associations to ensure as much consistency as possible in terms of the necessary forms, declarations and systems.

It is fair to say that most Asian countries are not embracing CRS with great enthusiasm, but they recognise the writing on the wall and will do whatever is necessary to ensure compliance with the evolving global tax norms that are developing.

Singapore recently recognised foreign tax evasion as being a predicate offence for money-laundering reporting purposes, after the Financial Action Task Force mandated such an approach. Hong Kong has long recognised foreign tax evasion for this purpose. One benefit of the role of the FATF is to force a convergence between countries as to how they apply their anti-money laundering rules, which helps to level the playing field between jurisdictions. But of course, the real issue relates to the degree of compliance in practice. Hong Kong will have its next mutual evaluation with the FATF in (likely) 2019 and Singapore in late 2015. This author has no doubt that both jurisdictions will seek to come out of the peer review process ‘whiter than white’ and will do whatever is necessary to avoid criticism and sanctions being potentially levied upon them.

Singapore and Hong Kong have issued guidelines for financial institutions to follow to implement systems and procedures to identify cases where foreign tax evasion should be suspected. Although inevitable, the use of a check-list of factors can tend to make identification a process-driven exercise rather than a qualitative risk-based assessment. That is perhaps inevitable in view of the size of banks and their large customer bases, but it does have inevitable consequences as a result of some possible over-reaction and damage to legitimate and legal business activities.

For example, bank ‘de-risking’ remains an increasing problem for many customers, particularly those from overseas who wish to avail themselves of local banking services in Hong Kong and Singapore. Many banks are routinely turning away clients from overseas, as well as applications from companies incorporated overseas or at least in those jurisdictions they regard with suspicion (eg, even places such as the BVI). One anti-money laundering official was heard to comment that he could not understand why someone would set up a tax-free company in an offshore financial jurisdiction except for the purpose of evading tax! There is still a lot of ignorance and work that needs to be done by the offshore jurisdictions to ensure that businesses can continue to operate globally and seamlessly where this is essential for legitimate business purposes.

This problem is exacerbated by the recurring leaks and disclosures about the use of tax havens that are being reported in the press, and by the media and populist frenzy which seeks naively to equate the use of tax havens with tax evasion. This feeds into the general compliance attitude prevailing in most major institutions, and so it is not surprising that banks simply do not wish to take risks and prefer to turn away activities which have been “tainted” in this way, even if this means turning away legitimate business.

An extreme example was under FATCA, in response to which many banks refused point-blank to do business with Americans, and closed their existing accounts held by Americans. One can’t help feeling that it was easier to do this than to set up suitable compliance procedures. Under the Common Reporting Standard, however, banks cannot respond in the same way with respect to the residents of almost 100 other countries. They won’t have any customers left! It follows that they will need to adjust and introduce proper compliance and training systems to enable their staff to identify those offshore clients who pose an unacceptable risk, and to admit others. This means more staffing and costs, but this is an inevitable cost associated with the higher-compliance world that banks now operate in.

Anti-money laundering rules invariably are supposed to be applied on a risk-based assessment of the customer’s credentials. They should not be, and are not, expected to yield perfect results in all cases. Yet, many institutions appear to be afraid of making a decision that turns out, unpredictably, to be the wrong one. It is indeed in the interests of all major financial centres that banks change their mind-set lest the financial centres become less international and more self-focused. This is hardly a formula for growth of global business, and seemingly counteracts the growing globalization which we are witnessing in all other facets on business.

When new developments occur and changes are introduced, the pendulum usually tends to swing to an extreme before coming back to a more workable center. This author has no doubt that this will similarly happen, eventually, with respect to banking and account opening procedures and the implementation of ‘know-your-customer rules’. Admittedly, the position might yet get worse before it gets better. However, the glimmer of hope on the horizon is the coming Common Reporting Standard which will help to achieve a better balance, at least in so far as banks’ concerns about tax evaders is concerned. This is because, if banks (together with securities houses and life insurers) are going to be reporting customers’ income and gains to the tax authorities in the countries in which their customers reside, the opportunities for tax evasion will be much reduced. This will force customers to be tax-compliant. Hopefully, in turn, this will make banks more comfortable about taking on new customers, and continuing existing customers, without being overly concerned about the customer being non-compliant with his or her tax obligations abroad.

China

Mainland China is looming more largely in the Asian region (as if it has not done so up to now!) as it opens up its economy. It is no secret that the central government is encouraging Mainland investors to invest abroad, primarily as a reaction to the Mainland’s huge capital surpluses and reserves. This has led to a frenzy among foreign fund managers and others to capture a share of the business that is coming their way out of Mainland China.

The long-standing tax uncertainty as to the taxation of foreign qualified foreign institutional intermediary (QFIIs) has finally been resolved. This is the mechanism by which foreigners have been permitted to trade in shares on PRC stock exchanges. The result is that QFIIs are being required to pay back taxes with respect to the last five years. That might not be the best result for the QFIIs and their customers, but it was not unexpected and represents a fair compromise. The reality is that QFIIs had already provided for this liability, and so have not been hit too hard by the result.

In another recent development, Shanghai has opened up trading on its stock exchange through the Hong Kong-Shanghai ‘stock connect’ programme which permits traders based in Hong Kong to deal with Shanghai listed shares. Unlike the case with QFIIs, the applicable tax rules have been largely clarified from the outset. It is expected that the Shenzhen stock exchange will similarly open up to Hong Kong closer towards the end of this year. These steps are a great boon to Hong Kong. Hong Kong is also asserting itself as a leading market for the trading of renminbi, as Mainland China gradually loosens controls over its currency.

Other aspects about Mainland China make it clear that there will need to be more focus than ever before on ‘getting it right’ when dealing with mainland Chinese clients. The tax authorities there have been issuing new tax circulars defining the scope of Chinese anti-avoidance tax rules that apply to corporations. Hardest hit have been “indirect equity transfers” whereby non-residents have been subjected to Mainland taxes when disposing of offshore companies (eg, in Hong Kong or BVI) that own underlying Mainland companies. Those rules have been expanded his year to cover indirect transfers of real estate and certain business assets in the Mainland.

The rumours about the introduction of an estate tax in China continue unabated (following on, in this region, from Thailand’s recent introduction of estate tax). It is also inevitable that Mainland China will be revising her individual income tax laws, which may mean that much of the traditional tax planning methods that have been adopted in the past for Chinese clients (and which, if done properly, are legally effective) will need to be reviewed and restructured in light of these coming changes.

Trust Centres in Asia

Singapore and Hong Kong continue to remain as the two dominant trusts and fund management centres in Asia.

Singapore took active steps over a decade ago to promote herself in these areas. She actively encouraged foreign trustees and fund managers to set up operations in Singapore by introducing user-friendly laws and regimes and by offering concessional tax rates, as well as blanket tax exemptions for the trusts and companies they administer from within Singapore.

In retrospect, this was (and remains) a case of Singapore at her finest, in reacting nimbly to global opportunities and taking advantage of the turmoil that has engulfed these industries in Europe and elsewhere. By contrast, Hong Kong has tended to be more complacent. Her government’s policy is to resist offering incentives to foreign investors. As a result, trusts governed by Hong Kong law have been rarities, and the trust industry in Hong Kong has generally served as a back-office or liaison centre for trusts established and managed elsewhere.

Finally, Hong Kong has responded, at least partially. She has updated and modernised her trusts law, with the aim of encouraging foreigners to establish and administer trusts within Hong Kong. However, unlike Singapore, there is no blanket tax exemption for such trusts (unlike the case of funds, for which express tax exemptions apply). This means that care need to be taken in Hong Kong to plan asset-holding structures and investments to ensure that they do not fall within the Hong Kong tax net. That is not necessarily difficult, but it requires attention. Hopefully, Hong Kong will take the necessary step in due course of introducing a blanket tax exemption for trusts that are established for non-residents of Hong Kong.

Mention must be made of New Zealand trusts, which remain popular. New Zealand offers an alternative trust regime to those of Hong Kong and Singapore, and has proved popular among those players who regard Hong Kong and Singapore with continued suspicion or reluctance. Oddly, this author is not aware of any major global institutional trustee who has responded to this development by establishing its own operations in New Zealand. Instead, most foreign trustees prefer to establish and administer trusts in New Zealand by relying on a coterie of very competent New Zealand service providers. New Zealand’s tax laws and disclosure laws, as well as its tax treaty network, have made trusts based there increasingly popular.

Summary

Overall, Asia continues to develop, and increasingly is becoming one of the main focuses of the wealth management industry. Growing wealth and opportunity in Asia have contributed to this, as well as a growing appreciation by Asian entrepreneurs of what the wealth management industry can offer them in terms of investment diversification, family office services, and handling of the “softer” family issues such as succession planning, training for the younger generations, and sophisticated asset and divorce protection mechanisms.