The considerations Asian settlors/beneficiaries and their advisors take into account in designing and situating optimal trust structures for the protection of family wealth (and its predictable succession) have undergone significant changes over the last 25 years.
This article traces the major shifts in the legal and political landscape during this period and concludes with a summary of the current principal considerations for settlors.
Over the last quarter century, settlors in North and East Asia (ex-Japan) have been motivated to establish trusts for a variety of different purposes. The fundamental objective - the protection of wealth and its ultimate predictable succession to heirs - has remained a constant. However, the threats to that objective, and hence the design and location of trusts, continues to change.
Hong Kong, because of the 1984 Joint Declaration on resumption of sovereignty to China and its implementation on 1 July 1997, continues to have additional and unique political risk factors that affect the calculus of settlors.
Hong Kong, Singapore and Malaysia have long had, and largely continue to have, territorial income taxes which mean that trusts are largely unnecessary for income tax mitigation. Hong Kong and Singapore had estate taxes until 2006 and 2008 respectively but these were territorial in nature thus only payable on local assets passing on death. Malaysia abolished inheritance tax in 1991, whereas Thailand introduced such taxes in 2014. Indonesia does not levy estate taxes. The Philippines continues to levy estate tax on a worldwide basis for residents and locally for non-residents. Taiwan has a similarly designed estate tax but at a low rate of 10 per cent with generous allowances and exemptions.
Trusts were widely employed by Singaporean and Hong Kong settlors to mitigate applicable estate taxes on local assets (foreign assets being exempt) essentially by transferring the value of local assets to offshore structures largely through debt creation and shifting techniques. Most of these estate tax mitigation trusts paid little consideration to long-term succession and governance objectives. The settlor commonly retained as much control as possible without vitiating the tax mitigation objective with little or no thought as to how heirs would succeed to control on the settlor’s death. Much trust litigation has already, and continues to, spring from this lack of planning.
With local estate taxes no longer a major consideration, foreign taxes (which commonly arise where overseas assets are situated or heirs are resident abroad and subject to worldwide tax) now dominate tax considerations of Asian settlors.
Mainland China is, of course, a special case. It is not surprising that with the concept of private property being a recent phenomenon there; estate taxes do not exist but are widely tipped to be introduced shortly - on a world-wide basis. China has a world-wide source income tax system but their laws, which seek to look through offshore structures to attribute their income to local residents on a current basis, are relatively unsophisticated.
The utility of trusts to mitigate foreign income, capital gains, and estate taxes in popular investment destinations such as the UK is now questionable to say the least. Recent UK changes look through foreign entities to tax UBOs on UK real estate gains and will tax its value on the UBO’s death. It seems likely that the US will at some stage follow suit - at least in relation to real estate.
Trusts as vehicles for Asian settlors to mitigate both local and foreign taxes therefore appear to be less useful than they once were. There is no doubt that with the advent of AML/KYC/CDD laws and practices, the unwillingness of intermediaries to touch tax suspect money (let alone assist with new tax cheating) and with automatic exchange of tax information through the Common Reporting Standard (CRS) and possibly public trust registers, the availability and use of trusts as devices to evade tax is finished.
For all these reasons tax mitigation should no longer be the prime motivator for Asian settlors to create trusts.
Protection from Claimants
Trusts have always offered varying degrees of protection from a wide range of claimants such as trade creditors and claims from spouses of both settlors and beneficiaries. Recent cases in Hong Kong suggest that a trust controlled by a settlor offers little protection on his or her divorce.
With rising divorce rates, Asian settlors are increasingly concerned about claims by their children’s spouses on divorce - claiming through their spouses’ beneficial interest in the trust assets.
Some settlors make the conclusion of a pre-nuptial agreement a pre-condition of children being included as a trust beneficiary. ‘No contest’ or ‘interrorem clauses’ in wills and trusts feature more often to dissuade disappointed beneficiaries from bringing legal claims.
There are mixed views on the importance of trusts in family governance planning. However, Asian families are generally attracted by the idea of a fully discretionary trust or trusts as the ultimate holding vehicle(s) because they reflect the idea that ‘all of the assets are owned by all of the family’ in an indivisible way. This ownership model helps promote unity of purpose and also, of course, control by those who exercise the discretion to distribute from the trust. More settlors are looking to embed governance rules related to succession of control through family constitutions and the constituent documents of corporate trustees rather than via the terms of the trust instrument itself.
Asian settlors (perhaps especially those who are part of the Mainland China diaspora) well understand, through dint of bitter experience, that ‘loose lips sink ships’. Privacy has always been their concern, and the patrilineal and patriarchal nature of traditional Chinese families reinforces their reluctance to let non-family members ‘in’ on family business matters. Also, kidnapping is not as uncommon as it should be in this part of the world.
Governments with lamentable human rights and rule of law records are not uncommon in this region and financial information about wealthy families in the wrong hands poses real political and personal security risks.
The advent of CRS in this region represents the greatest threat to financial privacy since trusts began to be used here. The creation of detailed and aggregated data pools both in the jurisdiction where assets are held and, on exchange, in reporting jurisdictions where a whole range of trust parties may reside (settlors, trustees, beneficiaries, and protectors) is a gift to those with a prurient or more darkly motivated interest in the financial lives of others.
Everyone knows that digitized information is forever vulnerable. The proposed protections under CRS are pathetically weak as are the sanctions for those who lose or abuse this data.
Asian settlors are already looking at their trust structures to see how privacy can be achieved/improved. This will involve an examination of where to place trust structures, their underlying companies and the assets themselves. There is, right now, lots of jurisdictional arbitrage given that the US has not signed up to CRS, nor is it likely to anytime soon. Also, others who have signed up to CRS have made the exchange of data collected conditional on a number of factors, which will ultimately mean that CRS will be a far from global system. Asian jurisdiction will, I believe, yield to European pressure by exchanging with EU members but are far less likely to exchange with each other and other non-European countries.
The reporting profile of trust structures and underlying entities is capable of at least some degree of limitation by judicious entity classification under CRS, reducing the number of trust parties, the segregation of different classes of assets into different structures and through accounting treatment.
Rule of Law and Jurisdictional Reputation
Asian settlors really do ‘get’ the rule of law, especially the need for an independent, competent and clean judiciary. This will continue to be high on the settlor’s list in choosing where to place the trust and in choosing its governing law.
Given the Panama Papers and other leaks and the inability of the smaller (especially Caribbean) jurisdictions to cope with the extremely heavy burden of CRS and pubic registers, which have been forced on them, there will be a process of domestication of structures by Asian settlors, especially to Hong Kong and Singapore. ‘Mid-shore’ jurisdictions like Hong Kong and Singapore are not only more reputationally robust, but offer a greater depth of service levels for trusts and their investments. These factors will also prove increasingly attractive to settlors in other parts of the world.
Tax mitigation will be less important for Asian settlors than it once was, with the possible exception of planning for a world-wide Mainland China estate tax.
Protection from spousal claims will continue to be of particular importance.
Family governance issues, in particular succession to control over ‘whole of family’ assets, will assume much greater importance as settlors learn from the mistakes of others, and the second generation assumes more influence in their family’s affairs.
The state of the rule of law will continue to be ‘front and centre’ when choosing trust jurisdictions and settlors will become more sensitive to a jurisdiction’s reputation. Domestication of trusts and holding companies will favour Hong Kong and Singapore.
Privacy will remain a dominant objective for trusts, and settlors will put their money (and structures) where they can be best protected in the post-CRS world.