24 February 2021
It is deep rooted in Chinese culture that all family problems should be resolved within ‘the four walls’, perfectly illustrated by the old adage ‘Do not wash your dirty linen in public’. Often families and private wealth managers find it daunting to contact lawyers, and when a problem eventually (as a last resort) reaches the legal advisor it is most likely to have evolved into a disastrous problem that could cost a significant part, if not all, of the family’s wealth to fix it. This bulletin seeks to provide practical pointers on the legal ringfences that could be put into place at the early stages to avoid such future nightmares.
Structure formation
A diverse range of services and products are being marketed to and consumed by high-net-worth individuals and families in Hong Kong. Hong Kong remains the hub for a large number of super-rich individuals and families with private wealth, predominantly comprising of easily investable assets, most of which is held in private trusts, the primary vehicle used for wealth and estate planning. This may sound simple but as the pool of high-net-worth individuals expands, wealth and estate planners in Hong Kong are seeing increasing demand from second and third tier wealthy individuals for sophisticated planning, particularly for intergenerational transmission of wealth, succession for family-owned businesses and long-term philanthropic goals.
Clients’ preference (or in many cases, preference of their service provider), and legacy reasons are often the governing factors for selecting structures and jurisdictions. However, poorly designed structures and inappropriate choice of jurisdictions could lead to drastic compliance issues, immobility of assets, unnecessary administrative costs, or impediments to business operations. It is therefore important to work closely with legal advisors to frame appropriate structures at the most suitable jurisdiction, based on the following key factors:
1. Specific needs of the beneficiaries
The relevant questions include:
a) Whether on-going support is required and for how long (e.g., for minor and old age beneficiaries)? In that case, what is the best way to ensure part of the assets remains mobile?
b) Is it necessary to have segregated wealth portfolios, and if so, would an offshore fund be suitable?
c) Is there any specific jurisdictional matter (e.g., a US citizen issue) that warrants more protection for certain beneficiaries?
d) Do they have any role in the family business? Are conflicts from wearing multiple hats foreseeable if a private trust company will be used?
2. Tax efficiency
Entities and activities in popular offshore jurisdictions (such as BVI and Cayman) do not attract tax, which is ideal for those who require their assets to be easily transferrable, coupled with a high level of confidentiality concerning ownership. In Hong Kong, while there is no capital gain tax for local entitles, profits arising in or derived from trading activities, a profession, or business undertakings carried out in the city are subject to profits tax. Therefore, remuneration or profits, even via offshore vehicles, received by a related Hong Kong entity in the structure might still be taxable.
Another aspect of tax consideration is the potential personal liability of individual beneficiaries, especially in receiving distributions.
3. Compliance issues
With the joint effort to combat money laundering and financial crimes globally, it is impossible to avoid compliance requests – from provisions of basic personal particulars to details regarding source of funds and income. Terms such as “beneficial ownership”, “economic substance” and “FATCA” make headlines frequently in all popular wealth parking jurisdictions. Selection of a jurisdiction based on the incentive of non-compliance of a reporting duty is unrealistic, as one would simply end up at a jurisdiction with little or no financial and professional infrastructure, and even then, such a jurisdiction would eventually develop and become regulated.
The correct approach towards compliance requests is to ask a legal advisor to map out the actions and information that would be required to fully comply with all reporting duties each year. Logically, the cost of proper planning and preparation would be significantly lower than the cost for handling the consequences of failing to comply with certain duties.
Key Documents
Trusts have been the default setting for asset protection and succession planning in Hong Kong for many years. Despite understanding the benefits, families are generally not willing to give up their control over the assets and will often seek to reserve certain powers. Recent court cases (e.g. JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] EWHC 2426 (Ch)) however proved that trusts that are controlled by settlors are vulnerable to attacks, with courts having developed ways to enable third parties (usually creditors or divorcing spouses) to enforce orders against trust assets.
In contrast, numerous jurisdictions have introduced specific provisions intended to enable the reservation of a wide range of powers by the trustmaker (settlor). A Hong Kong trust will not be invalid solely because the settlor has reserved for themselves the powers of investment or asset management. The statutory protection in Hong Kong however does not include the reservation of powers of revocation or powers to appoint and remove trustees or beneficiaries, which are available in offshore regimes including in Singapore.
It is therefore important to understand that all documents must always be drafted in a fact-specific way. However, as a general principle, the key is to reserve only the powers that are necessary for the settlor in question. For example, a settlor who has settled a business into the trusts may wish to retain the power to veto a proposed sale or other disposition of the business. Note, however, if this is combined with other extensive powers such as the power to replace trustees, the right to determine who is to be a member of the beneficial class and, for example, a right of veto over any disposition of trust assets, then it is likely for a Court to say that the settlor has the means to control the disposition of the trust assets and, in practice, to ensure that they have in place trustees who will bend to their will. Another general rule is that retaining the right of veto over actions is likely to be safer than positive powers. By merely being able to prevent actions taking place, a settlor is far less likely to be held as having retained beneficial ownership as they cannot by exercising those powers of veto alone bring about any disposition of the property.
Mitigating litigation risks
Disputes are inevitable and would often put trustees in a conflicted position. Typical contentious scenarios include the spouse of a beneficiary demanding disclosure of details of a trust during a divorce, beneficiaries unable to reach consensus on distribution or disagreement between the trustee and the beneficiaries regarding the dealing of certain assets.
The idea of taking a matter to court may sound intimidating, but most courts have statutory supervisory jurisdiction to give orders to deal with trust assets. Section 56 of the Hong Kong Trustee Ordinance allows the trustee to make an application to the court for the necessary power to manage or administer property vested in the trustee. This is a relatively narrow jurisdiction when compared to the much wider discretion that the offshore courts may exercise. The author acted for a trustee based in Hong Kong of a Cayman trust to seek an order from the Cayman court pursuant to s.48 of the Trusts Law to sanction a distribution proposal that the beneficiaries could not agree upon. It is therefore a good practice to seek directions from the court which has jurisdiction over the trust during the early stage of a dispute to mitigate the risk of full-blown litigation.
Conclusion
With the variety and complexity of issues revolving around private wealth management, as highlighted by the questions and scenarios set out above, wealth managers should work closely with legal advisors at early stages of planning, drafting, and also at the first sign of any potential dispute.
For further information, please contact:
Crystal Au-Yeung, Oldham Li & Nie
crystal.auyeung@oln-law.com
