Offshore trust: Structuring for Wealthy Chinese

Although China's economy is experiencing a slowdown amid global economic uncertainties, the number of Chinese super-wealthy is still gradually increasing, making financial and asset planning an inevitable issue they have to face in the coming years.

Nowadays more and more Chinese rich families are looking overseas for financial solutions and many of them have started to adopt western-style tools such as trusts and foundations in taxation and succession considerations. The trend is gaining popular as the younger generation began to take rein of their family businesses.

By the end of last year, there were 2.8 million millionaires in terms of US dollar in mainland China with an increase of 4% from 2011, according to a joint report compiled by Industrial Bank and the Hurun Research Institute in April. 70 percent of the millionaires are male with an average age of 38, and their most preferred investments are Real estate and stocks, the report revealed.

In mainland China, there were about 100,000 people who had been qualified as high-net worth individuals with assets worth more than 6 million yuan by the end of last year. The number of individuals with assets over 100 million yuan increased by 2 % from last year with a total amount of 64,500.

According to another report studied by Forbes in March, the number of Chinese consumers with investable assets of between $100,000 and $1 million will possibly increase 17.2 % to 12 million by the end of this year. The total private investable capital of Chinese citizens grew 13.7% annually in 2012 to 83.1 trillion yuan ($13.2 trillion) and reach 93.7 trillion yuan by the end of this year, according to Forbes.

Those born between 1960 and 1989 made up 81 percent of the mass affluent group, and 55 percent of them are male. More than two-thirds of them have college or master degree and 88 percent invest when seeking to grow their assets, Forbes said. The report showed that almost 90 percent of the respondents prefer low risk and stable returns on capital investment, which make fixed-income financial products and real estate two hottest investments. One fifth of the group plan to emigrate, 2.6 percent already own foreign residency, over half of these people reveal they would send their children overseas for education, according to Forbes.

Both of the reports indicated that there is a clear trend among wealthy Chinese: they are becoming younger; their wealth is growing steadily; they are seeking to obtain stable returns; and a growing number of them are willing to move overseas.

Apparently, rich Chinese are training their sight on offshore wealth management jurisdictions for a wider range of financial products and services aiming to take advantage of taxation and confidentiality.

However, it could still be hard for them to get a clear picture of how financial structure works in a way of protecting their wealth. Trusts and foundations are the most widely used tools that protect investors against dispute, bankruptcy, divorce or other issues. Establishing the right structure in a right jurisdiction is the key to successes in terms of asset planning and family succession for the continually expanding group of wealthy Chinese.

Trust
The concept of trust can be traced back to Roma. It is now widely considered as the most innovative contribution to the common law legal systems. In China, the trust industry has been expanding fast in recent years, but regulators have already stepped into curbing risky lending, making sure the sector is well under scrutiny.

Generally speaking, a trust refers to a relationship under which asset or property is held by one party for the benefit of others. The creator of a trust is called a settlor, who is able to transfer some or all of his/her asset or property to a third-party agent, which is called a trustee. The trustee holds or manages the property for the sake of the trust's beneficiaries, whom are named by the settlor.

Under such a scenario, the property's legal ownership, daily management, control of its equitable ownership and benefit distribution are separated, bringing tax-related benefits and ensuring the beneficiaries' ability to obtain returns even if the settlor is incapacitated or dead.

The trustee could be an individual, a company, or a public body. In most jurisdictions, the establishment of a trust requires a contractual trust agreement or deed. The settlor usually creates a living will to define how the property will be handled for the benefits of their spouse or children.

However, Chinese may find it contrary to their traditional concept of wealth management: The trustee is given the legal title to the property under a trust, though it is obligated to act for the good of the beneficiaries and only get compensation for the trusteeship.

China established the first trust law in 2001, but the development of private trust has long lagged behind the public trust industry. China Merchants Bank highlighted a deal with an 8-year-old girl for management of her assets in 50 years under a family trust in May. However, most Chinese lenders currently let private-banking sectors run their family trust business as they lack of experience in dealing with family assets in both domestic and overseas markets.

The asset threshold of a family trust offered by a Chinese lender is usually set at 30 million yuan while the trust can't be revoked within a period of 30 to 50 years. The annual fee is usually 2 percent of the asset under management.

Compared with established western markets, trusts in China still hold clients' assets instead of making real arrangement for their family wealth and succession. In addition, the Chinese trust law is not completed enough to cover family trust, the country has yet to set up a registration system for assets under trust, making it subject to external risks.

In addition, in Chinese law, the property under a trust must be made public before it can be set up. Therefore, concerns of privacy breaching rise among wealthy individuals when considering do so.

In contrast, setting up a trust in an overseas jurisdiction often gives more freedom. Although trusts are widely used in nations with English law, most civil law jurisdictions, which don't generally contain the concept of trust in their legislation, do recognize it under the Hague Convention on the Law Applicable to Trusts.

Take Liechtenstein as an example. It's a civil law jurisdiction which has adopted the common law of trusts. A Liechtenstein trust has no separate legal entity and minimum capital required. Liberal Liechtenstein company law allows the formation of trusts according to foreign law, such as English or US law, making it convenient for overseas settlors who already prepared statutory provisions to be adopted.

There's a growing trend that wealthy Chinese seek permanent residency in offshore jurisdictions with an aim to shift from a worldwide basis of taxation to being taxed on Chinese source income only. Thus, they are increasingly using trusts as a tool to manage their property overseas since they are allowed to transfer more funds offshore for start-up purposes in the new location and to receive inherited assets without restriction to non-residents.

In addition to tax benefits, trusts also allow beneficiaries to protect assets from creditors as the trust may be bankruptcy remote. For example, under a discretionary trust, settlor could be the protector and one of the beneficiaries. Therefore, the settlor may be able to be protected from creditors and benefit from the trust assets without owning them.

Foundation
Foundation is an independent special purpose fund with legal attributes, which is generally referring to a distinct legal entity. Unlike a trust, foundation is a separate legal entity that owns the assets managed by foundation council. The assets of a trust are under the ownership of entrusted trustee. This feature has made it more appealing to clients from civil law jurisdictions, like China, as people feel they can have more control over their property under such an arrangement.

Foundations are usually set up for charitable purposes, family patrimony and collective purposes. Unlike a company, foundations have no shareholders, though they may have a board, an assembly and voting members.

The assets endowed to the foundation become a separate legal entity and are separate from the private assets of the founder. In some countries, a foundation must have its legal personality when entering public registry. But in other jurisdictions, the legal personality can be obtained through the provision of required documents upon the creation of the foundation.

The operation of a foundation is carried out in line with its statutes or articles of association instead of fiduciary principles followed by a trust. It may have a variety of forms and may follow different regulations depending on the jurisdiction where they are created.

However, setting up onshore foundations in China, mostly charitable foundations, is somewhat troublesome as applicants have to go through a mountain of paper work, seek approvals from different government agencies and are under strict regulatory scrutiny.

In China, before establishing a foundation, the applicant must first get the sponsorship from a local government agency, or a so-called “professional leading agency” governing charitable foundation issues. After that, the applicant has to seek the greenlight from a local civil affairs bureau for registration and operation. A foundation is subject to the supervision of both agencies under the “dual management” regime throughout their organizational life.

In terms of taxation, if a charitable foundation engages in business which is not directly related to the charity purpose, it has to pay the corporate income tax for the business involved. Besides, a charitable foundation has to donate 70 percent of their annual surplus, and pay one to two percent tax on their maintained and incremental income. In contrast, there is no payout requirement or taxation on capital placed in offshore foundations.

In this sense, it may be wise for rich Chinese to consider establishing an offshore foundation in terms of investment or wealth planning. There are almost no restrictions or regulatory requirements with regard to whom they can donate to.

Although creators of offshore foundations are likely to pay a certain amount of tax when moving their onshore money into overseas jurisdictions, they don't have to meet annual disbursement quotas in the future, making wealth accumulation carried out in a stable manner.

As offshore foundations are usually set up in low-tax jurisdictions, some of them choose to operate as a business instead of charity so that they can be sustained by the revenue collected instead of requiring additional donations every year.

One of the best offshore solutions for Chinese when doing business is to use a Hong Kong-based company to run the business while using an offshore foundation to hold the ownership of the Hong Kong entity in order to minimize taxation and regulatory intervention.

Using a private foundation is not only tax-wise but also helps in preserving and protecting assets and net wealth of a family. What is more is that a foundation opens up ways to avoid problems concerning formalities of a will, claims of spouses or other family members when dealing with an inheritance. One of the major benefits is that the death of a foundation founder does not have any impact on the situation of the foundation on both tax and other issues.

Conclusion
An increasing number of rich Chinese entrepreneurs and businessmen are considering using trusts and foundations when conducting business plan or asset succession in order to maintain and grow the wealth of their families. Not only are Offshore jurisdictions with solid infrastructure and legal systems able to provide them with the right tools, professional service providers can also help them with their best interest.