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Offshore vs Onshore Trusts: How Can China’s Rich Choose?

Offshore vs Onshore Trusts: How Can China’s Rich Choose?

Many high net-worth families in China have distributed their assets via offshore trusts, including the Wu Yajun family and the Pan Shiyi family. Since 2013, FOTIC has handled 185 cases, amounting to more than RMB 3.7 billion, with a single trust’s value amounting to between several million and several hundred million yuan. Ping’An Trust and other financial institutions are particularly unwilling to yield to others. Behind the soaring data lies a market valued at up to RMB 11 trillion. Family trusts, a long-standing wealth inheritance system, have developed differently at home and abroad, and their unique features and charms often make China’s rich puzzled about how to choose between them. Professional lawyers are now available to show you the right path.

Offshore and onshore trusts, though both family trusts, are quite different in terms of property, the application of law, and the effects of isolating assets.

A diverse range of assets can be included in offshore trusts. Real estate, yachts, equity rights, and any legal, independent assets in existence that you can imagine can all be placed within trusts to benefit your offspring, your friends, or even religious groups or pets.  

But certainly in different foreign jurisdictions, the assets used for setting up trusts are somewhat different. For domestic trust structures, cash is the single most important, most convenient, and most acceptable trust asset. Some trust companies try to help people to place their equity rights within trusts, which is of paramount significance because the most important assets for HNWIs are not real estate or cash, but equity rights. This is proving to be very difficult. If the equity rights of a listed company are placed within a trust, the value will still fluctuate under the influence of the stock market, even after valuation. If the equity rights of a non-listed company are placed within a trust, the value will remain stable but will rarely be cashed, because of the listed company’s equity rights’ lack of liquidity.

As for setting up trusts by using houses, yachts, and vehicles as trust assets, this is less realistic, because trust registration is required by China’s trust laws, and if houses, cars, yachts, and other immovable and quasi-immovable property is taken as trust assets for setting up a trust, they must be registered, and will have a high tax burden. China’s HNWIs all long for trust-matched tax incentives, but the long-awaited tax incentives have not yet arrived. Those who own a lot of property are always proud of the houses they have, but due to lack of liquidity, they are not the target customers of trust companies who wish to expand their family trust business. 

The applicability of laws is also a key point for family trusts, which, to a certain extent, directly decide whether your family trust is legally valid and effective in its isolation of assets. Domestic family trusts are subject to Chinese laws and these laws directly affect the legal reality of a domestic trust. One example is in the way that the matrimonial community of property system is practiced in China. Suppose Mr. Zhang has not signed a prenuptial agreement, and has no evidence to prove his sole right to his property, and he places RMB 3 million into a trust, and designates his ex-wife as the trust’s beneficiary. This trust may then become invalid because it infringes on the property rights of his current wife. But, in offshore jurisdictions where matrimonial community of property is not recognized, such as Hong Kong, this trust may be valid.

The legal application of offshore trusts is even more complicated. Firstly, the laws of the place where the offshore trust is established generally apply, and the validity of the trust is naturally different in different offshore jurisdictions. Secondly, in a complex offshore trust structure, where trust assets are in different jurisdictions, or the nationality of the principal (beneficiary) comes from a different jurisdiction, the most significant relationship may be applied to decide on legal application and jurisdictions, which will lead to judicial conflict. One matrimonial dispute related to trusts involved a husband setting up an offshore trust with his equity rights and designating his elder brother as the beneficiary. His wife simultaneously brought two lawsuits before courts in Hong Kong and the Chinese Mainland, and asked the courts to declare the trust null and void. As a result, the court in Hong Kong ruled that the trust was valid and effective, but the court in Mainland China decreed it invalid and ineffective.

Offshore trusts differ widely from onshore trusts in terms of the asset isolation effect. If a person in China wants to have recourse for the assets placed within an offshore trust, the applicable laws are different and the legal expenses are very costly. It is possible that the final verdict may not be recognized and executed by Chinese courts after two or three years and several millions in legal expenses. This, however, is what makes the offshore trust attractive. Because offshore trusts exist in different jurisdictions (in particular, those who have not reached mutual recognition of judicial decisions and assistance in enforcement with China), litigation and recourse can be shielded so that trust assets can be preserved. From this perspective, onshore trusts are governed by Chinese laws and the isolation effect of assets is inferior to that of offshore trusts. 

Onshore trusts are likely to be ruled as invalid by Chinese courts due to their possible damage to creditors and lack of independence from trust assets. Therefore, they have no legal effect in asset isolation. Another factor weakening the assets isolation effect of the onshore trust is that China is not a country ruled by law in the full sense, and political considerations, media, public opinions and other factors will all have influence on the ruling and enforcement of a case.

Taken together, offshore trusts have unparalleled advantages over onshore trusts in terms of the flexibility of trust assets, jurisdiction, isolation of assets and even tax planning, but does China’s rich need to choose offshore trusts rather than onshore trusts just for this reason? No, data on onshore trusts has indicated that onshore trusts are also favored by China’s rich.

This may be attributed to two factors:

The first is that China’s rich has a natural sense of trust in China’s professional service providers, such as trust companies, private banks, and lawyers, and therefore, they are more willing to entrust their asset management to onshore trust companies. Moreover, they often lack trust in and feel uneasy when allocating trust assets with foreign companies because of differences in language, culture and laws.

The second factor is that onshore trusts can be set up quite simply with lower establishment and management costs, and without involving the selection of offshore territories and application of offshore laws.

The third factor is that onshore trusts also have the function of asset isolation and wealth inheritance. There are no explicit regulations on family trusts (private trusts) within Chinese law. This also means that the legal effects of this trust structure is not denied by Chinese law and an onshore trust established under the guidance of professional lawyers will also have the same effects on asset isolation and inheritance. 

The most significant relationship principle is an important reference criterion for establishing family trusts.

Which should China’s rich choose, an offshore trust or an onshore trust? The one that best suits your needs is best for you, and China’s HNWIs should make their decision according to their own situations and demands.

The most significant relationship principle is the most important reference point in choosing whether to establish an offshore or an onshore trust. For example, if the assets you plan to place within your trust are in Singapore and the nationality of your beneficiaries (children, spouse and others) is also Singaporean, then it is a good idea to set up your trust in Singapore; or if you are desperate for asset isolation and wealth inheritance and can bear the costly establishment and maintenance expenses of offshore trusts, offshore trusts may be a better choice. (An OIL in Shanghai specializing in offshore trusts stated that the establishment of an offshore trust costs USD 10,000, and management cost for trusts below USD 20 million was USD 10,000. Maybe you don’t think it’s high, but the management cost is not a once-off, and needs to be paid every year for 20-50 years or longer.) 

Similarly, if you have a lot of money in China, and both you and your beneficiary's nationality is Chinese, then it is recommended that you set up an onshore trust.

By Li Meng

Lawyer Meng Li’s experience in law practice is more than 10 years; she works at Beijing Deheng (Shanghai) Law Firm and leads a family wealth management team. She is also a member of Shanghai Lawyers Association Trust Business committee as well as the China Democratic National Construction Association.

With the co-operational resources from domestic and foreign financial institutions, Lawyer Li is dedicated to private wealth management and dispute resolution for Chinese and foreign clients. Lawyer Li has an emphasis on theoretical research; her articles of wealth management were published on various periodicals in China and overseas.

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