Trust and Foundations Opportunities for Chinese Families and HNWIs

By Baron Laudermilk By Baron Laudermilk

When this last report was published, China’s economy was experiencing a slowdown during global economic uncertainties. But now it has become a fact that China’s economy is decelerating. Authorities have set the GDP target for 2015 at 7.0%, but some influential analysts and economist have stated that China’s economy growth is actually anywhere from 3-5%. The stock market correction that occurred in June 2015, and is still lingering on today, is proof that China’s capital markets, economy, and overall financial system have major errors and fundamental problems that need to be addressed.

But despite the fact that China’s economy is witnessing a hard landing, the number of rich people in China continues to grow steadily, both in terms of high-net-worth individuals (People with assets that are worth US$1,000,000), and in ultra high-net-worth individuals (people with $30,000,000 in investable assets).

The number of billionaires in China, according to Forbes 2015, ranking of the world’s richest, claims that China minted 71 new billionaires, totaling 242 billionaires. According to the China Ultra High Net Wealth Report 2014-2015, the number of people from the Chinese mainland who hold assets worth at least 500 million yuan has exceeded 17,000. The number of China Ultra High Net Wealth people this year reached a record high for the 15 years the Hurun Research Institute has released the China Rich List.

The report found that most on the list are entrepreneurs, property developers or professional investors. Some 300 of them have assets worth at least 10 billion yuan, and about 5,100 have assets worth 1 billion to 2 billion yuan. The rest have 500 million to 1 billion yuan.

Indeed, more than 80 per cent would like to invest in overseas projects in the future, and half of them have already done so. With their wealth steadily growing, and with major uncertainties in their domestic market, wealthy and rich Chinese have found that overseas investments bring major returns and help diversify their investment portfolio.

With their new found wealth, rich Chinese have been investing major parts of their wealth in international Western real estate markets. One of their main destinations is the United States, and this is expected to continue and even accelerate in the near future. Investors in Chinese equity markets will flee to safe assets, and few assets offer the combination of relatively modest risk and high returns as U.S. real estate.

California is a Chinese favorite, but high prices there are cutting into demand. While Texas ranks third for all international homebuyer demand, behind Florida and California, it is favored by Chinese buyers, thanks in part to its strong employment and education opportunities.

Chinese buyers have poured $28.6 billion into U.S. real estate in the past year, more than double the amount spent by Canadians, the second most active buyers, according to the National Association of Realtors

Another major investment destination of rich Chinese is Australia. The almost $US4 trillion rout is fuelling demand for less volatile assets in one of China’s favorite real-estate markets, where a plunging Australian dollar is making property cheaper for offshore investors. Chinese developers last month snapped up most of the 15 sites in and around Melbourne sold by CBRE Group – five times the property broker’s usual monthly tally. The bulk of the deals were sealed after the Shanghai Composite Index started tumbling.

Clearly rich Chinese are seeking virtually any international asset to help them take advantage of taxation, keep their information and assets private, and are seeking for a wider range of financial investments offshore.

But it is difficult to wrap their minds around trusts and foundations, as these two financial structures are still largely absent in China. But trusts and foundations are a great way for rich Chinese to protect themselves against divorce, bankruptcy, disputes, and to safely and legally pass their wealth down to the next generation.

How Do Trust Work and Why They Are Important?

The most authoritative definition of a trust is: 'A fiduciary relationship in which one person (the trustee) holds the title to property (the trust estate or trust property) for the benefit of another (the beneficiary).'

A trust is a structure that separates control and legal ownership from beneficial ownership; so that at least one person and/or company agrees to hold and manage assets or property in a way that will benefit someone else (beneficiary).

Other parties in a trust structure include a 'settlor' who contributes the initial trust asset (which may be anything, including a nominal $10 cash or a house) to bring the trust into existence, and an 'appointor' who generally has rights to appoint, replace and remove trustees.

You could almost like a trust to a car. The car is put under the control of a driver (the trustee) to drive the car while carrying the passengers (beneficiaries) to a destination (when the trust ends, or is 'vested') where the cargo or luggage (assets and property) is unloaded and given to the passengers again. During the drive, the luggage is maintained in the best condition possible and the passengers may occasionally be offered food and drinks if the ticket contract allows it.

One of the big motivations for establishing a trust will be to protect one’s assets. Property and assets can be moved into a trust for protection from creditors, to maintain an estate until a beneficiary becomes old enough to have legal possession, or to isolate valuable assets from a trading company that may be more exposed to litigation.

Trusts, if set up in the correctly, can help you legally minimize some of your taxes. But it is a gray area, and the government is always seeking to close perceived loopholes in tax law across the globe. The key here is to work with specialists that understand the various loopholes within a specific jurisdiction.

Offshore Trust Options for Wealthy Chinese

In China, the laws make it difficult to establish a private trust that truly protects and isolates property. Due to the fractured legal and tax system, and especially because of the absence of a trust registration system, make it much harder to establish a trust domestically for Chinese peoples. If assets can’t be isolated domestically, then most ultra-rich will set up family foundations overseas. Many like to set up long-term trusts in international financial hugs, including Hong Kong, Singapore, The Virgin Islands, Jersey or the Cayman Islands.

Some Chinese rich peoples have adopted an offshore plan via the red chip structure. They create an overseas trust in a place with a well-established system while also establishing an overseas holding corporation to reverse-acquire the property in China. After this they can transfer the interests of that corporation into trust property and give it to a trust agent. The rich person is usually the “CEO” of the overseas holding corporation so they can secure property and make important decisions themselves.

But this way to establish trust has limitations and risks. For the Chinese rich, property that can be transferred abroad is restricted to income acquired legally through avenues like overseas investment or overseas IPO. In some industries that have restrictions on foreign capital, the property cannot be transferred through this structure without fear of legal trouble. In spite of this, overseas trusts still attract many ultra-rich. They can also help corporations reorganize investment across countries.

Many wealthy people across the globe are looking at STAR trust in the Cayman Islands. STAR trust has been recognized as unique and flexible estate planning tools. STAR trusts are frequently used in structured finance and commercial transactions where other special purpose vehicles are too inflexible or otherwise inappropriate.

Jersey, the largest of the Channel Islands, is also a recognized leading jurisdiction for the establishment and management of trusts. The island has a large and well-qualified professional trust sector, modern trusts legislation and an effective judicial system. It is also recognized as being in the top division of international finance centers in the regulation and supervision of its financial services industry. The Island offers fiscal neutrality for trusts established for non-Jersey resident beneficiaries.

Singapore is also rapidly becoming an important and key jurisdiction for establishing and operating various types of trusts. Many factors are aiding this trend. Singapore is home to many of the leading global financial institutions, as well as accountancy, legal and tax advisory firms; the country’s polity provides for a comprehensive legislation that ensures an attractive tax regime and strong regulatory framework for trust arrangements; the country’s market-friendly and stable economic policies encourage international investors to consider it as a favored destination for a variety of investment vehicles; and the booming regional wealth has generated a strong demand for its efficient management through trust structures.

The Structure of Foundations

Vehicles like a foundation allows the founder plenty of flexibilities, such as building a legacy for future family members, ensuring the aspiration of the founder are carried through to future generations, protecting a family's wealth, and fulfilling family members dreams. As the management of the foundation is in independent hands of the Council of the foundation, which operate like the board of directors of a company, there is bound to be less conflict of interest as is sometimes seen in typical trusts, especially where trustees are appointed from among the ranks of beneficiaries.

One of the key advantages is that a Trust is not deemed a legal entity unlike a foundation. Foundations are set up to be more like a corporate body; specifically a company established to manage the assets of the founder according to the wishes of the founder. Therefore a foundation allows for less grayness in its application and provision of the assets to the end beneficiary. In addition, similar to a company, a foundation is required to be registered which gives more certainty to its operation and administration.

The provisions described above allows for foundations to be better understood in civil law countries, as it fits in well into most if not all of its civil codes, which in turn provide the backbone to all civil law systems. There it provides an easily understood structure, which will work in the same manner as trust would under common law jurisdictions.

With a trust, the interests of the beneficiaries are the most important. But in a trust even though the Settlor may provide a Letter of Wishes, in an attempt to ensure his exact wishes are executed by the trustee, the trustee is not duty bound to comply with his wishes as the trustee does not have a fiduciary duty to do so. Such a situation then leaves the Settlor at the mercy of the trustee who has been appointed to manage the trust.

This problem does not arise with foundations as the will and interest of the Founder can be explicitly detailed in the Charter and the Founder himself may serve on the Council of the Foundation, ensuring that his wishes are known and allowing him a much greater degree of control as compared to a trust.

Another key advantage of a Foundation is that is can also be a tool for company succession as the council members can be appointed from members of the founder's family which provides a strong platform for council members to discuss and work on common objectives. For example, this allows for the entire council to discuss and determine the successor of the estate with ease and objectively.

In China establishing a foundation is not easy, and there are a lot of contradictions within the law. Acquiring a specialist who has extensive experience establishing a foundation in China is critical. Before establishing a foundation in China, 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 “okay” 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.

Using a private foundation in an international jurisdiction, such as the Cayman Islands, is not only tax-wise but also helps in protecting assets and 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.

Top International Options for Establishing a Foundation

Many of the world’s top international financial centers have the proper talent and legal soundness to establish a foundation that will ensure your assets are safe and protected.

Establishing a Foundation in the Cayman Islands has clear advantages compared with other jurisdictions across the globe. Once established, a Cayman foundation becomes its own legal entity. For a Cayman foundation in come into existence it requires the occupation of a” founder”, who is the person/organization forming the foundation, a “protector” who is required to ensure management compliance in a similar way to how a trust operates, a “beneficiary” like in the concept of a trust, is the person or group of people benefiting from the foundation and finally there is a requirement for “council members”.  There are however no requirements for shareholders.

A Cayman foundation takes on its own legal personality, as a result of this; the foundation itself becomes the owner of the foundations property, and can own multiple corporations and a wealth of different properties under the foundations name. Foundations are able to leave instructions to be carried out in the same way as a Trust can. Such commandments will be included in the Foundations Deed of Incorporation and its Articles of Association.

A Jersey foundation has some of the concepts of both private companies and trusts and may be established for such purposes as succession planning, as a vehicle for philanthropic purposes, to hold 'family' or wasting assets and for other purposes. Foundations may be used within corporate structures involving UK companies to protect individuals who do not wish to be disclosed in UK company accounts as a related party under IFRS. They provide a robust alternative to the traditional nominee shareholder. To hold assets "off balance sheet", to function as a succession planning vehicle. By placing assets in a foundation, founders can avoid the succession rules of their home state and can plan for the seamless devolution of family wealth in a tax-free environment. Jersey foundations can be used to hold a variety of assets for reasons of confidentiality.

Guernsey is also a premier international fiduciary center with a long history in the provision of fiduciary services. It is perhaps best known for its trusts law and administration of trusts, having a wealth of experience in this area, which continues to develop to meet the needs of its ever mobile international clients and also the developing international regulatory environment. Guernsey has some 190 licensed fiduciaries, ranging from large internationals to independent boutique operations.

A Guernsey foundation is an incorporated entity with separate legal personality but which, unlike a company, does not have shareholders. Instead, it holds assets in its own name on behalf of beneficiaries, or particular purposes, or both, and it operates in accordance with a constitution comprising of a charter and a set of rules. Unlike a company, it cannot carry out commercial activities except those necessary for, or ancillary or incidental to, its purpose. As such it is an entirely new legal entity for Guernsey; looking similar to a company but with an operation more akin to that of a trust.

These are just a short list of some of the best places to establish foundations that will ensure that your property is protected and passed down to future generations.

The Bottom Line

With the economic and financial problems of China clearer than ever, rich Chinese people have the opportunity to protect their assets with trust and foundations. These tools are ideal for wealthy individuals who are seeking to pass their wealth down a generation, and who want to ensure that their wealth is protected for years to come. Professional service providers with specialized knowledge of laws in an offshore jurisdiction, which has solid infrastructure and a sound legal system, are the key to establishing these entities properly and legally.




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