The year of the trust
More than 60 private trusts were set up in China between May 2013 and October 2014. During this period, many offshore trust companies commented that Chinese trust companies lacked true trusteeship services, and were more akin to investment banking firms coupled with custodian services.
Private trusts have been available for use as estate-planning tools, under the Trust Law of 2001, for the past 11 years. However, Chinese high-net-worth individuals (HNWIs) have only recently begun to set up private trusts.
Trusts under Chinese law
When introducing the trust concept into a civil-law system, it makes sense to begin with a less extensive type of trust than that used by common-law countries. Thus, the Trust Law treats the settlor, the trustee and the beneficiaries as if they were parties to a special contract, while, in common-law countries, there would be a three-party relationship, rather than a contract. Under this special contract:
- the settlor has special rights, which are then extended to the beneficiaries; and
- the trustee cannot resign without the consent of the beneficiaries and of the settlor, which means that the trustee cannot unilaterally replace itself with a new trustee.
The trust property is managed in the trustee’s name, in accordance with the wishes of the settlor as expressed in the trust document, and in the best interests of the beneficiaries, of whom at least one must be in existence at the creation of the trust. The key duties of the trustee are to keep the trust property separate from privately owned property and to keep separate accounts for the trust property.
Another aspect of this special kind of contract, similar to English and Welsh law, is that the settlor has the right to obtain information from the trustee about the trust and, in some cases, to remove the trustee.
China’s trust industry
Years of economic reform and the implementation of the opening-up policy have resulted in the accumulation of personal wealth and an increase in the number of HNWIs. Wealth creation is now slowing down, due to economic readjustment, and Chinese HNWIs have found themselves at the stage of wealth preservation; they are beginning to think of wealth succession and how to protect their wealth.
Chinese clients are starting to consider transferring wealth to their children by setting up trusts
Since the start of 2013, a few forward-thinking Chinese banks and trust companies have launched pilot private trust programmes to meet the frequent inquiries of HNWIs with regard to wealth preservation. Although offshore trusts are still the preferred option for these clients, it is not possible to legally convert all personal wealth into an offshore trust due to capital account controls under China’s foreign exchange regulations. Therefore, it is inevitable that Chinese clients will need to set up an arrangement for some of their wealth under the Chinese legal framework, which could be achieved by setting up a Chinese private trust under the Trust Law.
The China Banking Regulatory Commission (CBRC), the regulator for trust business in China, only permits licensed Chinese trust companies to be trustees for business. It is, therefore, not surprising to see that various trust companies are actively promoting their commitment and dedication to serving HNWIs as trustees for their private trusts.
Needs of Chinese clients
There are three main reasons for Chinese clients to set up trusts:
- Avoiding inheritance tax. Chinese clients are starting to consider transferring wealth to their children by setting up trusts. Many HNWIs are concerned about the draft Interim Regulations on Inheritance Tax, introduced in 2004, and revised in 2010. Although the regulations have still not been promulgated, they are a clear signal that the Chinese government will start to impose inheritance tax in the foreseeable future. It is specifically stipulated in the revised draft regulations that inheritance tax encompasses the entirety of a decedent’s bequeathed wealth, and gift property transferred within five years before death. Setting up a Chinese trust seems to be the best choice to avoid a huge amount of inheritance tax.
- Chinese HNWIs spend much time and effort in ensuring their children are on the right track from an early stage. Although many would not mind investing in sending their children to overseas schools, there are plenty of spendthrift examples to alert them to the fact that it is not wise for their children to have direct access to the trust and to spend as much as they wish. Even if the parents decide to make their only son or daughter a beneficiary under a private trust, they normally check with the trustees as to how to prevent their child knowing or realising, before they are sufficiently mature, that they are beneficiaries under a trust with a considerable amount of assets.
- Chinese clients who have accepted the idea of trusts prefer to segregate a certain amount of assets in a safety structure to ring-fence against risks associated with personal assets. Events such as the sudden collapse of a famous business empire – regardless of whether it is because of cash-flow problems or scandals – have alerted Chinese clients to the urgency of making an estate plan at an early stage.
Limitations of private trust assets
Due to currently unresolved trust registration and taxation issues, the underlying assets in all Chinese private trusts are cash and financial assets, instead of real estate, equity or other property. However, trust companies and insurance companies have explored whether life insurance policies can be included in a trust.
Challenges facing trust companies
Most Chinese trust companies focus on business trusts, which are mostly for corporate investment and financing. Thus, Chinese trust companies are playing the part of investment banking firms coupled with custodian service providers, which means it would be very challenging for them to provide a true trusteeship service, and to be qualified trustees.
Due to their past experience, it might be easier for Chinese trust companies to simply manage bankable trust assets or carry out investment management. It is more complicated to exercise discretion, judge situations and make the best decisions for beneficiaries. For instance, if a settlor sets up a rule that a beneficiary, perhaps their child, will get a fund to start their own business or make an investment when the beneficiary comes up with a ‘good business plan’ or is ‘mature and qualified enough to make a business decision’, the Chinese trustee could find itself without the experience to judge if the beneficiary meets the stipulated requirements. Chinese trust companies still have much room for improvement in this area, and they are turning to foreign trust companies for guidance.
The Chinese trust industry is attractive to financial institutions both inside and outside China. It would not be surprising to see a Chinese client use a sophisticated structure involving a Chinese private trust, Chinese will and offshore trust as part of their estate plan in the near future. Various representatives have lobbied the government to amend the current rules and regulations to facilitate a better environment for Chinese private trust business, but change has yet to come.
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