Tax management for family offices
An efficiently organised and operated family office is key to sustaining an affluent family’s wealth and wellbeing for the long term. A well-run family office caters for many functions, including succession, asset protection, risk management, wealth planning and management, family governance, and passing on family values. The list can go on, but the common thread is a holistic, global approach to tax management. Family offices that embrace such an approach can go a long way towards preserving capital and improving returns for the family.
A wealthy family with members and businesses in many countries is likely to be on the radar of different tax authorities; moreover, the more countries that are involved, the more delicate and complex the tax implications. For an office serving such a family, in-house international tax management is important.
This does not mean spending a fortune to hire a large team of tax experts to cover all the jurisdictions involved. Equally, hiring one practitioner who is expected to know all the jurisdictions is not advisable. The best way to manage tax issues is to ensure the family office has a sufficient degree of awareness and sensitivity to spot problems when they arise, and to know when it needs advice, and whom to.
Three-dimensional matrix model
Tax issues differ according to the family and depending on the location of the family, its businesses, its types of investments and other factors. While there are no hard and fast rules, a family office can develop its own list of sensitive issues using the tax management matrix model shown in the diagram below.
The model organises tax management elements in a three-dimensional matrix. The first dimension is planning for the broad types of tax issues that affect the family members personally. The second dimension has to do with planning for investments made through the family office. The final dimension deals with the three sub-groups of tax management: compliance, review and improvement.
Planning for family members
The aim of planning for personal tax issues is preservation of the value of the family members’ assets and inheritances. This type of planning can help to reduce or even avoid the impact of income taxes and death duties. Offshore companies, trusts and foundations may confer obvious advantages, but this depends on the tax laws of the countries concerned. A recent example is the US gift tax exemption. This allows US persons to transfer to a trust approximately USD5.25 million of assets for 2013, which would otherwise be exposed to US estate duty (if the gift exceeds USD5.25 million it will be taxed at a rate of 40 per cent).
That said, a family office should always apply a cost-benefit analysis to determine whether a planning structure is worthwhile. Setup costs as well as ongoing compliance costs will need to be taken into account and balanced against the likely tax savings. It is also necessary to take into account current populist anti-tax planning sentiments, which mean structuring might backfire if confidentiality cannot be assured.
A family office also needs to be aware of a family member’s domestic capital gains tax position. How a gain is classified as being on an income or capital account will affect tax treatment in many countries. In some jurisdictions, such as Hong Kong, capital gains are tax-exempt; other countries, such as China, impose lower tax rates on capital gains; and yet others - Indonesia and Thailand, for example - treat capital gains as ordinary income. Deferral strategies can also help to extend the timing of taxability.
Cross-border activities can also create planning opportunities. For example, a UK-resident non-domiciled remittance- basis taxpayer is not taxed on foreign income and capital gains unless they are brought into the UK. Accordingly, the family office should plan and execute segregation and management policies to avoid unnecessary or accidental UK remittances. To avoid controlled foreign corporation (CFC) rules, the family office can help to ensure ownership stays below the deemed income threshold and also make good use of exemptions. Double-tax issues are also likely, so the family office should help the family avoid being taxed twice on foreign-source income.
Further complexities arise where family members are citizens or residents of different countries, because planning must take into account the tax rules in each of the jurisdictions involved.
Planning for family office investments
Many family offices expect high rates of return from their investments. Obviously, tax costs reduce returns. Tax consequences should therefore be monitored throughout the investment cycle, from the making of investment decisions to the extraction of profits (or realisation of losses).
Using companies to build a tax-efficient investment holding structure is a typical move; however, the family office has to be mindful of the differences in local tax treatments. It is not uncommon to see layers of offshore companies, e.g. in the BVI, being used to hold investments. If the investments are in Hong Kong there is no tax implication when there is a change in shareholding in any of these holding companies, but there may be tax implications if the investments are in Japan, Malaysia or China.
The family office should be aware of the tax implications of different types of investments. Real estate investment is usually subject to greater regulation than investment in locally listed shares. Planning opportunities might be available using corporate structures, but there will be specific rules that apply to real estate investment. Some jurisdictions offer beneficial tax regimes or special exemptions for certain business activities, making them a more attractive investment. The size of investment also matters. In Australia capital gains are not taxed if the holding is less than 10 per cent of a listed company. To a considerable extent, the difference in tax treatments affects how family offices invest.
Withholding taxes on dividends, interest and capital gains can often be reduced through proper planning, but this is becoming more difficult as jurisdictions are increasingly ignoring interposed entities and focusing on the ultimate owners of such income.
Less visible to outsiders, but at the core of the family office, is how its location, legal vehicle and ownership structure affect its own taxability and that of employees. Key officers and investment personnel are always keen to find tax-efficient ways to maximise their income, management fees, and carried interest or other incentive fees.
The best way to manage tax issues is to ensure the family office has a sufficient degree of awareness and sensitivity to spot problems when they arise
Compliance and review functions
Compliance is an essential function of family offices for both personal and investment-related taxes. The more routine work includes meeting tax filing and record-keeping requirements and handling tax enquiries or investigations and claims for treaty and other benefits. These are annual exercises to be executed at each of the personal, corporate and trust levels (especially if income is generated under a trust or CFC).
Other functions include revisiting structures to ensure that they continue to be tax-effective, and reviewing new tax developments to see whether they confer potential tax benefits. Suppose a family uses a Dutch company to invest in Indonesia to take advantage of a 10 per cent withholding tax on dividends, and Hong Kong then enters into a treaty with Indonesia that confers a 5 per cent rate. In this type of situation, the family office could consider a restructuring.
In tax management, a family office should go beyond being merely responsive and should instead be proactive by constantly watching developments in the tax environment to achieve better tax efficiencies.
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