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Dynasty Trust – How can it be used to preserve family assets across generations?

By Anna Chan & Barbara Kwong

Dynasty trust, is an increasingly popular tool to pass on family wealth to the next generation. As its name suggests, trust assets are intended to live through dynasties across generations within the family. Contrary to an outright gift to your kids, a dynasty trust allows you to control (even after your passing) how and when the kids can receive, enjoy and use the family assets. It can also ensure that certain core assets are retained within the family generation after generation. If the same thoughts have crossed your mind, a dynasty trust may be for you.

Despite the fancy label of a “dynasty” trust, it still shares most features of, serve mostly the same purposes with, and requires almost the same pre-set up considerations as normal trusts.

What are the advantages of setting up a trust?

In general, trust is a useful tool, if structured properly, in achieving multiple purposes, including succession planning, tax planning, protection of assets in case of matrimonial disputes, and protection from creditors’ claims.

  1. Fast-tracking “inheritance”

A trust can help bypassing the otherwise cumbersome and time-consuming process of getting a Grant of Probate. As an illustration, if there is no trust in place, the process of the probate of the 1st Generation can take anywhere from months for simple estate matter, to years for complicated estate matter (which is not uncommon for high-networth individuals). Worse still, in certain jurisdictions such as the US, the deceased’s assets would be frozen until a Grant of Probate is obtained. Assuming it takes month to complete the process and consequently a huge amount of cash sat in the estate’s account frozen, the cash would not then be available for injection into the family business.  This might pose problem if the family business requires urgent cash flow or interim liquidity.

  1. Succession planning

A trust is useful in minimizing the risk of families mired in ugly spats over succession and control of business units, when there are assets and/or family business to be managed following the death of a family member. With a trust in place, a settlor can transfer property during his lifetime into the trust, setting out in clear terms as to how his properties and any family business shall be managed in a letter of wishes, and entrusting a reliable trustee to manage the trust assets. When he passes away, the trustees can still hold the reigns over the family properties in the trust in a timely manner, and provide for beneficiaries according to the settlor’s wishes.

  1. Tax planning

Trusts are recognized instruments for tax planning especially when a beneficiary is resident of a high tax regime where world-wide income or assets might be subject to heavy taxes. With the setting up of a trust, the trust can be carefully designed such that taxes are only imposed when there is trust distribution to beneficiaries, and can be tailor-made based on needs of the settlor and the beneficiaries.

A significant advantage to beneficiaries is that, beneficiaries can manage when trust distribution and hence taxable income is required to be paid. The beneficiaries’ income tax obligation is “deferred” in that sense. That being said, settlors still need to beware of any “throwback tax” and penalizing interest charge that may be imposed for distribution of any accumulated net income (“UNI”) of a trust in some jurisdictions, for example, distributions of UNI to beneficiaries in the United States under a foreign non-grantor trust.

For certain jurisdictions, recognized trust structures might assist beneficiaries to save enormous sum of tax. If you are interested to find out more, please go to:-

  1. Trust treatment in divorce

If you are going through a rough patch in your marriage, you might be concerned whether your assets will have to be divided with your estranged spouse, leaving your children with less financial provision than they would need. Some may therefore have their assets settled into a trust to avoid being pooled into the matrimonial pool when it comes to division of assets in a matrimonial proceeding. A trust with sophisticated set-up and carefully drafted trust deed may well serve such purpose and protect the trust assets from the attack of ancillary relief claims.

However, in certain circumstances, the court might declare the settlement of the relevant trust void, if the trust documents are not carved carefully enough by professionals. In the case of Kan Lai Kwan v Otto Poon, [2014] 6 HKC 111, the trust fund was held to be included in the marital pot to be divided between spouses, because the drafting of the trust documents showed that the supposed beneficiary (the daughter) actually did not have fixed beneficial interest in the trust fund: the trustee was generally deferential to the settlor, such that the trustee has insufficient managerial role over the assets. Precedents have set out various landmines in making a trust “façade” like what happened in the Otto Poon case, which settlors and their legal advisor shall be aware of.

  1. Protection from creditors’ claim

Setting up of trusts is also an effective way to protect assets from hostile claims. On the presumption that a trust is properly set up, the trust assets would remain intact from the reach of creditors even if a settlor becomes bankrupt.

However, one shall note that any disposition (including settlement of trust assets) may be subject to the claw back rules under the relevant local insolvency rules. For example in HK, the Bankruptcy Ordinance (Cap. 6), and the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), and the Conveyancing and Property Ordinance (Cap. 219) set out circumstances where liquidators have power to claw back certain non-arm’s length transactions, for example, if such disposition happens within a certain timeframe before the commencement of the bankruptcy or liquidation proceedings.  

When should I set up a trust?

It is a good idea to set up a trust and segregate certain assets for the benefit of your next/future generations when you are formulating your estate planning.  

It is also a popular option nowadays in Hong Kong for people to migrate to other jurisdictions. If your destination country has in place a high-tax regime, you may consider setting up trusts to manage your tax affairs. For example, in Canada, one of the most popular destinations where Hong Kong people are keen to migrate to, their aggressive tax avoidance laws have substantially restricted the room for tax structuring. However, if an offshore trust is set up properly, its worldwide income may not be taxable under Canadian tax regime. For details, you may refer to our article series on “Emigration from Hong Kong: The Importance of Pre-Migration Tax Planning”.   

Who should be acting as trustee?

Choosing trustees is an important decision which should not be taken lightly. Trustees shoulder responsibilities, and their duties are often statute-regulated, as is the case in Hong Kong. Below are the some of the common choices of trustees for settlors:-

  1. Friends and families: Most people like to consider friends and families as trustees, but might have failed to consider whether or not they are qualified to make financial decisions in the management of trust estate and their limited lifespan.
  2. Professional trustees: This may be a more appropriate option compared to friend and families for the sake of prudence. In Hong Kong, professional trustees have to be licensed under a new licensing regime for trust and company service provides, under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615 of the laws of Hong Kong) and be statutorily regulated to ensure that professional trustees are well qualified to manage assets.
  3. Offshore trustee companies: This may be the case if offshore trusts are set up, for example in Cayman Islands or the British Virgin Island. However, the costs of engaging offshore trustee companies can be significant compared to onshore ones. The relatively higher set up cost and annual maintenance fee might be a concern for cost-sensitive individuals.
  4. Banks: Many banks also offer trustee services. However, banks can be particularly critical in accepting trust assets when compared to trustee companies, and may only take wealth management products issued by themselves, or fixed deposit or real estate properties as trust assets. In particular, banks are generally reluctant to take shares in private company as trust assets, partly attributed to the increasingly stringent due diligence requirements imposed on banks these days in accepting funds or new clients, for anti-money laundering purposes. Therefore, banks are less preferred by businessmen who wish to settle their family business into trust structure.
  5. Other professionals: Solicitors and accountants who have worked with your business may also serve as trustees. Since they know the businesses in depth, they are likely to provide a bespoke service to your businesses and tailor-made the necessary trust documents. It is another plus if you prefer trustees with more flexibility than institutional trustees. 

What should a settlor take into account before deciding on the jurisdiction of a dynasty trust?

You might have heard of trusts in Jersey, the BVI, Guernsey and other offshore jurisdictions but how a settlor shall choose among the many jurisdictions? There are indeed various factors you would have to take into account:-

  1. Settlor’s reservation of powers

A valid trust requires the alienation of the trust property by the settlor. However, in many cases settlors would wish to retain powers to manage the trust, so as to ensure proper maintenance and growth of trust assets. Accordingly, a settlor may need to consider the statutes of the relevant jurisdiction to ensure that reservation of power by him is allowed in that particular jurisdiction, if he intends to reserve any power. So far as the statute in Hong Kong is concerned, the Trustee Ordinance (Cap. 29) specifically allows for reservation of powers by the settlors, which usually includes power of investment and asset management. However, it is important to note that any provision in the trust documents regarding reservation of powers by the settlor shall be carefully drafted, so as to avoid a trust being declared “façade” in light of the principals as set out in the Otto Poon case.

  1. Rule against perpetuities

An old common law principle, the “rule against perpetuities,”[1] prohibits trusts that could potentially last forever. The principle provides for trusts to be valid only for certain number of years, depending on the rules of different jurisdictions. To preserve wealth for generations and allow for long-term and strategic wealth planning, settlors who wish to set up dynasty trusts should take note of the legal position of different jurisdictions on the rule against perpetuities, and may need to avoid those jurisdictions which still uphold the common law rule. For example, in Hong Kong, the Perpetuities and Accumulations Ordinance (Cap. 257) abolished the rule against perpetuity and excessive accumulations for trusts created on or after 1 December 2013. This should prove an attraction to settlors who wish to create a high value dynastic trust lasting many generations.

  1. Trustee’s statutory duty

Trustees owe a duty of care that originates from common law. Precedent cases have also prescribed boundaries of trustees’ fiduciary duties owed to beneficiaries. In some jurisdictions, this duty has been codified into statutory laws to better protect trust assets and beneficiaries, such as by way of limiting certain exclusion of trustee liabilities to the advantage of beneficiaries, which is preferred by settlors.

In Hong Kong, trustees’ duties and powers are codified into the Trustee Ordinance (Cap. 29). The Trustee Ordinance requires a trustee to exercise reasonable care and skill, having regard to any special knowledge or experience that the trustee has or holds himself out as having, and (if he is a professional trustee) to any special knowledge or experience reasonably expected. This statutory duty has shed light on the ambit of trustee’s duty and provided clearer guidance on the standard expected, thus safeguard the interest of settlors and beneficiaries.

  1. Beneficiaries’ right to remove trustees

Beneficiaries’ right to remove trustees is a crucial check and balance against the trustees’ power. Where this is codified into statutes, it can become a nuclear weapon for beneficiaries who are dissatisfied with the trust administration to remove the trustee. Statutes may provide for a simplified, hassle-free procedure for the removal, which can often save time and cost compared to instigating court proceedings to effect such removals.

In Hong Kong, the Trustee Ordinance confers on beneficiaries the right to remove trustees from the administration of the trust by giving a written direction for the trustee to retire[2], subject to certain criteria. Such mechanism offers a degree of flexibility and eliminates dependence on the court’s discretion, which are not available in some other jurisdictions. For example, in Singapore there is no such statutory provision allowing beneficiaries to remove trustees by direction, thus beneficiaries have to apply to the court for a court order to substitute trustees instead.

  1. Trustee’s power to delegate

Under common law, trustees have a duty to act personally and cannot delegate their functions unless authorized to do so. However, some trustees may wish to appoint agents to provide professional assistance in trust asset management.  

In the past, one of the least satisfactory aspects of Hong Kong trust law was the difficulty in trustees appointing discretionary fund managers to manage the trust portfolio. Now, the position in Hong Kong has conferred broader discretion on trustees, which allows trustees to delegate some aspects of their duties for a maximum of 12 months under a power of attorney. That being said, some core duties of a trustee including distributions to beneficiaries, the decision whether a payment should be made out of capital or income, appointment of new trustees, and any further delegation by agents still cannot be sub-delegated.

  1. Dispute resolution

This factor is often neglected by settlor during peaceful time. Jurisdiction for dispute resolution could become problematic when there are disputes arising from the trust such as whether a piece of document is discoverable. For offshore trusts, even if all beneficiaries and trustees are physically in HK, the dispute might still have to be fought over on the other side of the world.  It is equally important to choose a jurisdiction with predictable and reliable judicial system in place. Taking Hong Kong as an example, Hong Kong has a well-established judicial system which follows the common law regime and doctrines of equity.  In addition, trusts in Hong Kong are governed by statutes including the Trustee Ordinance and the Perpetuities and Accumulations Ordinance. With its robust regulatory environment and mature legal system, disputes arising from trusts established in Hong Kong can be properly resolved under settled principles of law. 

  1. Administration fees, tax and double tax agreements (“DTA”)

The initial set up costs, as well as annual maintenance fees will add to the expense of the trust. It is also essential to consider whether a jurisdiction has a favourable tax system so that the trust can enjoy low tax rates on dividend, interest and royalty etc. arising from the businesses of the trust. Exemptions offered by DTA will help the trust to avoid international double taxation of income and property, and will save cost/expense for the trust.     

Hong Kong is world renown for having in place a favorable tax regime. Dividend income, bank deposit income, certain types of non-bank interest and bond interest are tax-exempt in Hong Kong. Rent and gains from foreign real estate, capital gains and foreign-sourced profits are also non-taxable. A resident Hong Kong trust which owns foreign assets can remit income and profits from such assets to the trust without incurring any taxes in Hong Kong. In addition, Hong Kong has an extensive network of DTAs with other jurisdictions. Trust income will not be taxed twice in the source jurisdiction and residence jurisdiction (known as source-residence conflict), if those jurisdictions have in place a DTAs with Hong Kong. This helps break down the tax barriers that obstruct cross-border flow of investment by trusts, and trusts in Hong Kong may claim relief from taxes paid overseas under DTAs.    

What are the ways a dynasty trust can be challenged, and how to avoid them?

As can be seen from the Otto Poon case, there can be instances where the trust assets in a dynasty trust might be considered necessary financial income for a spouse, hence be included in the matrimonial pot. This shall be considered in light of section 17 of the Matrimonial Proceedings and Property Ordinance (Cap. 192) in Hong Kong, which provides that where a disposition took place less than 3 years before the date of application of the spouse to set aside the same, the Court may presume that such disposition is done with the intention of defeating the applicant’s claim for financial provision.

Another possible challenge faced by dynasty trusts is when a trust estate as originally constituted had come to an end and has subsequently been “resettled” into a new trust i.e. new trusts are declared over the trust property with the result that its use or application is modified.

Therefore, to avoid a dynasty trust being challenged, the settlor is advised to carefully carve the terms of distribution in the trust deed, give due consideration to the timing of setting up a dynasty trust and avoid some the legal landmines which may make a trust “façade”. It would also be advisable to provide clearly as to trustee’s power in administration and management of trust assets so as to minimize disputes relating to such management, which can sometimes result in resettlement of a trust.

  Conclusion

Given the sound judicial system and favorable tax treatments, Hong Kong could be one’s ideal jurisdiction for the establishment and operation of a dynasty trust. Considerable rights, powers and protections are conferred on settlors, trustees and beneficiaries to enable better management of the dynasty trust. As long as trusts are structured properly to avoid challenges, family wealth can be preserved for generations to come. 

If you have any question regarding the topic discussed above, please contact our partner Anna Chan at [email protected] or associate Barbara Kwong at [email protected] for further assistance.

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

 

 

[1] It requires that future trust interests (i.e. interests that do not take effect immediately), must be certain to vest within a defined period of time known as the perpetuity period.

[2] Section 40A, the Trustee Ordinance.

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