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

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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 anna.chan@oln-law.com or associate Barbara Kwong at barbara.kwong@oln-law.com 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.

Priority freebies given to in-house lawyers!

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Join us for a webinar (3 CPD points) presented by our disputes partner, Eunice Chiu, on dealing with vexatious litigants.  

  • Date: 17 July 2020 (Friday)
  • Time: 2:30pm – 5:45pm (15 mins break)
  • Level: Elementary / Intermediate / Advanced / Updates
  • Language: English
  • CPD Points: 3
  • Course Code: L20CP03
  • Venue: Webinar via ZOOM
  • Host: Lex Omnibus

See flyer: Dealing with vexatious litigants in civil and administrative proceedings

Limited freebie spots – priority given to in-house lawyers. Email us if you’re interested: marketing.oln@oln-law.com

OLN Ranked by Benchmark Litigation Asia-Pacific 2020

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Oldham, Li & Nie is pleased to announce that Benchmark Litigation Asia Pacific has recognized the firm in the publication’s 2020 rankings. 

OLN ranked “Recommended Firm of 2020” by Benchmark Litigation Asia-Pacific in the following Practice Areas:

  • Commercial and Transactions – Tier 3
  • Family and Matrimonial – Tier 2
  • Private Client – Recommended

About Benchmark Litigation

Benchmark Litigation, the definitive guide to the region’s leading dispute resolution firms and lawyers, was first published in 2008 covering the litigation and disputes markets in the United States and Canada and has broadened its coverage to include Asia – Pacific, Europe and Latin America – becoming a truly global guide.

Surviving the Current Economy Series Part 1: What Options are Open to Corporate Debtors

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At the start of the COVID-19 pandemic, we saw many small to medium sized businesses (SMEs) going into panic mode.  They sought legal advice on how to deal with issues arising from immediate or near immediate cash flow problems and creditors, and at the same time, limit their potential liabilities and protect their assets.

We are now more than 3 months into this new way of life.  In the business world though, for the first quarter of 2020, there are reports of most businesses suffering large percentages of revenue loss.  There are employee lay-offs, salary reductions and in some instances, companies simply closed shop for good. 

Would our legal advice be any different now compared with 3 months ago?  Yes and no.  The laws have not changed but the global spreading of the virus has created further limitations on businesses, e.g. travel limitations have resulted in the cut-off of supply chains.  Such changed or changing circumstances may require a revisit of commercial and therefore legal strategy.  

In Part 2 of this series, we will explore options available to businesses/companies operating in specific sectors of the economy at this juncture.  For now, let’s discuss the basics of insolvency law as many clients appear most concerned about outstanding debts and cashflow problems.

Commercial Considerations 

Directors and shareholders should first and foremost consider whether the business is worth keeping, taking into consideration the current economic climate, business projections and personal preferences.  An all-round risk assessment of the business and its commercial value, along with an analysis of whether short term obligations can be met should be conducted.

Negotiations with creditors

The short-term analysis is highly based on whether creditors (e.g. financial institutions, landlords, suppliers and employees) are willing to give the business a break.  

When entering into negotiations with a creditor, be straightforward and ready to offer a concrete plan of repayment.  Often times, creditors are equally interested in allowing the company to continue, with a view to the company arriving in a better position to settle the debt in the future.  A concrete repayment/fund raising plan will instil confidence in the creditor.
Where the creditor is a bank and the debt arises from a loan, the loan is usually secured against certain assets of the company (e.g. equipment, revenue), assets of the majority shareholders (e.g. landed properties) and personal guarantees of the directors and shareholders.  On the strength of the personal guarantees, bankruptcy could be a real risk faced by directors and shareholders. Successfully working out a deal with the bank is pertinent but it requires skill, especially if the business is an SME with far less bargaining power.

Negotiations with landlords can prove to be fruitful in the current HK economy, in particular where the lease is about to expire.  Extractions of rental reductions are common-place whilst negotiating for a break clause (the right to terminate the lease early), rent abatement clause (the suspension of rental payments upon the happening of certain events), force majeure clause (essentially the termination of the contract upon the happening of certain events beyond the control of the parties), and rent-free periods should be explored.  

Force majeure clauses and how they operate have been discussed by our firm here: https://oln-law.com/are-you-frustrated-by-your-force-majeure-clause.  For what the law allows when dealing with employees, our firm has published an article on this: https://oln-law.com/employment-matters-to-consider-in-economic-downturn. 

Scheme of Arrangement as an alternative to being wound up/liquidated

If negotiations fail and the company otherwise cannot find a way to pay its debts as they fall due, the company should consider entering into a scheme of arrangement which is essentially the company’s proposal on how to compromise with creditors on their respective debts, generally resulting in creditors accepting less than the amount that they are fully owed.  It is an alternative to being wound up.

Once the proposal is completed, the company must apply to the Court to convene a meeting of shareholders and/or creditors to seek their agreement to the scheme of arrangement.  Agreement under section 674 of the Companies Ordinance (Cap. 32) means 75% of creditors’ votes (in person or by proxy) in favour of the scheme.  Upon obtaining such agreement, the scheme must sanctioned by the Court.  In deciding whether to sanction the scheme, the Court will consider the following factors (Re China Singyes Solar Technologies Holdings Ltd [2020] HKCFI 467): 

(1)    whether the scheme is for a permissible purpose;
(2)    whether creditors who were called on to vote as a single class had sufficiently similar legal rights such that they could consult together with a view to their common interest at a single meeting;
(3)    whether the meeting was duly convened in accordance with the Court’s directions;
(4)    whether creditors have been given sufficient information about the scheme to enable them to make an informed decision whether or not to support it;
(5)    whether the necessary statutory majorities have been obtained;
(6)    whether the Court is satisfied in the exercise of its discretion that an intelligent and honest man acting in accordance with his interests as a member of the class within which he voted might reasonably approve the scheme; and
(7)    in an international case, whether there is sufficient connection between the scheme and Hong Kong, and whether the scheme is effective in other relevant jurisdictions.

The implementation of a scheme of arrangement in HK is time-consuming and costly, particularly as it involves separate Court applications and meetings.  Even when a meeting can be conducted, it may be difficult to obtain 75% support, for example, if creditors consider that they may have a better chance of recovery in separate legal proceedings.  Moreover, until the scheme is fully sanctioned by the Court, there is nothing that stops creditors from commencing legal proceedings in the Courts against the company. 

Winding Up

Of all options open to creditors, winding up a company is the most severe.  The process involves a liquidator stepping into the shoes of the company to collect and realize on the company’s assets and settle outstanding liabilities of the company.  The process will almost always involve directors who will be required to assist the liquidator in giving all sorts of information about the company including its financial information and flow of money, sometimes via affidavits and testimonies in Court.

An order for winding up will be made in the following 3 scenarios:

1.    The debtor fails to pay or fails to provide sufficient security for a sum of more than HK$10,000 within 21 days after being served with a statutory demand.
2.    The debtor fails to satisfy wholly or partially a judgment or order of the Court granted in favour of a creditor.
3.    When the creditor proves that the debtor is unable to pay its debts as they fall due (cash flow test) or the assets of the company are not sufficient to meet its liabilities (the balance sheet test).

One of the defences often used to resist an order for winding up is that the debt is the subject of a genuine dispute.  

Commercial transactions to avoid when the company is undergoing difficult times

The liquidator has wide powers to investigate the affairs of the company and the acts of its directors and officers.  

In particular, the liquidator may call into question the following types of transactions:
    
1.    Transactions at an undervalue, defined as where (i) the company makes a gift without receiving any consideration; or (ii) the company enters into a transaction for a consideration that is significantly less than the value of the consideration provided by the company, e.g. selling the company’s shares to a relative at a fraction of the value.  The relevant time frame under scrutiny is 5 years before the date on which the winding up of the company commences (i.e. the time that the winding-up petition is presented).

2.    Unfair preferences, defined as acts of the company that place certain creditors in a better position than they normally would have been, e.g. paying creditors with lower priority before those with higher priority.  For an unfair preference given to a person who is connected with the company (i.e. an associate which includes a spouse of the director or the director’s blood relations), the relevant time frame under scrutiny is 2 years before the date on which the winding up commences.  For an unfair preference given to an unconnected person, the relevant time frame under scrutiny is 6 months.

If a transaction is found to be a transaction at an undervalue or an unfair preference, the liquidator will commence legal proceedings to recover the assets from the current owner.  Once a transaction is found to be a transaction at an undervalue or an unfair preference, the directors of the company may face civil or criminal sanctions for approving/allowing the transaction to take place.  

For the above reasons, directors need to be extremely careful when handling the transactions of a company undergoing difficult times or that is otherwise already trading insolvent.

If you wish to learn more about what options are available to corporate debtors facing the possibility of being wound up, please feel free to speak to our litigation partner, Eunice Chiu.

Eunice Chiu
+852 2186 1885
Partner, Dispute Resolution
Oldham, Li & Nie

CHINA – Strengthening Intellectual Property Protection from 2020 – 2021

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The China National Intellectual Property Administration has issued a Plan for “Implementation of the Opinions on Strengthening Intellectual Property Protection from 2020 to 2021” (“Plan”) on 20 April 2020, which detailing the roadmap to strengthen Intellectual Property Right (“IPR”) Protection in China covering patents, trade secrets, trademarks, copyrights, pharmaceutical products, e-commence as well as plan to deal with piracy, counterfeiting, and enforcement.

We summarize parts of the Plan concerning trade mark (Including infringement and counterfeiting) as follows:

1.    Trade Mark Laws and Regulations
  
•    Reviewing and revising Trademark Law as appropriate to strengthen trademark protection and enforcement

•    Stipulating punitive compensation for intellectual property infringement 

•    Refining criminal procedures and penalties, destroy infringing and counterfeit goods, and regulate government disclosures

•    Viewing legislative research on the protection of geographical indications (Completed before end of December 2021)

•    Revising the measures for the registration and management of collective marks and certification marks (Continue to advance)

•    Introducing judicial interpretations to combat online infringement and counterfeiting (Completed before end of August 2020)

•    Formulating interpretations of the Supreme People’s Court, Supreme People’s Procuratorate on the specific application of laws in handling criminal cases of intellectual property infringement (3) (Completed before end of August 2020)

•    Amending certain provisions on the Anti unfair competition of counterfeiting (Continue to advance)

•    Studying and compiling management standards for intellectual property protection of e-commerce platforms and formulating policy documents to control piracy, infringement and counterfeiting on e-commerce platforms (Completed before end of October 2020)

•    Formulating policy documents for the destruction of infringing and counterfeit goods (Completed before end of July 2020)

2.    Strengthen the administrative enforcement and judicial protection of intellectual property rights

•    Formulating and issuing standards for trademark infringement judgment (Completed before end of June 2020)

•    Publishing annual report on typical cases for patents, trademarks, copyrights, new varieties of agricultural plants and other types, as well as administrative enforcement and judicial protection in the fields of customs and cultural markets (Completed before end of December 2021 and continue to advance)

•    Cracking down on counterfeit goods with health and safety risks, increasing the frequency of handling cases, and establishing a system to publicly release the above-mentioned law enforcement action data and information on a quarterly basis (Completed before end of May 2020)

•    Promoting pilot inspection and identification of trademark infringement disputes, improving the inspection and identification system for intellectual property infringement disputes, and studying and establishing an infringement damage assessment system (Continue to advance)

•    Organizing special actions for intellectual property law enforcement protection, destruction of infringing and counterfeit commodities, and crack down on intellectual property infringement (Continue to advance)


3.    Improve the construction of a large-scale intellectual property protection mechanism

•    Studying and establishing a connection and information sharing mechanism for trademark administrative confirmation and major infringement administrative law enforcement cases and carrying out pilot projects (Continue to advance)

•    Carrying out pilot projects of hierarchical classification supervision based on credit in the field of intellectual property and regulating bad faith trademark registration (Completed before end of December 2021 and continue to advance)

4.    Optimizing key links for fast protection of intellectual property

•    Improving trademark examinations capabilities by shortening the examination period to less than 4 months (Completed before end of December 2021)

•    Exploring a rapid review mechanism for trademark registration, modification, renewal and other applications (Continue to advance)

•    Intensifying the itinerant trademark review cases and establishing an open review mechanism for major cases (Continue to advance)

•    Formulating the management, training and quality control related regulations of the Intellectual Property Protection Center and enhancing the ability of rapid collaborative protection (Completed before end of December 2020)

5.    Expand foreign exchange and cooperation in intellectual property protection

•    Improving overseas intellectual property information service, early warning and other platforms, strengthen the dynamic tracking and research mechanism construction of major trade countries (regions) intellectual property laws and policies revisions and major dispute cases, and building overseas trademark dispute case databases (Continue to advance)

6.    Strengthen the protection of intellectual property protection resources
 
•    Strengthening the construction of infringement and counterfeiting administrative law enforcement and criminal justice information sharing platforms (Continue to advance)

•    Promoting the establishment of an information system platform to combat IPR infringement cases (Continue to advance)
 
　　 
7.    Promote intellectual property protection publicity and cultural construction

•    Continuing to run large-scale publicity activities such as the National Intellectual Property Publicity Week, China Intellectual Property Annual Conference, China International Trademark and Brand Festival, etc (Continue to advance)
 
8.    Strengthen the protection of intellectual property protection organizations

•    Carrying out performance appraisal of cracking down on the infringement of IPR and the manufacture and sale of counterfeit and shoddy goods (Continue to advance)

•    Improving piracy report reward mechanism for IPR infringement (Continue to advance)

You will see that the CNIPA is actively pursuing changes / implementations in respect of IPR protection within two years, so we may need to wait and see on the updates of CNIPA in the coming years for the outcome of the Plan.  

Full version of the Implementation Plan can be found from the following link: https://www.cnipa.gov.cn/art/2020/4/20/art_53_118147.html (in Chinese only)

Should you have any questions related to this article, please contact evelyne.yeung@oln-law.com and we will be pleased to answer and assist.

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.

New Trend of Japanese Corporates Retreating from China

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In early April 2020, the Japanese Government announced its plan to earmark about USD$2.2 billion as part of its economic stimulus package to help manufacturers to shift their production out of China.  This effort has surfaced following the outbreak of coronavirus in China and its devastating disruptions to supply chains after temporary suspension of production bases in various parts of the country. 

According to latest statistics, there are over 30,000 Japanese entities having establishments and presence in the PRC.  Not surprisingly, most of them structure their investment in China via Hong Kong intermediaries for tax efficiency reasons.  With the rolling out of the stimulus measures, will we be witnessing a new trend of Japanese companies moving out from China?  What are the factors the enterprises should consider on their decision to “exit” China? What is the most tax efficient way to structure the investment post-exit? Should the Japanese enterprises maintain their regional head office in Hong Kong post-exit?

To leave or not to leave?

Targeting at Japanese manufacturers whose production is highly dependent on China (including pharmaceutical products, automobile, electronic components and other computer components), this new funding aims to encourage these manufacturers to build a stronger supply chain by shifting more high-value added productions back to Japan (Total: JPY 220 billion) and diversifying other manufacturing activities to neighbouring ASEAN countries (Total: JPY23.5 billion yen).  Depending on the company size, these subsidies will cover from at least one half (for large corporations) to two-third (for SMEs) and even 75% (for SME groups) of their relocation expenses, including building and equipment acquisition and installation.

Though the proposed domestic return may gain support from export-oriented companies due to the rising labour costs in China and the US-China Trade War while some others may consider strengthening their procurement chain from outside China, there might be hesitation for enterprises with strong domestic market demand in China (notably the automobile industry).  In addition, it is expected that the Mainland authorities, with a very strong desire to attract foreign enterprises to develop its high-technology (e.g. AI and 5G), will continue to provide more incentives to convince them to stay in China.  At present, the tax incentives to such sector include a 15% preferential Corporate Income Tax (“CIT”) rate designated to foreign enterprises which are qualified as new/high technology enterprises, key software enterprises, technology-advanced service providers and those operating in Qianhai Shenzhen-HK Modern Services Industry Cooperation Zone and Zhuhai Hengqin New Area.  Besides, tax reductions and exemptions also apply to specific industries and projects.  For instance, qualified new/high-tech enterprises (established in certain parts of PRC) and software enterprises are entitled to enjoy a “2+3” tax holiday, meaning that they could enjoy first two years of exemption from CIT followed by three years of 50% CIT reduction.

Costs of exiting China – How to shut down a WFOE?

However attractive the stimulus measures might be, if the costs outweigh the benefit one could potentially receive, Japanese enterprises might still have hesitation to exit China. Currently, there are a number of ways to shut down a wholly foreign-invested enterprise (or commonly called “WFOE”) in China, with the most common being a formal dissolution.  After paying up all the salaries and social insurances, taxes and debts, the WFOE must submit dissolution applications with various Chinese authorities one by one (including Commerce Bureau, Industrial and Commercial Administration Bureau, Statistic Bureau, Finance Bureau, Tax Bureau, State Administration of Foreign Exchange, etc.).  The entire process, though complicated and time-consuming (often take around one year), remains the prudent way for management and shareholders as non-compliance by simply walking away and abandoning the WFOE may result in severe repercussions (including penalty, criminal and personal liability and failure to establish a new business in China again).  The likely costs involved shall include administrative and other dissolution expenses, publication of notice and tax clearance prior to dissolution.  Investors should therefore be mindful and seek independent advice for the best course of action before terminating their operation in China.

Whether to Keep Hong Kong Regional Head Office

Historically, Hong Kong is preferred over Singapore as a better option for Japanese enterprises to expand their business, likely because of the vibrant capital market, the more volatile stock market, an independent judiciary and a simple and competitive tax system.  More importantly, Hong Kong’s strategic location in the post-CEPA regime allows Japanese investors to have access to the opportunities in Mainland market. 

As alternative to the manufacturing bases in China, Japanese enterprises have found vigour by establishing more than 10,000 bases (2019) in other Southeast Asian countries, such as Thailand (3,925 bases, representing 5.2%), Indonesia (1,911, 2.5%), Vietnam (1,816, 2.4%), the Philippines (1,502, 2.0%) and Malaysia (1,295, 1.7%).  Despite the similarity between the tax system in Hong Kong and Singapore, in determining whether Hong Kong or Singapore is more appropriate to set up their regional head office, enterprises should also consider the following factors:-

  1. The relevant Double Taxation Agreements (“DTAs”) that HK and Singapore have each signed with these ASEAN countries —  While business profits are not generally at issue because they are taxed in the country where they are derived (and not in Hong Kong or Singapore on the basis of territorial source concept), attention should be paid to the reduction of withholding tax levied on incomes (e.g., dividends, interest and royalty) to be received by the Hong Kong or Singaporean head office.  The relevant applicable withholding tax rates under the DTAs with the eight ASEAN countries are summarised in the table below.
Japanese busineses in China in Hong Kong

Financing Needs and Future Investors’ Pitching — Hong Kong remains the market leader in equity and debt capital raisings in Asia possessing US$2.4 trillion worth of bank assets (triple of its keen competitor Singapore).  With strong physical and technological infrastructure, Hong Kong has edge over Singapore to meet corporate financing needs with a domestic market capitalisation of US$4 trillion (as compared to US$0.8 trillion in Singapore) and its corporate bond issuance stands at US$33 million (more than double of Singapore).  Coupled with Hong Kong’s proximity to their underlying businesses in Japan, better access to strong equity and debt capital raising markets in Hong Kong will continue to attract Japanese corporations seeking a stronger presence or expansion in the region.

  1. While two cities appear to be on par in terms of various tax incentives, regard must be made to other non-tax factors, e.g. availability of talent pool, corporate structure, etc.

If you have any question regarding the topic discussed above, please contact our partner Ms. Anna Chan at anna.chan@oln-law.com 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.