Preserve your assets with a Principal Residence Trust

Preserve your assets with a Principal Residence Trust

Preserve your assets with a Principal Residence Trust

The family home is often one of the key family assets. It can be the object of friction among family members, and be subject to tax on sale or death, unless proper planning is implemented.  A trust can be used to address these issues and minimize risk of loss.

Clients often ask me, “How can I best protect and preserve my assets, such as the family home, for my heirs?”

I recently advised a couple before their upcoming second marriage, who wished to discuss what legacies they wanted to leave to the children they each had from previous marriages.

I suggested they each get independent legal advice (“ILA”), but they insisted on being advised together, so I had them sign an acknowledgment and waiver of ILA.

They were both contributing to the purchase of a new home, and wanted to ensure that on death the one-half contribution of each went to the children of the first marriage of each.

I recommended that they establish a Principal Residence Trust (“Residence Trust”) to hold the new home. As they were to settle the Residence Trust on themselves as trustees, for the benefit of themselves and the respective heirs of their estates, a simple change in legal title would be registered.

I explained that the Principal Residence Trust would preserve the availability of the Principal Residence Exemption from future capital gains that may be realized on the disposition of the home, under the Income Tax Act (Canada) (“ITA”). On the death of either of them, the Residence Trust would continue to own the home, so no probate tax would be payable on the value of the home. On the purchase of this Cdn$2 million home, the probate tax in Ontario would otherwise be about Cdn$30,000.

On the death of the first spouse, the surviving spouse would have the power to deal with the assets of the Residence Trust in his/her discretion, but preserving those assets for the beneficiaries of the Principal Residence Trust. After the death of both spouses, the trustees would be empowered to deal with the matrimonial home in accordance with their respective wills.

I pointed out that the ITA’s definition of a Principal Residence allows for a trust to own the home and, on disposition, designate specific family members who have been beneficiaries of the Residence Trust and have ordinarily inhabited the home. In the case where this home is the only one claimed by the designated individual as his/her principal residence for each particular year of ownership, the trust may claim the Principal Residence Exemption. https://www.grllp.com/ 

Principal Residence Trust

Lorne Saltman

Gardiner Roberts LLP
+1-41-6625-1832
www.grllp.com
[email protected]

Liechtenstein foundations and trusts for asset protection and wealth preservation

Liechtenstein foundations and trusts for asset protection and wealth preservation

What benefits do Liechtenstein foundations and trusts offer for asset protection and wealth preservation?

Some of us are in a fortunate position where asset protection and wealth preservation are not much of a concern because we live in countries where corruption is rare, governments are relatively stable and creditworthy, courts and governmental authorities are efficient, crime rates are low and chances that illegitimate claims will be enforced against our assets are remote.

For people living in a country where one or more of these factors are missing, however, the danger to their assets may be real and the fear that their wealth may fall into the hands of others without justification may be well-founded. For those who are legitimately concerned about asset protection and wealth preservation, Liechtenstein foundations and trusts offer distinct advantages which will be described below.

Liechtenstein foundations

Let there be no mistake: Liechtenstein provides legal assistance in criminal matters to other countries and has entered into treaties allowing the exchange of information in tax matters with an increasing number of jurisdictions. Furthermore, the creditors of a founder or settlor of a Liechtenstein foundations or trust are not without protection under Liechtenstein law: any gratuitous transfers to a trust or foundation may be challenged by creditors of the founder/settlor within one year from the transfer. If such creditors can prove intent of the founder/settlor to defraud creditors, the statute of limitations is five years.

However, for those who are looking for a safe haven for their assets without any pressure from existing creditors and want to structure their wealth in a tax-compliant way, Liechtenstein foundations and trusts offer the following advantages:

(1) Protection of privacy

In case of Liechtenstein (private) foundations, registration in the trade registry is voluntary. Even if a private foundation is registered, the identity of the founder or the beneficiaries is not disclosed. The names of the foundation council, however, are mentioned.

In case of Liechtenstein trusts, there is a registration requirement (mainly to ensure the payment of the annual tax of CHF 1,200), but this registration does not include the names of the settlor or beneficiaries.

(2) No pre-trial discovery proceedings

In contrast to a number of jurisdictions, in case of pending or threatened litigation there is no duty to disclose documents to the adversary. The only documents that may need to be disclosed upon a court order in the course of litigation are documents so-called “common documents” of the plaintiff and defendant, such as written contracts between them, or other contracts where there is a preexisting obligation to disclose them.

(3) No enforcement of foreign judgments

Liechtenstein does not enforce foreign judgments without a re-litigation on the merits unless there is an enforcement treaty (or other binding declaration) in place with the country whose courts rendered the judgment. This distinguishes Liechtenstein from a large number of jurisdictions, in particular those influenced by common-law, which often enforce foreign judgments if they were rendered in fair proceedings. Other jurisdictions only enforce foreign judgments if the other country would do the same, but have a presumption of such reciprocity.

So far Liechtenstein has only concluded enforcement treaties with Switzerland and Austria and a multilateral convention on the mutual enforcement of certain child support judgments. Liechtenstein is not a member to the Lugano Convention on Jurisdiction and the Enforcement of Judgments, and EC Regulation 44/2001 on jurisdiction and the recognition and enforcement of judgments does not apply.

In the absence of an enforcement treaty, foreign judgments may be used by a plaintiff to obtain a preliminary court order in Liechtenstein. However, the defendant may bring legal action against such a preliminary order so that the dispute will need to be re-litigated in Liechtenstein in any event.

(4) Short statute of limitations for a challenge of the transfer of assets to the foundation

In order to protect creditors, any gratuitous transfers to a trust or foundation may be challenged by creditors of the founder/settlor within one year from the transfer. The statute of limitations for transfers to the foundation/trust is five years from the transfer of assets to the trust or foundation if creditors can prove intent of the founder/settlor to defraud them.

After the expiry of these deadlines, no challenges of the transfer of assets to the foundation or trust are possible under Liechtenstein law, provided that the Liechtenstein foundation/trust is structured appropriately. In particular, decisions must be taken by the foundation council/trustee, and the foundation should not be seen as the alter ego of the settlor/founder or the beneficiaries.

(5) No attachment of the interest of beneficiaries

Both, Liechtenstein foundation and trust law, grant considerable flexibility when it comes to the determination of the rights of the beneficiaries in the trust or foundation documents. However, when asset protection is a concern, in many cases a discretionary structure with several possible beneficiaries is preferable where distributions of the capital or income of the foundation or trust are left to the discretion of the foundation council/trustee. This will ensure that there are no legal claims of the beneficiaries that can be attached by third parties.

Taxation of Liechtenstein trusts and foundations

Liechtenstein trusts are subject to an annual tax of CHF 1,200. Liechtenstein foundations may apply for the tax status of a “Private Asset Structure”, provided that they only hold private wealth and do not engage in economic activities. A foundation taxes as such a Private Asset Structure is only liable to pay the minimum annual profit tax of CHF 1,200, and no tax filing needs to be made.

However, even without this special tax status, certain types of income, including all dividends and capital gains from participations and any revenue from foreign real estate are exempt from the otherwise applicable 12.5% profit tax. In case of a foundation which only holds the shares of a holding company, it may therefore not be worthwhile to seek the status of a Private Asset Structure because any dividends and capital gains from the participation will be tax exempt even under regular taxation.

Besides the taxation in Liechtenstein, in each case the tax consequences of the establishment of the trust/foundation and any distributions from the trust/ foundation in the jurisdictions of the settlor and the beneficiaries need to be considered carefully with the assistance of local advisers. https://www.marxerpartner.com/

Principal Residence Trust

Markus Summer

Marxer & Partner
Why Chinese HNWIs wishing to establish offshore trusts should act now?

Why Chinese HNWIs wishing to establish offshore trusts should act now?

Chinese HNWIs should act now as China may introduce a tax reform with the new estate tax, exit tax on emigration and adopt new rules to tax the contribution of appreciated assets into an offshore trust.

Chinese high net worth individuals (“HNWIs”) are very interested in using offshore trust for wealth planning because of the unique benefits offshore trusts offer and also due to the fact that Chinese domestic trusts are not suitable for wealth planning.  As to the timing, we think Chinese HNWIs should act now so that they could avoid the adverse consequences caused by the next wave of Chinese tax reform.

China may introduce estate tax soon

Estate tax has suddenly become a very hot topic in China recently.  There has been a lot of media coverage on this over the past few months.  In 2004 the Ministry of Finance issued a draft of the Provisional Regulations on Chinese Estate Tax for public comments.  Although the draft was revised again in 2010, it had never become law.

The introduction of estate tax was then repeatedly mentioned as a medium term goal in several important resolutions on reform adopted by the central government over the past few years.  There were even rumors earlier this year that Shenzhen would become the first city to introduce estate tax on a pilot basis, which caused widespread panic among local residents, but those rumors turned out to be a false alarm.

Why estate tax has suddenly become a media focus is the natural result of the widespread frustration and anxiety among Chinese people about the increasing income disparity between the rich and the poor. The people who are in favor of estate tax argue that estate tax can significantly help to solve this income disparity issue.

However, the opponents take the view that it is simply too early to introduce such tax in China because China doesn’t even have the required basic infrastructure for collecting and administrating such tax (e.g. a nationwide asset registration system and a reliable asset valuation system), let alone certain key technical issues that would need great wisdom to figure out the answers for, such as the exemption amount, the tax rate, etc..

Despite of those hurdles such as the infrastructure and the difficulties in working out those technical issues, in my personal view, because generating additional tax revenue from estate tax is not a top goal for China (at least not yet), the timing for the introduction of estate tax in China would mainly depend on whether and how quickly China can have good control over the income disparity issue.  If China fails to do so, estate tax may arrive much earlier than people would anticipate.

Needless to say, if China introduces estate tax, it will automatically introduce gift tax.  So for those who think they could get around with the estate tax by giving wealth to their children or other family members as gift should think again.

China may also introduce exit tax on emigration

Many countries impose an exit tax on persons who cease to be tax residents in those countries.  This often takes the form of a capital gains tax against unrealized gain attributable to the period in which the taxpayer was a tax resident of the country in question.  Exit tax can be assessed upon change of domicile, habitual residence or citizenship.

China also taxes its tax residents on worldwide income, but nonresidents are taxed only on China sourced income. So if a Chinese individual becomes a nonresident from a resident, under current Chinese tax rules, the person will no longer need to pay Chinese tax on non-China sourced income, even if the income represents the unrealized capital gains attributable to the period when the person was still a Chinese tax resident.  The change of such tax residency often takes place when the person emigrates from China to another country.

We may see a change to such rules soon if the current emigration wave continues to rise.  Although there is no official study confirming this, China is now the largest emigrant source country in the world.  While the emigration is generally not Chinese tax-driven, it will be just a matter of time before the Chinese tax authorities realize the resulting permanent tax revenue loss.  At that time, the introduction of exit tax would likely be inevitable.

China may adopt new rules to tax the contribution of appreciated assets into offshore trusts

China currently doesn’t have any specific tax rules on trust.  As a result, in the case of offshore trust, when a Chinese settlor contributes appreciated assets (e.g. company shares) into a trust, people generally would take a position that the contribution should not give rise to any Chinese tax.  If such appreciated assets are offshore assets, when they are disposed of by the trustee, no Chinese tax would apply because the trustee is not a Chinese tax resident.

If the trustee distributes such income to the beneficiary or beneficiaries, under current Chinese individual income tax rules, another position could be generally taken that the distribution should be considered gift and thus not taxable in China.   In other words, the use of offshore trust could minimize the Chinese tax that the settlor should have paid if he or she disposed of such assets directly.  The current capital gains tax rate for individuals is 20%.

China will soon reform its individual income tax law. The trust taxation rules will certainly be part of the reform and it won’t be too difficult for the Chinese tax authorities to detect the loophole mentioned above.  Or they may fix it earlier simply by introducing a deemed sale rule or a general anti-avoidance rule. https://www.zhonglun.com/en/

Legal and Tax restraints for Chinese HNWI Offshore trusts

Legal and Tax restraints for Chinese HNWI Offshore trusts

Issues arising from setting up an offshore trust for a Chinese HNWI include the recognition of the trust itself and other legal and tax constraints.

As more Chinese HNWIs have realized the unique benefits of offshore trust, especially in the areas of asset protection and succession planning, the number of Chinese HNWIs using offshore trust for wealth planning is increasing fast. However, setting up an offshore trust for a Chinese HNWI can be a complex task due to the Chinese legal and tax constrains.

The recognition of offshore trust in China

The first big question about offshore trust is always whether it is even legally recognized in China. Offshore trust is not specifically recognized by any of the written laws including the Chinese Trust Law. There is also no court case providing any guidance or clarification. However, just like that offshore holding companies are recognized in China, the general understanding based on the Chinese legal principles is that offshore trust should be recognized in China if it meets all the legal requirements in the jurisdiction where the foreign trust is formed.

The community property issue

Under the Chinese Marriage Law, the property obtained by a couple or either spouse during their marriage period is generally considered community property. Community property is jointly held by both the husband and the wife, which means that, even if only a small portion of the community property is disposed of by one spouse without the consent of the other spouse, such a transfer would be invalid. There are already enough court cases in China enforcing such rules.

As such, securing the consent of the other spouse is the essential precondition for contributing community property by one spouse to an offshore trust. Without such consent, the contribution could be held invalid under Chinese law (assuming China has the jurisdiction), which means the relevant assets may thus need to be returned by the trustee. This issue normally arises when a husband sets up an offshore trust for the benefit of his second family or when he intends to hide assets from divorce.

A related issue is when the consent of the other spouse is not obtained, whether the trustee shall have any liability. This issue will most likely come up when the trust assets are ordered by a Chinese court to be returned to the couple but the value of such assets under the trustee’s management has decreased significantly. Although there is no clear rule in China and there hasn’t been any court case in China providing any guidance, the answer to that question would likely depend on whether the trustee has acted with malice. Unfortunately, the term “malice” is not defined by Chinese law in the trust context. Trustees thus should exercise enough caution before taking on the trustee role.

The regulatory restrictions on putting assets into an offshore trust

Dependent on the location and type of the asset, there could be Chinese regulatory restrictions on contributing such assets to an offshore trust. For offshore assets, there is generally no Chinese regulatory restriction on the contribution of such assets to an offshore trust. If those assets are onshore assets, the contribution of such assets to an offshore trust is extremely difficult under the Chinese foreign exchange control rules, banking rules, foreign investment rules, and outbound investment rules.

For example, a Chinese individual is legally allowed to remit out only USD 50,000 annually. Another example is that a foreign entity (e.g. a trust company) is not allowed to own real property in China unless it is for self-use (e.g. used as office space for its Chinese representative office). As a result, the offshore trusts we have seen typically do not directly own onshore assets.

The uncertain tax treatment of an offshore trust

There are no specific tax rules on either domestic or offshore trust. By applying the existing general tax rules, until specific rules on trust come out, one could argue that technically a settlor would not be taxed on the contribution of assets to an offshore trust even if such assets have appreciated in the hands of the settlor.

Also, a Chinese non-settlor beneficiary would not be taxed on trust distributions as China doesn’t tax gift income yet. Lastly, the trustee would not be taxed on accepting or holding the trust property as long as it is a non-Chinese entity and operates outside China. However, whether such technical analysis could be respected by the Chinese tax authorities is an open question as, to our knowledge, there hasn’t been any actual administrative case on this.

The uncertainty regarding the withholding and reporting obligations of the trustee

While the existing Chinese anti-avoidance rules apply to enterprises, not individuals, they could come into play in the offshore trust context, especially when a special purpose holding company is formed underneath the trustee and controlled by the Chinese settlor. In that case, the SPV could be considered a Chinese tax resident if it is considered effectively managed in China. If so, the SPV would be subject to Chinese income tax on its worldwide income and need to file a tax return in China.

Even if the SPV is not considered a Chinese tax resident, if the trust property is Red Chip company shares, there could still be a technical requirement under Circular 698 that any transfer of the SPV should be disclosed to the Chinese tax authorities through an information filing. Failure to comply with this reporting requirement would be subject to a fine. In practice, a number of foreign trustee companies are reluctant to follow this rule because they take a position that such Red Chip companies are formed with bond fide business purposes. However, whether the SAT would respect this position has not been tested up till now. https://www.zhonglun.com/

How could PRC community property rules impact offshore trust planning?

How could PRC community property rules impact offshore trust planning?

Property acquired during marriage will be presumed as community property if not otherwise structured. Property planning helps to obtain clean title to the assets that a PRC settlor wishes to contribute to an offshore trust, and thus prevents potential risks and claims.

With the rapidly growing number of PRC high net worth individuals (“HNWIs”) and their increasing awareness of wealth planning, the use of an offshore trust by these HNWIs as a vehicle of wealth protection and preservation is becoming more and more popular in the PRC.

Setting up an offshore trust for a PRC HNWI could be a complicated task not only because of the PRC legal and tax constraints, but also as a result of the potential impact of the PRC community property rules. Under the PRC Marriage Law, any property acquired during marriage is presumed to be jointly owned by both spouses, i.e. community property. Therefore, a spouse contributing community property to a trust without the consent of the other spouse could face serious legal risks. The trustee in such a case may be exposed to certain liabilities as well if there is a lack of due diligence.

PRC Community Property Rules

Under the PRC Marriage Law, any property acquired by a couple or either spouse during marriage is presumed to be jointly owned by both spouses, unless there is specific evidence that would point to a contrary conclusion. Community property includes but is not limited to salaries and wages, bonuses, business income, investment income, income related to intellectual properties and gift income acquired by either spouse during marriage.

In comparison, separate property mainly refers to the following:

  1. Property acquired by a person prior to marriage
  2. Property acquired by gift or inheritance during marriage while the underlying gift agreement or the will specifies that the property belongs to one spouse
  3. Property agreed to be one spouse’s separate property in a pre-nuptial or post-nuptial agreement.

With the broad definition of community property, as a practical matter, most of the PRC HNWIs would be subject to the community property rules, especially those who are in their 40s or 50s and created their family wealth over the past two decades during which the PRC achieved record-high economic growth. To them, almost all their family wealth would theoretically be community property, even though some assets may have been recorded under one spouse’s name for title recording purposes.

One important question is whether the income generated from the investment of one spouse’s separate property during marriage would be community property or not. The answer is generally yes, with the exception that bank interest earned on separate property remains as separate property.

Because of the PRC community property rules, when community property is contributed by one spouse into an offshore trust without the consent of the other spouse, the contribution would be held invalid, which means that such property may thus need to be returned to the claimant spouse. One tricky related issue here is whether the trustee would be held liable to the other spouse, especially in the event where the trust assets have depreciated in value.

While there are no clear rules in the PRC dealing with such an issue, based on the general legal principles, a PRC court would likely base its decision on whether the trustee acts in good faith or with malice. Since the term “malice” is not clearly defined by the PRC laws, a PRC court may exercise extensive discretion on the interpretation. A trustee should thus conduct sufficient due diligence regarding the ownership of the assets in question and enough care must be taken to minimize such risks.

How to Best Deal with PRC Community Property Rules

A married couple can try to use pre-nuptial or post-nuptial agreements to work around the community property issue. The pre-nuptial or post-nuptial agreement is gradually becoming the most efficient way for spouses to determine their desired ownership entitlement to their community property, which is legally allowed under the PRC Marriage Law. A legally enforceable pre-nuptial or post-nuptial agreement preempts the application of the default community property rules.

Such an agreement can be executed either before marriage, at the point the couple get married or during the course of their marriage. And it can cover any property already owned by the couple and even their prospective property. It can also have the retroactive effect as long as that is a manifestation of the spouses’ genuine intent.

A common question asked by some US tax practitioners is whether the execution of a post-nuptial agreement would be treated as a gift from one spouse to the other spouse, which could potentially create certain US tax issues. A typical scenario is where the wife, a US citizen or green card holder, enters into a post-nuptial agreement with her husband, a Chinese citizen, under which she agrees that certain assets would belong to her husband. The theoretical view in the PRC currently seems to be that this should not be treated as a gift.

In the context of offshore trust, another common question is whether a consent letter signed by the other spouse, instead of a formal post-nuptial agreement, would be sufficient under the PRC laws. The current view of many practitioners in the PRC is that a carefully drafted consent letter based on the full knowledge of the other spouse should be sufficient.

Conclusion

Obtaining clean title to the assets that a Chinese HNWI wishes to contribute to an offshore trust is far more complex than it appears. Without proper planning or care, the contribution would be problematic to both the settlor and the trustee. Therefore, both of them are highly recommended to seek sufficient professional legal advice before taking the first step. https://www.zhonglun.com/en/