In a new era, High net worth individuals and China’s ‘mass affluent’ can now manage legal risks with once exclusive products and wealth strategies
Four decades of “reform and opening up” have created a booming China, and nurtured the rich and the “mass affluent” in a steady stream. The wealthy families allocate a large portion of their family assets across the globe, and some even have family members from different countries or regions.
In an era of economic globalization and the internet boom, apart from possessing large swathes of properties in mainland China, the mass affluent are able to gain access to the wealth management products in many countries and regions easily, with low thresholds, and at low cost. Wealth planning ideas such as global asset allocation, foreign wealth management and offshore trusts, once exclusive to the rich, are now widely distributed among the mass affluent.
Internal risk management
To guarantee the succession of personal wealth, the authors suggest that high net worth individuals (HNWIs) bear some foresight when adopting all kinds of wealth succession tools such as prenuptial agreements, wills, insurance, trusts, etc., and make sure that these tools are legal and valid in the jurisdictions where the assets are located.
Take prenuptial agreement as an example. In recent years, the news of divorces among the rich in China, and in other countries, hits the headlines more regularly. Most wealthy people pay a lot for divorce because they did not sign prenuptial agreements, while for those who did, the cost of divorce is contained in a reasonable and acceptable scope.
The regulations on prenuptial agreements – including requirements as to whether attorneys and notaries are needed, the scope of assets subjectable to the agreement, marital property ownership allowable, and whether the assets scope and property ownership are modifiable – vary across different jurisdictions.
Marriage Law is part of the civil law, although academics never stop arguing about how to strike a balance between the “freedom of contract” and the “public order” enshrined in families. Some jurisdictions disallow the exclusion of the subject of legal protection through agreement, for example, it is illegal to make unreasonable labour division in marriage through prenuptial agreement, because such an arrangement is not aligned with the nature of marriage on the part of the over-burdened spouse.
Another example: the prenuptial agreement would be rendered invalid completely or partially for non-compliance with the boni mores principle if its arrangement of rights and obligations is tilted or makes one party disadvantaged in divorce. Marriage Law and the Law on Application of Laws to Foreign-Related Civil Relations in China, and other applicable laws and regulations, stipulate very few restrictions on the prenuptial agreement.
The parties are allowed to arrange the ownership of the assets before and after marriage, and to “dissolve” such ownership at any time through the modification of the agreement. They can also pre-define the applicable law to the asset ownership, i.e., the parties may agree upon the law of the habitual residence, the state of nationality or the locality of the majority of the properties of one party as the applicable law.
External risk management: Offshore trusts
Many Chinese financial institutions require the shareholders or actual controllers of the company, or even their spouses, to provide guarantee when they grant loans to the company, and in the case of default, they are asked to perform the guarantee obligation. Many valuation adjustment mechanisms (VAMs) also require the shareholders or actual controllers of the company, or even their spouses, to provide guarantee for the repurchase agreement under the VAM.
A typical case where the debt extended to the family fortune of the entrepreneur because the company failed to keep up with the promise in the VAM is the case of marital debt of the entrepreneur of Beijing Galloping Horse Film & TV Productions. This case enlightens us that HNWIs should practice “risk remote” management.
Offshore family trusts and universal life insurance are common practice. Take family trust as an example. Many HNWIs in China establish offshore family trusts to manage the risk. They typically transfer the offshore properties to the trust in the way of donation at zero consideration.
Offshore trusts are entities entirely separate from the founders, theoretically, and placing assets into the trusts is not defined as a business dealing between individual and related party, and is not subject to the modifications of article 8 of the Individual Income Tax Law.
Even when the trust is pierced through, making the placing of asset as the transfer of asset of the founder to the beneficiaries, such a practice can also be justifiable according to article 13 of the Administrative Measures for Individual Income Tax on Incomes from Equity Transfer (Trial) (Announcement No. 67 of the State Administration of Taxation in 2014), and is eligible to be exempt from the modification.
The Individual Income Tax Law does not have explicit requirements on offshore trusts and anti-tax evasion, and in this light there is certain room for legal tax planning for the offshore family trusts. However, the wealthy should be extremely cautious to include the assets in mainland China into the trusts, as it involves complicated processes, and tricky and contentious tax issues.
In the authors’ view, legal planning for personal wealth is still at a fledgling stage in China. The business is innovative, extensive and profound, and there is much room for development in China.
Fu Zhongwen is the Director of Family Law Committee at Long An Law Firm. He can be contacted on +86 136 4181 2144 or at email email@example.com
Zhu Changying is the Deputy Director of Family Law Committee at Long An Law Firm. She can be contacted on +86 138 1916 2199 or at email firstname.lastname@example.org