Introduction
The problems of preservation of wealth and succession planning have attracted increasing attention in China over the past decade, particularly as the first generation entrepreneurs who were enriched and empowered by China’s economic reforms started to age and retire. The use of trust structures appears to be a viable solution, but the concept is, as some would argue, not supported in full by the current legal and regulatory system in China. Setting up offshore trusts, particularly in the Cayman Islands and the British Virgin Islands, has become a popular, though often not well-understood, choice for Chinese HNWIs.
This article will look at the essential components of a trust, types of trusts which can be set up in the Cayman Islands and how they would benefit Chinese HNWIs with specific corporate, family or individual objectives.
Components of a Trust
A trust is a legal arrangement whereby a person who owns certain assets (the settlor) transfers the legal title of the assets to another person (the trustee) who then holds the assets for the benefit of others (the beneficiaries). The traditional trust structure contrasts with the trust regime promulgated under China’s Trust Law of 2001, which does not require the transfer of legal title in the trust assets from the settlor to the trustee or the settlor to declare himself as trustee for the purpose of establishing a valid trust.
The settlor, trustee, beneficiaries and trust assets are the four basic components of any trust. The terms and conditions upon which the trustee holds the trust assets, the powers of the trustee, the rights of the beneficiaries, investment and distribution of trust assets and other matters are normally set out in a written trust instrument.
The Settlor
Whilst it is common for the settlor in a Cayman trust to retain a certain degree of control over the trust, such control needs to be specifically reserved in the trust instrument. This may include powers to appoint and remove trustees and powers to approve or revise distributions of trust assets. The key to bear in mind is that the settlor should not be seen as exercising fiduciary powers of the trustees so as to make the trustees obsolete, nor should it exercise control and power over the administration of the trust assets such that he retains de factor control over the trust assets.
One should also take note that a settlor can be one of the trustees or beneficiaries of a trust, but the settlor cannot be the sole beneficiary and the sole trustee, as the trust would otherwise be viewed as a sham and therefore void.
The Trustee
A trustee is vested with the legal title of the trust assets and is responsible for administering the trust in accordance with the terms of the trust instrument. The trustee also owes fiduciary duties to the beneficiaries and needs to exercise his powers in the interests of the beneficiaries. This may differ from certain Chinese trusts whereby the trustees’ powers to deal in the trust assets are subject to the consent of the settlors who retain ownership of the trust assets, which arguably puts the settlors’ wishes before the beneficiaries’ interests.
The Beneficiaries
A common concern among HNWIs looking to set up a family trust is the description of beneficiaries, which must be capable of being identified with sufficient certainty. Whilst it is not necessary for beneficiaries to be named (or even born) upon the establishment of the trust, they must belong to a group that can be ascertained at any point in time. The trust instrument may also provide for addition or removal of (classes of) beneficiaries.
The Trust Assets
Similarly, the trust assets must be capable of being ascertained at any time, though it may take the form of any real or personal property, tangible or intangible. Further assets may be added to the trust after it has been set up.
The Protector
In addition to the above four basic components, Cayman trusts often provide for the role of a protector. A protector is appointed by the settlor to check and balance the wide powers of the trustee in order to protect the interests of the beneficiaries. This is usually a close friend or adviser of the settlor who is vested with specific powers, such as to remove or appoint trustees and to approve certain investment powers of trustees. The idea is that this person would understand the wishes of the settlor better and help ensure that those wishes are reflected in the trustees’ decisions. However, it is important to note that a protector should not be given too many powers such that he would be deemed a trustee and therefore subject to the various fiduciary duties of trustees.
This role is well-suited to Chinese settlors looking to set up an offshore trust with professional trustees who may not have the requisite knowledge of the Chinese culture and/or the particular circumstances of the family, corporate or industry involved.
Types of Cayman Trusts
Different types of trust may be set up in the Cayman Islands in view of the circumstances and intentions of the settlors, and the most common types are briefly described below.
Fixed Interest Trust
Under a fixed interest trust, the beneficiaries will normally be granted an interest in the income and capital of the trust fund during their lifetime. The trustees have limited discretion over the distribution of the trust fund.
This type of trust is suitable for estate planning purposes. For instance, the trust may provide for income of the trust fund to be distributed to the settlor and his spouse during their lifetime (as primary beneficiaries), with the capital being distributed in fixed proportion to their children subsequently. This addresses the concerns of many Chinese settlors who want to ensure that even if legal title in the trust assets is transferred, they remain entitled to a regular source of income until their death without necessarily dependent on their children.
Maintenance Trust
Unlike a fixed interest trust, income from the trust fund of a maintenance trust is accumulated and forms part of the capital over a designated period of time. The trustees are given discretionary power to make appropriate distributions amongst the beneficiaries for their maintenance and subsequently distribution of the trust fund.
Maintenance trust is often used in family provision whereby children or grandchildren of the settlor are only entitled to be paid an amount which the trustees deem sufficient for the purposes of their education and maintenance until they reach a certain age, after which the children would then be entitled to a fixed proportion of the trust fund. This helps avoid passing an excessive amount of fund to the children when they are still young, whilst at the same time allows the trust capital to accumulate over a long period of time.
Discretionary Trust
A discretionary trust offers the most flexibility and efficiency for the settlor and the beneficiaries. In such a structure, the trustees are often vested with wide discretionary powers over when and how the trust income or capital is distributed - so long as the trustees exercise their powers with regard to the interests of the beneficiaries as a whole. As the beneficiaries are not entitled to any particular proportion of the trust fund, they merely have a right to be considered when the trustees exercise their discretion.
Given its flexibility, discretionary trust may be useful in various scenarios. For instance, as beneficiaries do not have absolute entitlement to neither income nor capital of the trust fund, the trust assets would not be counted towards part of the estate for tax purposes in a lot of jurisdictions. Another example would be cases where the settlors are unsure about the future needs of the beneficiaries at the time when the trust is set up, and would defer decisions to be made by the trustees as and when required. Naturally, the choice of trustees is of great importance in discretionary trust.
Revocable Trust
As the name suggests, a revocable trust is a type of trust which can be revoked by the settlor after the trust is being set up. At first glance this option offers even more flexible than a discretionary trust. However, it is actually not commonly used, primarily because it negates many benefits of using a trust structure in the first place. In most jurisdictions, trust assets under a revocable trust is still considered part of the settlor’s personal assets, in which case the settlor cannot enjoy advantages such as avoiding the need to obtain a grant of probate or to pay stamp duty or inheritance tax.
As a result, one would only expect a revocable trust to be set up when the settlor’s desire to retain the utmost power to revoke the trust and compel the return of the trust assets outweighs any benefits in financial saving and asset preservation which may be brought about by an irrevocable trust.
Charitable Trust
Normally a trust is expected to have identifiable beneficiaries, with the notable exception that a trust may be established for charitable purposes. Under Cayman law, a charitable trust may create a new charitable fund or provide for existing charities. The applicable purpose of a charitable trust is fairly wide, as it may relate to relief of poverty, advancement of education or religion and other purposes beneficial to the community at large, as well as demonstrating an element of public benefit. A charitable trust may have unlimited duration.
As charitable trust is not created for the benefit of specific individuals, it cannot be used to achieve personal objectives such as succession planning and preservation of wealth. One particular use of Cayman charitable trust has been developed in securitization and structured finance transactions, where assets owned by a special purpose vehicle are placed in a charitable trust, thereby allowing such assets to be “off-balance sheet”.
Special Trusts – Alternative Regime (“STAR”) Trust
Most offshore jurisdictions have provided for non-charitable purpose trusts, under which trust assets are vested in the trustees for specific non-charitable purposes. Under the Trusts Law (2001 Revision), which replaced the Special Trusts (Alternative Regime) Law 1997, a STAR trust may be established exclusively for non-charitable purposes or jointly for the benefit of persons, so long as they are lawful and not contrary to public policy. Indeed, a unique feature of STAR trust is that it can be set up for persons, purposes (charitable and non-charitable) or both.
Under a STAR trust, no beneficiary has any right to enforce the terms of the trust; instead the settlor may specify a person to assume the role of an “enforcer” who is to have standing to bring proceedings to enforce the trust (often against the trustees). At least one of the trustees of a STAR trust must be a trust corporation licensed in the Cayman Islands or registered as a private trust company.
STAR trusts have been widely-used to achieve a number of objectives. Firstly, it may be used in securitization and structured finance transactions instead of charitable trusts as mentioned above. In such a case, the purpose of the trust can be simplyto hold shares in a special purpose vehicle. Secondly, as a STAR trust may be established with unlimited duration and therefore not limited to the 150 year perpetuity period that is applicable to other types of non-charitable Cayman trusts, it is useful for setting up long term private or family trust. Thirdly, a common structure is for a STAR trust to hold shares in a Cayman private trust company, which in turn acts as trustee of certain trust(s). This avoids the problems of succession with regard to ownership of the private trust company. Fourthly, the right to information of beneficiaries may be restricted by the trust instrument, which may be desirable for settlors who do not wish to disclose terms of the trust to certain beneficiaries (e.g. minors). Fifthly, where a settlor’s intended philanthropic purpose does not qualify as a charitable purpose, a STAR trust may be established instead. All these are the major advantages and uses of STAR trusts, though they are by no means exhaustive.
Conclusion
Although Cayman law is derived from English common law, the jurisdiction has been innovative in revising and enacting legislation to refine its law relating to trusts – a notable example being the introduction of STAR trusts. With the wide range of trusts on offer, Chinese HNWIs would have no difficulties in identifying the most suitable type of trusts in view of their intended objectives and particular circumstances.
