By Andrew J. Toles.
Several years ago, though I had no experience in the mountains, I decided to climb one of America’s tallest peaks. I quickly learned the value of having an experienced guide. A mountain guide helps the climber make hundreds of difficult decisions about training, technique, preparation, gear, weather, route and various judgment calls along the way to the summit. For the newly-rich in mainland China the challenges of becoming a philanthropist are no less daunting than peering up at a mountain for the first time after resolving to conquer it. Emerging philanthropists in China – a population that is growing daily – would do well to partner with a professional guide. This article will serve as a useful trailhead for that journey, with particular focus on the expanding role of offshore trusts.
What is Philanthropy?
In the original Greek the word "philanthropy" literally means the love of mankind. However, the term has generally evolved to mean the voluntary allocation of private wealth for public good. While defining "public good" is subject to debate, it is widely understood to include education, disaster relief, environmental protection, public health and poverty alleviation.
An ancient Chinese proverb states,“Great thoughts come from the heart.” That is where philanthropy begins. It is a matter of the heart. Another Chinese proverb counsels us, “If you want happiness for an hour, take a nap. If you want happiness for a day, go fishing. If you want happiness for a year, inherit a fortune. If you want happiness for a lifetime, help somebody.”
A million high net worth individual (HNWI) Chinese, enriched by the explosive modernization of China, have now experienced happiness for a year. Figuratively, they inherited a fortune, whether by their own ingenuity in business or simply by being in the right place at the right time. This group of one million is now discovering the truth of this Chinese proverb that a fortune only brings happiness for a year. Increasingly, they longfor happiness that lasts a lifetime. They want to help someone. Now they are exploring philanthropy as a means to do so.
What are Trusts?
Trusts have not yet gained popularity in China. They are a product of the English legal system developed over several centuries. The key feature of a trust is that it separates the legal ownership of property from the right to enjoy the benefits of the property. The one who makes a trust (the settlor) transfers legal title of the trust assets to the new owner (the trustee). The trustee is then bound by fiduciary duties--that is, legal obligations--to manage the trust assets and to distribute them from time to time, solely for the benefit of others (the beneficiaries). In some cases the beneficiaries are limited to charities. Other popular uses for trusts include family estate arrangements, commercial transactions and business relationships. Generally, the terms of a trust are described in detail in a written trust agreement that clarifies the rights and the duties of the parties.
Charitable trusts are sometimes confused with charitable foundations. While both share similar objectives, there are meaningful differences in form and function. Foundations, like corporations, have a board of directors or council which is responsible for operations. These directors, unlike trustees, typically are not bound by fiduciary duties to the foundation's intended beneficiaries. Nor do foundations disclose their books or account to beneficiaries in the manner often required of trustees. Unlike trusts, a foundation generally must be registered and expose its charter document to public view. Foundations are popular in civil law jurisdictions like those governing nearly all of Europe, including Switzerland.
What Does “Offshore” Mean?
Strictly speaking, "offshore" refers to a jurisdiction other than one's own residence. Thus, for mainland Chinese every nation outside of the People's Republic of China is considered offshore. Several countries have developed a reputation for attracting capital from foreigners. The first was Switzerland. Many others have followed including the British Virgin Islands (BVI), Cayman Islands, Channel Islands, Bahamas, Bermuda, Singapore and Hong Kong. These countries often refer to themselves as international financial centers (IFCs). The Tax Justice Network, an organization critical of IFCs, estimates that IFCs hold as much as US$32 trillion in financial asset, double the amount of China’s total household wealth. IFCs that are grounded in English common law generally offer more fertile soil for planting charitable trusts. Some examples are Hong Kong, the Cayman Islands, BVI, the Channel Islands and Bermuda.
What are the Benefits of Charitable Offshore Trusts?
China’s first legally registered private foundations (PFs) were birthed in 2005. While they are gaining popularity among China’s elite givers, by 2013 the number of PFs had not yet reached 2,000 according to the China Foundation Center. The cover story of the Spring 2013 issue of Asia Outbound highlights several problems (or barriers to entry) for China’s domestic PFs. These include: (1) an onerous regulatory environment that, until just recently, involved “dual management” or active supervision by a government department; (2) steep annual distribution requirements; and (3) restrictions on business activities and the risk of substantial tax liability. Because domestic PFs are the most likely alternative for China’s new philanthropists, the benefits associated with charitable offshore trusts should be measured against this backdrop. Here are several:
● Wealth Safety: An unprecedented number of HNWI Chinese are immigrating. According to a recent report by China Merchants Bank and Bain & Co., as many as 60% of China’s HNWI have considered or completed investment immigration. This report points out that wealth safety is second only to their children’s education as the motivating factor. In 2013 there were more than 6,000 Chinese investment immigrants to the United States alone, according to the annual Report on Chinese International Migration 2014, published by the Centre for China and Globalisation. China’s wealth is also finding its way to other safe havens. The Wall Street Journal estimates that total outflow of investments from China in 2012 was US$225 billion. This tidal wave of cash, especially funds controlled by Chinese immigrants, would be well served by the stability and security afforded by offshore trusts. This stability and security stem from the availability of sophisticated financial professionals (for example, attorneys, accountants and wealth managers), proven business structures, stable government, laws and regulations, and access to international markets.
● Privacy: Most Chinese philanthropists wish to avoid the public spotlight. Undoubtedlythis dynamic has made it more difficult for Bill Gates to persuade his Chinese counterparts to sign the billionaire’s Giving Pledge. Onshore giving through domestic PFs invites the scrutiny of government regulators and the public, while offshore jurisdictions enable a Chinese family to do their charitable giving quietly without unwelcome publicity.
●Unlimited Growth: Charitable offshore trusts are free to accumulate earnings from year to year and grow their asset base. This feature allows a relatively modest investment in philanthropy on the front end to become a treasure trove for public good in the future.
● Flexible Investment and Grant-Making Powers: A recent trend in global philanthropy is the advent of social ventures. These are generally structured as for-profit businesses designed to accomplish a particular social or public benefit. Because of the strict regulatory regime governing much of the charitable sector, private foundations frequently have trouble in financially supporting these social enterpriseseither by way of investments or grants. As an investment, there is a risk that such activities will be considered to be an unrelated business of the PF, resulting in serious tax or other negative consequences. For grant-making purposes, these ventures do not qualify as legitimate charities. Charitable offshore trustsare the ideal solution. They enable Chinese philanthropists to invest the trust endowment as they wish and support whom they wish without oversight by government regulators. Many charitable offshore trusts would be more appropriately labeled “philanthropy offshore trusts”because their grant recipients are not required to (and often do not) fit within any legislative definition of the term charitable.
● Tax Avoidance: With proper planning, charitable offshore trusts enjoy a tax-neutral environmentand are not subject to any income tax or excise tax. Tax incentives may be the most enticing draw to IFCs, but the avoidance of unwanted tax liability is just one of many compelling advantages of offshore philanthropy.
What are the Drawbacks of Charitable Offshore Trusts?
Despite all the benefits, charitable offshore trusts are largely unknown and unused by HNWI Chinese and may not appeal to most. The accompanying Philanthropy Flow Chart illustrates four scenarios based on the geographical location of the earnings (or assets) and the location of the charitable recipient. Offshore jurisdictions play a primary role in three of the four scenarios. Therefore, offshore trusts could be quite helpful in each of these scenarios for reasons described above. But the first of the four scenarios, by far the most common, is seemingly confined within the borders of China, with no apparent role for offshore trusts. According to the recent UBS-INSEAD Study on Family Philanthropy in Asia, 76% of China's philanthropy was directed to recipients within China.
Presently, there are two important drawbacks for Chinese givers to consider before creating a charitable offshore trust. First, if the earnings (or assets) used to fund the charitable work are located in China, there could be some difficulty in moving those funds offshore. For determined Chinese, however, this likely won't be a major obstacle. As the Chinese saying goes, "The man who removes a mountain begins by carrying away small stones." To prove the point, on 10 July 2014 the South China Morning Post published an article listing seven methods that Chinese are using to transfer money offshore.
The second and more significant drawback is that once offshore, it may be very tricky to deploy those funds for the public good back onshore. Stated another way more familiar to my Chinese friends, "Once you pour the water out of the bucket it's hard to pour it back." The reason for this is that China, like many other countries, limits the ability of its civil society organizations to receive foreign money in order to stave off unwelcome foreign influence in China's domestic affairs. If mainland Chinese can't pour the water back, they face another problem in that "distant water won't quench your immediate thirst." Nevertheless, in many cases even this hurdle is not insurmountable with the help of an expert guide.
How Are Charitable Offshore Trusts Structured?
There is great flexibility in the form of charitable offshore trusts. To illustrate, we'll describe a common structure used in Bermuda, one of the leading IFCs for this kind of arrangement. As shown in the diagram, at the top of the structure is a purpose trust. A purpose trust allows assets to be held for almost any lawful purpose, with no requirement to name any beneficiaries. Typically, the stated objective of a purpose trust is simply--and only--to own the shares of a private trust company (PTC). The Chinese settlor selects a corporate trustee to serve as trustee of the purpose trust and often provides a letter of wishes to give guidance to the corporate trustee on how to vote as trustee of the purpose trust.
The PTC is the Chinese settlor's very own trust company whose sole function is to act as trustee of a charitable trust. The PTC is managed by its directors and officers who may include family members, professional advisors and friends of the Chinese settlor, thereby giving the settlor's family the freedom to take an active role in the affairs of the charitable trust. A Bermuda PTC is not required to go through any complicated licensing process to qualify as a trustee. While the corporate trustee of a Bermuda purpose trust is usually located in Bermuda, it need not be. Nor must thedirectors of the PTC be residents of Bermuda. The only required connection to Bermuda in this example is a company secretary who can be retained for a nominal annual fee.
The charitable trust is then empowered to own shares in operating companies and hold investment assets, whether they be direct investments, interests in private equity funds or other investment vehicles.
The View from the Top
Doing philanthropy, truly helping others, carries a unique power to cause our own problems to seem less significant. Consider the valuable insight in the old Chinese adage, "I was angered, for I had no shoes. Then I stumbled across a man who had no legs." The joy that fills our hearts when we care for others is a prize worth pursuing. But some look at the mountain and fear its lofty heights. They scorn the counsel of trustworthy climbing guides. At times they may even declare it cannot be done. Yet, as the resilient Chinese put it, "Those who say it cannot be done should not interrupt those doing it."
The spirit of generosity is sweeping across the Chinese landscape. This becomes increasingly evident with each response to tragic natural disasters like the one that shook Sichuan province in 2008. Pioneers in philanthropy see the needs and opportunities and are rising to the challenge. More and more of them will do so and thrive in partnership with professional advisors in this new community of philanthropy developing throughout China. And in the coming months and years many, I venture to say, will find that charitable offshore trusts provide the best possible route to the summit.
