This is not a question of placing eggs in different baskets, but rather a question how someone with foresight can find a safer place to store the coming year’s harvest. The privacy that is challenged by CRS is a threat to global private property rights. What role the offshore trust will play in this context is the question we will discuss.
Conditions for everlasting family inheritance
First, let’s tell two stories.
I talked to locals when visiting Africa. I asked why their natural resources were so good, but they are doing nothing and staying poor. The locals said that there was no way out. If they worked and planted, others would steal. So, instead of working hard, it was better to steal too. Africa is undoubtedly an environment that is extremely unfavorable to the creation and accumulation of wealth and also an environment to be avoided by modern civilizations because wherever somewhere is prosperous, rights are clearly defined and properly protected. China’s economic growth in the past 30 years was precisely a reform of the distribution of rights. It is important that your labor incomes are protected from being taken away by force or stolen by others in society.
Having said that, I am reminded of the situation in the last years of the Ming Dynasty. Although Emperor Chongzhen at that time made great efforts, the corruption of the empire went bone-deep, and the decree of the Emperor could spread no further than within the Forbidden City.
In the case of successive droughts in Henan Province, taxes were not reduced, but increased instead, for the taxes were urgently needed for dealing with the Qing soldiers in east Liaoning Province and Li Zicheng’s insurrectionary army. So the farmers found that the best approach was to roam around and beg because the income from farming was less than that from begging. Anyhow, begging is tax free.
Although the above two examples are quite extreme, the author wants to explain that respect for property rights and reasonable taxation are the most basic prerequisites for wealth accumulation. During periods of time when material wealth has accumulated, the wealthiest families are more eager to strengthen these two areas. Taking a German family business as an example, although establishing a trust in Liechtenstein may not bring a special direct benefit to taxation, it does play a vital role in reducing excessively heavy responsibilities and burdens at the place where the family business is located or where the family resides, so that the net value of assets and the family’s decision-making can enter a “center” that is more focused on the long-term development of the family itself. These pain points can be subdivided into distribution rights and management rights from the perspective of power.
CRS-resultant embarrassments
Recently, CRS started its first batch of information exchange measures. The author sees from the flood of web articles among circles of friends the spreading of a blind hatred of the rich. It is as if all overseas rich people are sinners; they should hand over their money and have it shared among the masses. At least if the tax authorities imposed large fines, it would give observers satisfaction.
I think most rational people don't agree with this kind of gangster mentality. CRS sounds like a tax issue on the surface, but it’s actually not that simple. Let us take the example of the vagrant beggars of the Ming dynasty. If they could have their wealth take root locally without any difficulty, they would not lead a vagrant’s life. Roaming about is a distrust of the existing system. This distrust can be simply expressed as how much tax one has to pay if CRS information is exchanged, and whether there are other burdens when overdue tax is paid. Unfortunately, there seems to be no such thing as universal wording of these issues, let alone explicit regulations. So the awkwardness that CRS brings is not a tax issue, but a privacy issue. Because when this kind of privacy disappears, owners of wealth face a lot of uncertainty, which is exactly what family wealth and wealthy families must avoid.
Of course, this is not an especially bad situation. The new individual income tax policies to be implemented in early 2019 have already mentioned the taxation of overseas assets. Although it is unclear how overseas income will be divided into different tax rates, at least we have seen a clear tax rate. Nothing is more negative than the unknown. Many people will say that defining a clear type of tax on overseas income means that taxation against overseas income necessarily has to begin – as if some danger is approaching – but the author believes that, on the contrary, clarifying rules is always better because there is a law to follow.
The unexpected potential embarrassment arising from CRS does not only affect the Chinese; its impact is global. The exchange of CRS necessarily requires a global interpretation of general taxation terms, but these terms do not exist, and will not exist in the short term, or perhaps ever. Therefore, CRS will inevitably cause worry and confusion.
The author believes that overseas trusts can reduce and alleviate these confusions and provide clearer governance capabilities for the top tiers of wealthy family.
Distribution rights
We’ve put aside the rise in tax costs that may be caused by the CRS exchange. Although the information exchanged via CRS is only used for taxation in principle, in some cases after the privacy is compromised, a Pandora’s Box will in fact be opened. Many resultant problems will appear.
In the case of information disclosure, a client’s debt, divorce, compulsory inheritance and other issues will affect his overseas assets. Although discretionary trusts can successfully resist the demands for splitting assets brought about by these problems, due to complex legal conflicts, the settlor will remain in a passive position in their place of residence. Under such circumstances, the possibility that the settlor will retain their property as cash will become smaller, the liquidity of global capital will be greatly weakened, and the world will fall into a deeper recession.
In other words, if privacy cannot be guaranteed to trusts (especially offshore trusts) then the preservation of debt, divorce, and compulsory inheritance that could be achieved later is of little or no value. Conversely, if trusts can achieve privacy more effectively, we may just enter the best era for trusts because the pressure is indeed great.
Management rights
The trust’s planning of management rights has unique advantages. Because the trust can go beyond the mandatory inheritance order and the mandatory requirements for the same shares, and ensure flexible planning, it is possible in particular to construct a mechanism to manage family businesses and family assets without losing flexibility, even after the settlor’s death. Managing family businesses requires talented people – even those who are outside the family – but the default heirs under the civil law system may not always be appropriate.
The transparency necessitated by CRS may indirectly interfere with this. When the trust manager wants to take office, other family members who are not permitted to take office may attack him via the transparency of the information available. Regardless, the onshore jurisdiction where the family business is located will not change the offshore top-level structure, nor affect the appointment of managers and the investment decisions for overseas cash assets. However, due to the loss of privacy, disputes over management rights may result in deep involvement by the onshore jurisdiction, which will be a serious intrusion into the trust’s governance.
Selection of territory
It is clear that the offshore trust needs to be able to provide privacy. How can this be achieved? The principle is simple: to find the jurisdiction where CRS is not applicable. At present, there are no territories that can provide quality trust services besides the United States. This is also what the current media have recently discussed: that US trust companies are learning a new skill so as to take over the business of customers from traditional offshore jurisdictions.
If this trend materializes, how will the OECD and AEOI participating countries view this issue? Will they continue to tolerate the existence of this huge loophole in the United States? To what extent does the United States play the role of a new offshore center? We have to wait and see.
Selection of types of trusts
In order to obtain better wealth preservation, there is no doubt that the structure of the trust should be paid attention to. Fixed-income trusts are more likely to be compromised in the face of debt, divorce, compulsory inheritance, etc. However, while discretionary trusts bring benefits to asset preservation, the effective insertion of flexible control mechanisms is also very important.
In summary, in the current situation where CRS poses a great challenge to privacy, the best policy is to select a non-AEOI participating jurisdiction and carefully design the trust’s structure.
