The pace of China’s rapid economic ascent – albeit with some recent signs of slowing – has been such a well-known fact that it seems hard to believe that parts of the country’s wealth planning sector are still in their infancy.

A wealth planning area that has not yet fully developed but is likely to do so is the trusts sector. The concept of a trust, while familiar in those jurisdictions influenced by the UK and other "common law" nations, is still relatively novel in the People’s Republic of China. But the use of trusts by wealthy Chinese people is rising, argues law firm Baker & McKenzie.

“Concepts like trusts that are often familiar to us in the UK, US or other parts of the world are being imported into Asia. In the PRC, people have known about  a 'trust' concept for some time (trusts are in Chinese domestic law) but they have been very much a contractual  arrangement, rather than an approach where there is a fiduciary relationship,” Ashley Crossley, chair of Europe & Middle East Wealth Management, at Baker & McKenzie, told this publication in a recent interview.

But this is changing. And Chinese HNW individuals are looking at centres such as London for expertise.

“Up until about 18 months or so ago, Chinese clients were not really interested too much in either London or common law structuring techniques like trusts. They had other favourite destinations and other structures. [But] Chinese people have started to come into the London wealth management market. The trusts business in London has generated a lot of interest,” he said.

One of the drivers for change has been in the PRC’s taxation of real estate (part of measures to cool the red-hot market). This has prompted Chinese property holders – real estate has been a primary wealth asset - to look at trusts to secure their wealth. Trusts can be seen as a new “safe house”, Crossley said.

Scale

The potential scale of trust-related business, barring a big slump in the Chinese economy, is large. In the Capgemini/Royal Bank of Canada report on global wealth trends, issued in June, it showed that Asia-Pacific is now the largest HNW market in the world, having overtaken North America with a HNW population growth rate of 1.6 per cent in 2011 to reach 3.37 million – a figure which signifies a growth rate of 11 per cent in two years.

But some Asians are keen to leave the region and hence will need to be able to protect their assets through vehicles such as trusts. For example, late last year it was reported that the number of wealthy Chinese trying to apply for an American green card has shot up 1,000 per cent, according to figures from the US immigration office (Source: Wall Street Journal). In 2011, some 2,969 Chinese citizens applied for the EB-5 Visa and 934 were approved. Under the programme, foreign investors must finance commercial projects in the US by investing either $500,000 or $1 million and create at least 10 full-time jobs.

One factor to consider is China’s current fixed exchange rate regime, although there are signs of liberalisation ahead. Foreign currency accounts are allowed in and out of the PRC; individuals can, among other things, remit $50,000 per annum (in addition to current account remittances). Forex rules allow people to move money abroad; however, the PRC doesn’t allow dual passports, Baker & McKenzie has pointed out.

It is not surprising that legal big-hitters such as Baker & McKenzie are drawn to the wealth planning potential of trusts for China and other Asian tigers; as it announced in its annual results, Asia continues to be one of the bright spots for revenues. The law firm has reported record worldwide fee income of $2.313 billion, up 2.1 per cent, for its fiscal year ended June 30, 2012. The biggest gains were in Latin America, but the Asian region generated single-digit increases, which is at least better than flat performances in Europe and North America. The Asia-Pacific region accounts for 28 per cent of all revenues, so there is plenty of upside potential.

Domicile and residence

Crossley explained some of the taxation finer details that are important in understanding the PRC’s wealth planning potential. For instance, liability to PRC tax is determined by domicile status, although individual income tax is a residence-based tax. For those domiciled in the PRC, they pay individual income tax on worldwide income; for non-doms in the PRC, those who are non-resident for five years or less pay income tax on income sourced from within the PRC only; a PRC resident for five full consecutive years pays individual income tax on worldwide income while resident.

“If you leave the PRC for, say, five years, you can lose your China domicile. Chinese families have taken advantage of this by sending their families overseas and using tax planning,” explained Crossley.

Also, in the past, a lot of Chinese entrepreneurs sought to capture wealth by initial public offerings; the IPO market, for various reasons, is less effective as a liquidity event today – in part due to economic conditions – so other ways of unlocking and then securing wealth must be found. This is good for the trusts sector, he said.

Also, increased PRC anti-avoidance legislation on corporate structures makes alternative wealth structures more attractive, he said.

The Chinese approach to trusts is akin to the old English approach (prior to recent UK reforms). The assumption is that whatever assets that a person has that are not taxed upon are not taxed in a trust. For the purposes of tax, an offshore trust has no legal personality in law for China. However, the ability of Chinese high net worth individuals to get into such trusts is, at the moment, relatively limited due to exchange controls.

In the past, there had been a slow trickle of enquiry at B&M’s offices in Shanghai, Beijing and elsewhere, but for the past 18 months, almost exactly coinciding with tax changes on real estate, this has changed. Enquiries from domestic Chinese clients about trusts have surged, Crossley said. 

“China property prices increased 10 fold in the last decade so UK property looks much cheaper and with good exchange rates,” he continued.  

B&M put on a conference based around the theme of such trusts in July (which your correspondent attended); and several lines of client business have come from that, Crossley said.