When PRC Tax Meets Offshore Trust Law: Reflections on the New Individual Income Tax Rules

Trustees administering structures for families connected to jurisdictions such as the United States or the United Kingdom have long been accustomed to a home country tax authority asserting a claim over trust assets or income regardless of where the trust is established or governed. The US grantor trust rules and the UK’s rules on transfers of assets abroad and settlor-interested trusts each address, in their own way, income and gains generated within an offshore structure while the settlor remains connected to the home jurisdiction. Seen in that light, the Announcement looks less like a novelty and more like a maturing of the PRC’s approach to outbound wealth, brought closer to practice already familiar elsewhere.

This history is worth bearing in mind because offshore trusts have continued to serve their core purposes, including succession planning, consolidation of family assets, continuity of governance across generations, and protection from forced heirship or other jurisdiction-specific rules of the settlor’s home country, even as those home countries have progressively asserted tax claims over the underlying wealth. A settlor’s home tax position and the trust’s own legal validity, governance and asset protection functions are related but distinct questions.

Clients coming to this issue tend to fall into one of two positions, and the appropriate next step is not the same for both.

Some clients are themselves the settlor of an existing structure, often established some years ago, and are now asking whether it remains fit for purpose given a materially different PRC tax position. For them, the relevant question is less “was this the right structure at the time” and more whether the trust, as currently drafted and administered, still achieves what the family originally set out to achieve once the new tax cost and compliance burden are taken into account.

Others come to the question indirectly, as beneficiaries of a family trust, as the next generation who may in time become settlors or successors, or as trustees and family offices responsible for a structure they did not themselves design. The rules are not confined to a straightforward resident-settlor trust. They also contain provisions for, among other things, trusts settled by non-residents that make distributions or deemed distributions to PRC resident individuals, arrangements ostensibly funded by non-residents but in fact controlled by PRC residents, and trusts that are subsequently inherited by PRC residents.

Certain circumstances tend to make a review more pressing than others: (i) a structure that has simply not been revisited since it was established; (ii) a settlor or beneficiary whose personal or tax residence position has changed, or may soon change; (iii) a meaningful shift in the value or nature of the assets a trust holds; (iv) governance arrangements, including the roles of trustees, protectors and family members, that have evolved informally over time without being reflected in the underlying documents. None of these circumstances, on its own, points to a particular outcome. They simply suggest that the assumptions underpinning a structure may no longer match its current reality, which is itself a reasonable trigger for a fresh look, independent of the change in tax law.

BVI and Cayman Islands trust law was built with change in mind. A trust that no longer suits a family’s circumstances may, depending on its terms, governing law, available powers and consents, and any applicable regulatory and tax considerations, be capable of amendment, trustee succession, restructuring or, in appropriate cases, a change of proper law or administration. The same is true of the companies that typically sit beneath these trusts, which can be reorganised, recapitalised or wound down through established BVI and Cayman company law procedures. A shift in how a settlor’s home country taxes an arrangement does not, in itself, exhaust these tools. It simply gives families a reason to consider whether they are worth using.

Our work on this front usually begins once a family and its PRC advisers have reached a view on the tax position, at which point we help work out what, if anything, needs to change in the trust or its underlying companies to reflect that view, and see those changes through under BVI or Cayman Islands law. Just as often, the answer is that the existing arrangement still holds up well and does not need to be unpicked. We are also glad to be involved earlier, alongside PRC advisers, where a family wants an offshore law view on how a structure is currently put together before any decisions are made.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Legal Insight, please contact me or your usual Loeb Smith attorney.

Senior Associate: William Yang
E: william.yang@loebsmith.com

William is a Senior Associate in the Corporate and Funds Group and he advises fund managers and sponsors, corporates and financial institutions on cross-border mergers and acquisitions, IPOs and other capital markets transactions, joint ventures, private equity and venture capital investments, and the formation and launch of Cayman Islands and BVI investment funds.