Benjamin Franklin once said that the only two certain things in life were death and taxes. Indeed, in Hong Kong it was possible to suffer both indignities at the same time.
That was until the Financial Secretary for Hong Kong, Henry Tang Ying-nin, made the following announcement in his annual budget speech of March 16, 2005 to the Legislative Council ("Legco"):
"On balance, after weighing these factors, I propose to abolish [estate duty] and will introduce the relevant bill into this Council as soon as possible"
Good to his word, the Revenue (Abolition of Estate Duty) Bill 2005 (the "Bill") was gazetted on 6 May and introduced to Legco on 11 May 2005. Under the Bill, estate duty will no longer be applicable to the estate of any person who passes away after the commencement of the relevant Ordinance, should the Bill pass into law.
Reasons for the change
As noted in the section of his speech extract above, there are a number of factors that the Financial Secretary considered before reaching his decision.
In the first place, there is a pure tax policy perspective. When estate duty was introduced in Hong Kong in 1915, it was intended to "enable the whole community to benefit upon the death of persons who had grown very rich partly through the appreciation in value of assets and progress of Hong Kong to which the whole community contributed". Given the absence of any other capital taxes and, comparatively, very low rates of income tax, this consideration might be thought to remain equally valid today. However, another view is that, over time, estate duty has come to fall unfairly on, the middle classes. Of course an upward adjustment to the thresholds at which duty applies would be another means of addressing any concerns in this regard.
Secondly the Financial Secretary appears to have taken the view that abolition of estate duty, or at least as it applies to Hong Kong situated financial assets, would boost the financial services sector in Hong Kong and Hong Kong's attractiveness as an international financial centre. In this regard, it is telling that the text containing the proposal to abolish estate duty appears in the section of the Financial Secretary's speech entitled "Promoting Asset Management". Others, however, have argued that there is no evidence to support such a contention and that estate duty is largely irrelevant in this regard.
Whatever the outcome, once the consultation process began most interested parties in Hong Kong anticipated that there would be changes of some kind. However, given the approach recently adopted by Singapore (arguably Hong Kong's closest regional rival in asset management) in their estate duty regime, many doubted that there would be a complete abolition. Some others further thought that estate duty would only be amended and/or abolished as a sweetener for the introduction of, say, a broad-based sales tax.
The complete abolition of estate duty will cost the government about HK$1.5 billion a year. It remains to be seen what the outcome will be. However the remainder of this article considers the likely planning implications for high net worth individuals (HNWIs) if Hong Kong estate duty were to be abolished in its entirety (as opposed being retained but amended, e.g. by thresholds increased, etc).
Abolition and its impact on HNWIs
If the Hong Kong estate duty is abolished, the consequences for Hong Kong's HNWIs, both those with wealth planning structures already in place and those considering establishing such structures, are not likely to be significant.
While many structures have been put in place at least in part to mitigate Hong Kong estate duty, there are only a small number of structures that were established solely for this purpose. Further, structures such as trusts generally have a number of objectives and benefits other than, and often more significant than, Hong Kong estate duty mitigation. These include:
Intergenerational succession planning
Especially where the elements generating the family's wealth are more valuable and/or effective kept together as a whole rather than broken up between succeeding generations, structures can be used to preserve the unity of the assets while allowing multiple ownership and/or different roles in management between family members (e.g. to reflect different aptitudes and appetites in successive generations). Disputes over inheritances may also be minimised as a structure may provide clear direction as to the distribution of assets to heirs. With a proper structure in place, HNWIs may make financial provisions for themselves, their spouse and children or other beneficiaries during their lifetime and after their death in an efficient manner. These structures may also be tailored to safeguard and promote the interests of minors or other susceptible beneficiaries, such as children with special needs.
Emergency planning
A proper structure may also serve as a contingency planning vehicle to make financial provisions for the HNWI and their family in the event of an emergency. The trustee continues to manage the trust assets in accordance with the trust terms and, if necessary, makes distributions to meet the financial requirements of the family.
Probate planning
Even with the removal of the need for estate duty clearance, probate can be a long process, for example where there is a contested will. This would be a problem because all of the deceased's assets are frozen until probate is obtained. If the family's sole means of support are assets forming part of the deceased's estate, this can be disastrous for the family. A trust structure would enable speedy and smooth administration and distribution of assets, saving the time and cost of going through probate formalities. And one must also note that probate procedures are not limited to Hong Kong, but also in most jurisdictions where HNWIs hold assets.
Asset protection
While it is generally not appropriate to establish a structure primarily for such purposes, an incidental benefit of a trust is that after a certain time, the trust assets are generally protected against claims by creditors, rapacious ex-spouses, spendthrift children, etc. In addition, as in the case of a discretionary trust, assets are held in the name of the trustee or its wholly owned company. The identity and interests of the beneficiaries can be kept confidential until the trust terminates.
Planning for other tax regimes
With high net worth families in Asia generally and in Hong Kong in particular having increasingly complex and international families and asset positions, structuring is often quite efficient in relation to taxes from other (often high tax) jurisdictions, such as the US where estate taxes are currently as high as 47%.
Structuring: Business as Usual
As can be seen, structuring will not become obsolete, as it will be a rare structure indeed where Hong Kong estate duty mitigation is the sole benefit, even if this was the main consideration when the structure was established.
One benefit of the abolition of estate duty is that in many cases it may allow structures to be simpler and more flexible. In particular, asset holders who generally had to be significantly excluded from involvement in estate duty mitigation structures may now be able to be included as beneficiaries and/or have some input in the administration of the structure. This may in turn make structuring more attractive in cases where the previous practical cost to the asset contributor (i.e. effective exclusion from his or her assets) was considered too high.
Unfortunately (depending on your perspective), in the trust context at least, simpler structures are unlikely to make structuring cheaper. While there may be a degree of savings on fixed component costs (e.g. annual company fees), trustee fees are generally calculated by reference to one or more of (i) asset size, (ii) asset type and (iii) day-to-day administrative and fiduciary considerations. Since only the latter of these is affected in any way by the complexity of the structure, and even then not significantly, the abolition of Hong Kong estate duty is unlikely to have a direct impact on these pricing considerations.
To some extent on the other side of the coin, however, it was relatively easy to quantify the benefit of Hong Kong estate duty mitigation. As such, mitigation was often a decisive factor for an individual when choosing whether or not to establish a structure. That said, Hong Kong's trust users have become increasingly mature vis-à-vis the operation and benefits of trusts over the decades, and as such the abolition of Hong Kong estate duty will not materially reduce either the number of existing structures or the number of new structures being established.
Finally, HNWIs with existing structures should not rush out to change their structures just yet. It could be an absolute tragedy if a structure were to be modified in contemplation of the abolition but one or more of the asset contributors passed away before the abolition took effect. HNWIs can by all means start thinking about the issue now, but no restructuring should be effected unless and until the Bill is passed and becomes effective.
