Since China’s market economy started booming some 20 years ago, a nouveau riche class of more than a million has steadily come up. And with the possibility of the first generation of wealthy Chinese eventually retiring in the next decade or so, planning succession and inheritance issues for high net worth individuals in the country will become a growth area for wealth management lawyers. In fact, a recent round of discussions about a proposal on estate tax in this context has caused several concerns to be voiced. Liu Zhen finds out more

Getting wealthier

After two decades of high-speed growth, a new monied class in China has emerged which has access to an impressive amount of capital. The number of high net worth individuals (HNWIs), who own investable assets of more than RMB 6 million ($1 million), may vary in different market studies. But one thing is certain - most of these reports agree there are no less than one million millionaires in the country. Little surprise that China is the fastest-growing wealth market in the world.

In 2012, the value of total private investible assets was 80 trillion yuan ($13.1 trillion), which doubled from that of 2008 with an annual growth of 21 percent, according to a recent speech by the chairman of the Agriculture Bank of China, Zhang Yun.

Most of the this nouveau riche population came upon their money over the last 10 or maybe 15 years; after the ruling Communist Party began to build a market economy and encourage private wealth accumulation.  Unlike heirs and heiresses in other countries, a majority of these wealthy Chinese proved to be successful entrepreneurs in the reform who started from scratch and are still expanding their businesses. A Bank of China report cited a survey in 2011 saying that the average age of Chinese millionaires is 39 years, and 55 percent of them earned their fortune through their own enterprises.

This fact can be interpreted in two ways – one, that these wealthy Chinese are quite new to wealth management and inheritance and two, that they may want tighter control and higher profits from wherever they spend their money.

“Many of the ‘new rich’ are still building up their businesses and putting their cash back into their businesses,” says Michael Olesnicky, Hong Kong-based partner at Baker & McKenzie.

Meanwhile, many of them have also begun to realise the need for professional wealth management assistance. Private banking was legalised in China only in 2006. By the end of 2012, the private banking department of the “Big Four” state-owned banks has started taking care of assets worth 1.7 trillion yuan for about 120,000 clients.

“Chinese people learn stuff fast,” says Ian Devereux, partner and head of Stephenson Harwood’s wealth management group in Greater China.

Private bankers in China are expected to provide high-yield products. And eventually, as the next generation of Chinese business people grow up in the next decade, the rich families will also have to consider succession and have more requirements for assets protection apart from wealth creation. Approximately a third of HNWIs, and one half of ultra-HNWIs – who hold 100 million yuan in investable assets – are now considering inheritance planning, according to a recent report by consultancy Bain & Company.

“In the first generation of Chinese entrepreneurs, we have not seen the need for family wealth planning on a large scale yet. But as the society develops and regulations [get] completed, legal services related to wealth management may become a growth area for us,” says Gong Mulong, partner at King & Wood Mallesons. “It’s not a mainstream practice nowadays.”

Wang Hao, senior partner of RayYin & Partners and wealth management specialist, says currently there are abundant client resources in China, and clients have clear appeals. But the services or legal structures available are limited, and professionals, especially lawyers, available to help them are very few. And as this market only just started up, very few Chinese law firms have identified wealth management as a practice, adds Gong of KWM.

“There is a big gap in the market to fill,” Wang opines.

Although still in its infancy, the PRC market has started to grow already both for private bankers and lawyers, and in the next few years, it will be expanding a lot more, says Devereux.

“Estimatedly, there’s one million high net worth individuals in China, and about 100 ultra-high net worth individuals. It’s a lot of people. If just 20 percent of the HNWIs want to do it over five years, that’s 200,000 in total or 40,000 a year. It’s a very big market, a lot of employment or jobs for lawyers,” he calculates.

Trust trusted

The limited choices in China at the moment, says Wang, include wealth management products in short-term or long-term private trust or life insurance in the long term.

“In the past, succession was often carried out through nominal holding of assets, testaments or insurance. The conventional arrangements each have their own problems and none of them are as good as trust in the long term,” she says.

As explained by Devereux, in establishing a private trust, lawyers are like the builders of a house, in which the client’s assets can be accommodated at their wanted location, but do not actually care what furniture will be put in; whereas private bankers are the actual money managers or housekeepers. But as private trusts were not introduced in the PRC until very recently, experienced wealth management lawyers sometimes have to teach Chinese clients and even some other lawyers and private bankers what trust is in the initial stages.

“We introduce trust to the PRC lawyers, also some private bankers in the PRC, who also do not know much about trust and assets protection or estate planning,” says Devereux.

Similar to their taking up of private banking, Chinese clients have demonstrated an impressive learning curve and a positive attitude on the trust issue. Bain’s reports say a third of HNWIs and more than half of the ultra-HNWIs have expressed interest in establishing family trusts, and 15 percent have already done or started to do so.

“They now accept the concept of private trust and many have started to try that out,” says Wang.  “We had to tell them the basic things about a trust, but in the past two years, they know it quite well. What they want to know now is about the actual executions in practice.”

Trust can be set up either onshore or offshore, says Wang. Generally, going offshore is preferred. A report by the Bank of China in 2011 estimated 20 percent of Chinese HNWIs’ assets were outside China; Bain’s reports say the percent of HNWIs and ultra-HNWIs with overseas investment have roughly doubled since 2011 to help risk diversification and garner investment opportunities. The market for wealth investment within China is limited, suggests Olesnicky. Also, only a few types of assets are allowed for onshore trust in China – other than cash that is. In addition, a large amount of uncertainty still remains, in particular about how effectively the trust structure in China can insulate risks, as there aren’t enough judicial precedents.
“The relevant experience is lacking,” she says.

In the private banking market for the wealthy Chinese, domestic banks still dominate. But international lawyers with offshore trust capabilities and overseas management experience are probably more advantageous, especially when they also have Chinese language skills, says Devereux. Since investments are typically held offshore, legal advice is necessary to ensure proper tax compliance both within and outside China, adds Olesnicky. But Wang points out that very often, certain assets within Chinese territory are very difficult to transfer cross-border and in such cases, PRC laws apply. These are times when a knowledgeable PRC lawyer is indispensible.

“Not all assets can be effectively moved into an offshore trust structure, so an onshore trust as a supplementary or secondary choice is also considered by many,” says Wang.

Inheritance tax

Although it has been proposed for years now, an inheritance tax levied on someone who inherits money or property does not currently exist in China. But in the past couple of months, the discussion about a possible adoption of inheritance tax was heatedly discussed by the media, particularly before the 3rd Plenum of the Communist Party’s 18th Congress, where leaders planned key political reforms and economic policies for the next five years. Government sources told Reuters Beijing is considering it in order to help reduce the widening wealth gap and social inequality.

At the end of the Plenum, however, no actual progress was revealed. Fact is there isn’t a timetable yet, as many other things in China, but lawyers hope to have it in place as soon as possible.

“As soon as we know what’s involved in the legislation we can advise it properly, but right now, there is very little information about the legislation,” says Devereux.

Wang believes it could come out in the next few years. Above all, the authorities must be able to figure out how much assets a person possesses on his death. And the construction of such a national property registration system is still in progress. “I think there is some time before the launch of inheritance tax, but it would definitely not be as long as in 10 years time,” she says.

Gong adds that it takes time to work out a whole set of mechanisms in order to avoid loopholes for tax avoidance, “I believe it will be launched together with gift tax and other relevant policies, including regulations on charity operation.”

On the much-debated threshold, Wang suggests it be set at eight to 10million yuan, given the speed of inflation and soaring housing prices. “To tax on assets lower than that may lay too heavy a burden on the middle class, which is not the goal of the policy,” she says.

In taxation law practices globally, the rates of inheritance tax vary from one type of asset to another, but are normally progressive and could be as high as 50 percent, says Gong. But it is still unknown how much China is likely to take. Wang warns if the rates are too high, it may also lead to an unwanted situation as the rich  would then be motivated enough to seek avoidance.

Despite being unclear, the inheritance tax will no doubt have a huge impact on wealth planning for the rich in China. Wang says her clients have started taking this into consideration. She suggests they classify their assets first, either to transfer it offshore, or to think about other arrangement such as life insurance or an onshore trust.

Other solutions include switching their assets into lower-rate types, or putting them into a company’s name, or mortgaging their shares in the company, and so on. “There are various things we can do to deal with it,” adds Devereux.

Investment immigration

Another possible consequence of the inheritance tax is that some of the HNWIs might consider immigrations. In fact, a number of them had either completed immigration or had applied for it even without an inheritance tax. A Hu Run Report in 2011 said nearly half of HNWIs polled were considering immigration. Having a second or alternative passport or a permanent residency is popular among the rich in China and the most common path to do so is by investing.

Childrens’ education is one of the main drives, says Devereux. Parents who have children studying in the U.S., U.K, Australia, Canada or Europe may prefer to have a residency in these countries. From a lawyer’s perspective, they are in need for visa and tax advice, according to Olesnicky.

Gong indicates that the popular immigration destinations are likely to be high-tax countries. This is particularly the case for educational immigrants.

“We always educate our clients to take into account whether the country has global tax burden, or inheritance tax. Otherwise, they would face similar problems as they face in China, or will face in China,” says Wang.

She points out that not all immigrants actually “move” to their resident countries. In fact, a huge number of them still live in China and the major source of their properties are in China. Unless they transfer all their possessions to an offshore structure – only if all the assets are able to be transferred offshore – and they avoid staying in China more than certain days a year, they would inevitably remain taxpayers of China. Either way, compliance is key.

“You don’t want to do things that will get you in trouble in either China or in those countries in which you’re investing,” says Olesnicky.

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