MULTI-DIMENSIONAL REAL-WORLD EXPERIENCE

Because we have supported international families for over forty years, we understand the complicated legal issues our entrepreneurial family clients face every day: multi-dimensional estate planning, trusts, confusing cross-border tax regimes, and conflicting family opinion obstructing the need for decisive and rapid decision-making.

That is why our tax and legal advisers always offer advice that is, first and foremost, pragmatic and commercial, to deliver the essential outcomes you are striving for.

When necessary, we will source counsel from our international network of external advisers. However, we will never delegate responsibility for finding the right solutions.

We understand that the actions you take following our recommendations must operate effectively not only at inception but also for years down the line. We ensure our counsel is always simple to understand and communicate. We believe that wherever there is unnecessary complexity, risk may be around the corner.

 

OUR INVOLVEMENT

Working with the same commitment, flexibility and accessibility that you would expect from your own in-house counsel. Stonehage Fleming’s lawyers are from a diverse range of jurisdictions and disciplines, with senior members of the team acting as strategic technical advisers to your family.​

The legal and tax areas we cover are:

 

  • Trusts, estates and succession planning
  • United Kingdom, United States and South African tax
  • Cross-border taxation
  • Foundations
  • Wills
  • Philanthropy / Charity
  • Family governance
  • Investment structuring
  • Trust disputes
  • South African Exchange Control and Emigration
  • Trust implications of divorce
  • Commercial agreements
  • Employee incentives

 

 

Specialist Legal & tax advisory Services

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Taxation, Lifestyle and Morality

George Osborne’s 2015 “Summer Budget” raised some challenging questions for those who are resident but not domiciled in the UK. For centuries the UK has welcomed wealthy foreigners’ contributions to our economy, allowing them to maintain unremitted offshore income and gains outside the UK tax net. The problem is that, economic arguments aside, it is now generally considered unacceptable for such special treatment to be enjoyed indefinitely by people who have become long- term residents, particularly if actually born here.

The clear message to the Resident, Non-Domiciled (RND) community is not only that they will have to pay substantially higher taxes, but that the historic arrangements are becoming increasingly difficult to justify, morally. The implication is that these individuals have a social duty to make a larger contribution to their adopted country.

It is never easy to have a privilege removed, and in this case the proposed changes may have a profound impact on the financial, business and lifestyle arrangements of many wealthy families, particularly those with widespread business interests. For some, the issue is far more than financial, as increased taxation (particularly inheritance tax) may jeopardise their ability to retain control of family businesses that have been built up over decades.

The responses of such families to the changed environment have been varied, but surveys conducted by this firm provide evidence that attitudes are changing:

  • Whilst reasonable measures will be taken to mitigate tax, many RNDs accept they will have to pay more.
  • Some, particularly the younger generation, accept that there may be a moral obligation to make a bigger contribution.
  • Some of those whose initial response was to leave the UK have yet to find an alternative which both has sustainable tax benefits and an agreeable lifestyle. The UK remains attractive relative to most alternative locations.
  • Many RNDs have established deep roots and family ties in the UK and have concluded that very substantial savings would be required to justify relocation.
  • Those who have already decided to leave are mainly those whose lifestyle is essentially international and whose residence can be changed by a relatively minor adjustment to the time they spend in the UK.

Most families affected will already be exploring their options, but changing attitudes may need to be reflected in the brief they give to their advisers.

Tax planning is no longer an exercise in outwitting the authorities, but rather finding a more balanced approach which takes account of increasing risks and changing social attitudes.

Artificial schemes, which operate within the letter but not the spirit of the law, are increasingly unlikely to succeed. They can also open an individual up to a wider investigation of their affairs, which is usually expensive to deal with, even where there is no wrongdoing.

Now is an ideal time for families to develop an agreed approach and set of guiding principles, accepted by all relevant family members. In particular, the younger generation may take a different view from their parents and, bearing in mind that tax planning spans generations, it is desirable that the arrangements put in place now are acceptable to those who may have to deal with the consequences in years to come.

The following are some thoughts which might help with deliberations:

1. WHAT IS FAIR, AND WHAT IS NORMAL

The question of what is fair is a tricky one. It can be argued that it is fair that everyone should pay the same rate of tax. Equally, it can be argued higher earners should pay a higher rate of tax, following the mantra “from each according to his ability, to each according to his need.” Further still, it can be argued that as an immigrant to the UK, one should only have to pay tax on income arising in the UK: why should the UK government have the right to tax monies hard earned elsewhere in the world?

In this context, it is helpful to look at where the UK falls in comparison to other major economies. Resident non-domiciliaries have, for a long time, been generously treated under the UK’s tax regime and the question is whether, following the tightening of the legislation, they are still better off than they might be elsewhere?

COUNTRY INCOME TAX CAPITAL GAINS TAX INHERITANCE TAX OTHER
United Kingdom 20/40/45% (10/35/42.5 on dividends). 18/28% Spouse exempt, £325,000 tax free, otherwise 40% Non-domiciliaries can for up to 15 years claim a) the remittance basis - no tax on unremitted income and gains and b) exemption from IHT in respect of non-UK assets.
United States Progressive rates up to 39.6% Generally taxed at 20% Subject to a current exempt amount of US$5.34 million, tax is charged at 40% US residents are taxable on their worldwide income and gains. Only very limited provisions allowing short-term residents to shelter foreign assets from tax.
Germany Progressive rates up to 45% 25% Rates vary depending on the relationship between donor and done, as does the tax free amount, and apply to lifetime gifts as well as testamentary giving. While the principle of testamentary freedom applies, a disinherited heir may claim 50% of the amount they would have been entitled to in intestacy. German residents or those with a habitual abode in Germany are subject to the tax on their worldwide estates.
France Progressive rates up to 45%. Additional rates of 3% - 4% for income up to/over EUR 1million in certain circumstances. 19% Spouse exempt, child sibling 45%, other 60%. Forced heirship also applies to certain assets. Wealth tax payable on assets of over €0.8 million. Heavy social security payments.
Australia Top rate of 45%. Taxed at income tax rates. Rate is reduced by 50% for assets over a year old. None. Temporary residents taxed on Australian source income and gains only.
South Africa Progressive rates up to 41% on worldwide income. Maximum effective rate of 13.65% on SA resident individuals on worldwide gains. Testamentary freedom. R3.5 million can pass tax free, otherwise 20%. Spouse exemption exists. Temporary residents / immigrants can shelter foreign income and gains provided they do not fall within the definition of tax resident in South Africa.

SOURCE: Private Client Tax, Third edition 2015, John Rhodes, Stonehage Law Limited

As can be seen, the UK still has a broadly favourable regime compared to many other major jurisdictions. It is reasonable to conclude therefore that the UK’s current regime is relatively fair and normal, and indeed still likely to be more advantageous to RND’s than most comparable alternatives.

2. WHAT ABOUT TAX HAVENS

A tax haven is defined by the OECD as having three key identifying criteria: 1) Nil or nominal tax rates; 2) Protection of personal financial information; and 3) Lack of transparency. On the face of it, these are an attractive proposition for a wealthy individual looking to keep his affairs private and reduce his global tax liability.

The immediate benefits of living in one of these jurisdictions are obvious: little to no income, capital gains, or inheritance taxes and a perceived higher level of privacy and anonymity with regards to assets.

However, for most people, the sheer levels of life upheaval and lifestyle changes required are often the deal-breakers. The day counting; the constant travel; the time spent away from one’s family: these things can be, or can become, too much of an additional burden.

It is also clear that the days of secrecy and privacy are over. The Foreign Account Tax Compliance Act (FATCA) is already well under way and the Common Reporting Standard (CRS) has effectively been with us since the start of 2016. This means that most account holders will have details of their holdings and income reported to the tax authorities of their home jurisdiction. Most of the major tax havens have reluctantly already signed up to these arrangements, under pressure from the international community.

Perversely, the only major jurisdiction not currently participating in CRS is the USA, which is relying on FATCA to provide all of the information they need, having forced the world to comply with their legislation!

3. THE MORALITY DEBATE

We must distinguish the morality of the individual from the morality of the law. People increasingly criticise the wealthy even for taking advantage of tax breaks deliberately created by the government and politicians are often keen to exploit this misplaced public ire for a short-term win.

The morality of the law is debateable. One can easily argue that the UK government has no right to tax funds that have been earned overseas, without any reference to the UK. On the other hand, it can equally be argued that if you are a long term resident of the UK and enjoy all the benefits that come with that, you should pay tax in the same way as any other “normal” UK resident.

Recent government policy changes and announcements are consequently designed to ensure that once you become a “long-term” resident, you should be treated for tax purposes on the same basis as those who are UK domiciled. For the time being, the government has determined that 15 years is the “long-term” watershed; less than the 17 years previously set for IHT in 1974, but much longer than any similar initial period in other countries such as Spain or even Israel.

More broadly, objections are frequently raised when wealthy individuals try to use ‘artificial’ schemes to gain tax advantages that were not intended. A notorious example is the film schemes which took advantage of an intended tax break, but pushed the boundary too far by removing most of the risks which the legislation was designed to encourage. It is not always obvious at what point the line is crossed between an intentional tax break and ‘an artificial scheme’.

FOCUS ON FILM SCHEMES
Gordon Brown originally enacted this legislation in 1997 in order to provide a boost to the British film industry, initially for 3 years, although it was ultimately extended a number of times. Initially, this appealed to many as an interesting alternative investment, but eventually people found ways to financially engineer products such that the benefits could be enjoyed by investors with significantly less risk. It is difficult to know when these schemes began to cross the line of acceptability and this may well not have been clear to investors at the time investments were made - it is easy to be caught out when one thinks there is a genuine investment opportunity.

No one is obliged to leave their affairs in such a way that the taxman will get the maximum possible share, but anything done to decrease that share constitutes tax avoidance. It quickly becomes apparent that tax avoidance is a vast grey area and what might or might not be immoral is a subjective question - one man’s “morally repugnant” tax avoidance is another man’s ISA, or duty free shopping basket. An individual’s approach to tax avoidance or mitigation must be based on their own level of comfort.

There have been high profile cases in recent years of people and corporations being exposed for engaging in various degrees of tax avoidance schemes. These range from companies such as Starbucks and Google transferring profits to lower tax jurisdictions and the “K2” scheme (used by individuals to move income offshore), to the swathes of people caught out by the ultimately failed film schemes. These have all been met, rightly or wrongly, by a strong, negative public reaction which has often been reinforced by criticism from the very top of government.

Whether or not you consider these schemes immoral (note that they were all legal), there is another matter to consider here - the issue of reputational damage. It is difficult to put a price on this but for many entrepreneurs, who hold the majority of their assets in their business, the impact of this has the potential to be significant; tarnishing both the name of the business and indeed the family name, which can be a brand in itself.

An individual is entitled to take advantage of tax legislation to whatever extent and in whatever way they are personally comfortable with, so long as they remain within the bounds of the law.

Some may take advantage of all legal means to minimise tax and others only of tax breaks which were clearly intended by the authorities. Some will always seek tax minimisation, whereas others will aim to keep their overall tax bill to a ‘reasonable’ level, an objective which needs to be defined and discussed with tax advisers.

It is important to note that those with fiduciary obligations such as company directors or trustees have to justify their decisions to their beneficiaries. Bearing in mind their effective obligation to maximise profits, a strong case will have to be made if tax minimisation is not one of their main objectives, particularly if personal moral values are coming into the equation.

4. ANTI-AVOIDANCE

Historically, offshore structures, while often used for tax avoidance, are also used for matters entirely unrelated to tax, including the mitigation of political and/or personal risk, and succession planning. In these matters, the tax consequences are often a secondary consideration.

In some countries, wealthy individuals can face imprisonment and the confiscation of their assets simply for having a difference in opinion with the ruling party. Transferring assets out of your own name and out of the country is thus an obvious way to mitigate this risk.

The relative anonymity of an offshore discretionary trust can also be put to good use in reducing risks for wealthy families. Kidnapping, for example, is a real threat.

Testamentary freedom may seem like a given to many, but there are a number of countries that restrict, to a greater or lesser extent, the ability to decide how one’s assets should be divided on death. Several offshore jurisdictions have laws that specifically do not recognise forced heirship and placing your assets into trust can allow you to pass on your estate freely.

In all of these scenarios, the avoidance of tax will be a likely by-product, rather than a driving factor in the planning. Do moral arguments against tax avoidance still stand up here? Even British legislation recognises that anti-avoidance provisions will only apply where tax avoidance is “the main, or one of the main” reasons for the planning.

5. WHAT SHOULD I BE DOING?

In light of the major changes coming, it is a good opportunity to take a step back and look at the bigger picture: to assess one’s priorities and consider what level of tax risk one is willing to accept. No-one can predict specific future changes to the tax system with any confidence, but the direction of change is clear. Families can take the opportunity to put in place structures that are reasonably futureproof. The alternative is to adopt a more reactive approach, and try to adapt as the legislation is announced.

Given the constant changes, and the upheaval that they can cause, many families find it useful to agree a strategic framework and set of guiding principles, which help define their approach and philosophy. These provide a benchmark for individual decisions, as well as being a useful guide for the family’s tax advisers, in developing their proposals. It is also an important benefit of drawing up such ‘policy documents’ that the process helps identify and reconcile differing views between family members. The younger generation, for example, often has a slightly different attitude to tax avoidance and, given that they ultimately have to live with the result of any long-term planning, an agreed philosophy makes obvious sense.

WHERE IS MY RISK?

There are a number of areas where an individual taxpayer faces risk. Investment selection is self-explanatory and the closer one pushes the tax boundaries the greater the risk, naturally. However, it is also worth noting that having an excessively low tax bill can also add risk. Not only do you make yourself more of a target for HMRC, you are also likely to receive less leniency and a more thorough investigation in the event of an enquiry.

Such a framework will be particularly helpful to those considering the implications of the changes to the UK RND rules, given the many complex alternatives which could be explored. It will promote sounder, more consistent and more ‘joined up’ decision making. Greater clarity of purpose will reduce unnecessary debates and thus reduce the costs of professional advice.

6. CONCLUDING THOUGHTS

Ultimately, deciding an approach to tax is a personal issue. There is a danger that personal advisers have engendered a mind-set of minimising tax at all costs, with little regard for anything else.

Individuals need to ask themselves: do I have an idea of the level of tax that I would consider to be acceptable? Am I able to achieve this level of minimisation within the bounds of moral decency? Am I willing to accept a higher level of tax payable in order to reduce the level of risk faced and to continue to enjoy the quality of life I have achieved in the United Kingdom?

With the direction of tax changes undeniably in favour of tighter legislation, fewer legal loopholes and a more focused approach on tax avoidance, there is an opportunity to consider a new, sustainable philosophy and approach, with some clear guiding principles.

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Inter-Vivos Trusts: Nebulous Creatures of Immense Pedigree with a Glorious Past & Promising Future

With all the negative publicity surrounding offshore trusts, it would be easy to think that the days of the trust are over, that the risks and costs now outweigh the benefits and that wealthy families will be looking for alternative ways of holding their assets.

At this stage, however, the evidence is the contrary. The trust is a unique structure for holding assets developed in England around 1200 AD and adopted in practically all jurisdictions which have a legal system based on the principles of English Law. Nowadays the trust is increasingly recognised internationally even in Civil Law Jurisdictions (including, for example, Switzerland and most recently Hungary) and is extensively used in both China and Japan, despite their very different legal systems.

The trust has survived many previous attacks, mainly because it has numerous legitimate uses and is a superb vehicle for family succession planning. It is obviously true that increased regulation has added to costs, that the demand for transparency has diminished financial privacy and that increasingly determined tax authorities are curbing the ability of offshore structures to avoid tax. However, there remain many legitimate and compelling reasons for settling assets into a trust, which have perhaps been temporarily obscured by the highly negative and illinformed press, associating all offshore trusts with money laundering and tax evasion.

The reality is that a small number of participants have helped to give the whole sector a bad press, by taking on clients whom most would regard as unacceptable.

Trusts under Attack

Regulators

The number of international regulatory changes in the past two years is unprecedented, with new AML regulations, EU Directives, transparency initiatives, exchange of information and the ability of foreign tax authorities to learn the identity of beneficiaries. These include the US Foreign Account Tax Compliance Act (FACTA) and the OECD’s Common Reporting Standard (CRS), both of which are threatening the privacy we have taken for granted for so long. The cost implications of these new initiatives are substantial, with all the obligations for enhanced due diligence, disclosure and reporting.

Tax Authorities

With government budgets under pressure all round the world, the rich are an obvious target:

  • Increased transparency and exchange of information, combined with greater vigilance by the authorities will make it more difficult to use secrecy for illegal tax evasion.
  • Opportunities for legal tax avoidance are being reduced by legislation designed to levy taxation on the basis of substance over form.

Media

The often deliberately misleading media campaigns will continue, increasing pressure on politicians to take action against so called ‘tax havens’ and raising concerns that data theft will cause breaches of confidentiality.

The combination of loss of privacy, increased costs, reduced tax benefits and now the potential reputational risks of being associated with offshore structures obviously prompts the question:

“What is the future for offshore trusts?”

The short answer, is that once the current furore has subsided, it will be recognised that Trusts are needed today just as much as they have been in the past.

The Lessons Of History: Trusts Are Resilient

Whilst implementation of FATCA and CRS is a challenge, there were similar concerns over the introduction by the US of the Qualified Intermediary Regime (QI) in 2001, but it was business as usual, following implementation. Similarly, despite current concerns, the reality is that trust laws continue to be recognised or promulgated on both sides of the Atlantic as well as in Russia, Eastern Europe, Asia and the Middle East, in response to growing international demand.

For the vast majority of individuals and families using Trusts, their tax planning is perfectly legitimate and not based on secrecy or tax evasion. That demand has not waned attests to the durability, versatility and inherent ability of trusts to preserve, manage and develop wealth as “part of the social and economic fabric of society.“1 Foundations, limited partnerships and corporations simply cannot compare with the benefits and flexibility trusts provide.

Legitimate Trusts For Legitimate Purposes

The many legitimate uses for trusts include: succession and estate planning (thereby alleviating the need for probate); tax planning during life and upon decease; continuity of family businesses; provision for heirs unable to take care of their financial affairs (spendthrifts, minors and the like); for testamentary freedom and protection against forced heirship claims; vehicles for charitable giving; and last, but by no means least, asset protection.

With increasing accumulation of wealth across the Globe and unprecedented numbers of businesses established over the last thirty years, families obviously require holding structures which promote effective succession and protect the assets they have built, especially in countries which are politically unstable.

And what better vehicle than a Trust, which can protect wealth for future generations, while simultaneously allowing families to retain enjoyment during their lives?

The essential element of a Trust, that distinguishes it entirely from other legal vehicles, is the gratuitous transfer of property from the settlor to the trustee, which results in the assets no longer belonging to the settlor. Following the transfer, the assets legally belong to the trustee and creditors will only gain access to these assets if it can be shown that the Trust was made with the intention of defeating legitimate creditor claims or is otherwise technically invalid. This will not be easy if the Trust has been established with appropriate legal advice and properly administered by an independent trustee.

The selection of a “real trustee,” who is independent and fully competent, is crucially important. A trustee who fails to act independently and takes instructions from the settlor and/or a beneficiary, can subject a trust to possible attack by creditors. They may argue that he was not a legitimate trustee of an Inter Vivos Trust but rather a mere nominee custodian holding the assets on bare trust for the settlor. The reality is that responsibility of the trustee is to all the trust beneficiaries and not to the settlor.

In many cases settlors wish to retain a degree of influence and certain jurisdictions have made specific legal provisions to enable this. The Hague Trust Convention2 makes it clear that “the reservation by the settlor of certain rights and powers…are not necessarily inconsistent with the existence of a trust.” However, the less powers the settlor reserves, the stronger the trust. Under certain circumstances it may also be advisable to delegate some powers on to protector committees, family councils and investment committees. The latter may provide family members a forum for discussion, without the risks created by settlor retention of powers.

Even where the validity of a Trust is not questioned, the residence of the Trust for tax purposes might be challenged3. Offshore Trust laws allowing settlor reserved powers will not help protect a Trust if it is pulled onshore because key decisions are made by individual’s resident onshore. The precise definitions vary significantly according to the jurisdictions involved but the conduct of the trustee and the extent of proper trust administration (or lack thereof) by the trustee, will be the evidence principally relied upon by the tax authorities in such cases.

Ease and Continuity of Succession Without Probate

Many wealthy families prefer to hold assets in trust structures to preserve continuity of purpose, to involve trusted family advisers in key decisions, to help avoid family disputes and to prevent the assets being threatened by poor decisions on the part of individual family members.

Frequently settlors come from jurisdictions that limit testamentary freedom (so called ‘forced heirship’). Thus if the wish of the settlor is to ensure that the fortune he/she generated is managed after death pursuant to their wishes, a trust is an obvious solution. Many financial centres have passed legislation that specifically provides for the trust to be governed by the laws of that jurisdiction, irrespective of the law of the settlor’s domicile.

Another benefit of an Inter Vivos Trust is that it is wholly private and avoids the complexity, costs and time that probate takes for international families with assets located in many jurisdictions. There is no requirement for court orders to enable the trustee to continue to act after the death of the settlor or subsequent beneficiaries. The management of the trust assets continues smoothly and these assets can ultimately be distributed, without any public process, quietly and privately.

Holding A Family Business

Families with family businesses need to address the issue of succession, coupled with responsible ownership. Shares directly held by individual family members can give rise to significant problems on death, divorce, bankruptcy, changing financial circumstances or differences of view. Trusts, on the other hand, can offer continuity of ownership from one generation to the next. It is not unusual for differences of opinion to arise between members of the family directly involved in the management of the business and those who are merely shareholders. Such differences can develop into unpleasant and destructive disputes, which often result in enormous legal costs, potentially serious damage to the business and, worst of all, long lasting feuds between family members.

Settling family business shares onto a Trust can assist tremendously. Whilst conflicts cannot be entirely avoided, setting out clear rules to govern the family business in a structured fashion, under the stewardship of appointed trustees, can help mitigate family disputes. It will also increase the chances of the family staying together and keeping control of the business. A trust can provide a mechanism for consolidation and reservation of voting powers, which will limit conflicts arising.4

This presupposes a genuine Trust with a trustee who has a close relationship with all beneficiaries, who can negotiate a course which will be accepted by all parties, in line with the requirements of the trust deed. Without these relationships across generations, a trustee is little more than an administrator.

Where possible, the trustee will try to ensure his or her efforts are supported by a family constitution which addresses and defines the family values and the purpose of the wealth.

Providing for Spendthrifts

Most HNW families will face the probable dissipation of their wealth over three generations unless protective measures, such as a trust, are put in place. This process is called wealth entropy. Trusts can be used to protect the family from their inheritance and the inheritance from the family.

Similarly, many wealthy families do not want their children to inherit family wealth in a lump sum at a relatively young age. They want to ensure their children will receive the assets only if and when it is determined they have the maturity to properly handle such wealth. Placing the assets into trust, with specific tailored provisions, will allow the settlor’s objectives to be achieved, whilst protecting the children from themselves and from others.

Asset Protection

Trusts properly implemented with a bespoke, irrevocable, discretionary trust deed, can offer protection against third party creditors but also against liability arising from direct ownership of assets and the claims of divorcing spouses, or disgruntled heirs. However, a Trust can only provide asset protection (AP) if it is established in an appropriate jurisdiction and the settlor relinquishes beneficial ownership, dominion and control to an experienced and competent trustee. This must be done at a time when there are no existing or foreseeable claims against him/her, as alternatively the trust may be viewed by the courts as an attempt to defraud creditors. UK courts, in particular, are extremely alert to any possibility that the trust might have been created to defeat the settlor’s own creditors, even if the settlor was clearly solvent at the time.

However, a trust created by a solvent settlor for the benefit of beneficiaries such as children should prevent their creditors from collecting against the assets in contrast to a direct gift of the same assets.

Additionally, it is important to remember that whilst AP Trusts are subject to the basic principles and laws applicable to Trusts generally, they require specific planning by experienced professionals. Thus whilst such Trusts may always be subject to challenge, a well-planned Trust with a “real trustee” is the best tool available to protect a family’s wealth from unjustified or unexpected claims.

A Trust is not always a silver bullet in divorce cases instituted in the UK courts, but they do provide another layer of protection. The enforcement of an English court order granted in matrimonial proceedings in the Trust’s offshore jurisdiction will be a major hurdle, which the spouse will have significant difficulty overcoming. Furthermore, not all the cases are bad, as the particularly poignant choice of words used by the court in the A v.A divorce case5 (which upheld the husband’s two trusts noting that the trustees had conscientiously performed their fiduciary duties), reflects:

“...even in the Family Division, a spouse who seeks to extend her claim for ancillary relief to assets which appear to be in the hands of someone other than her husband must identify, and by reference to established principle, some proper basis for doing so.”

Tax and Regulatory Neutrality

In a global world it is increasingly common for assets to be owned by a variety of investors from different jurisdictions, whether or not they are of the same family. Each of those jurisdictions will have different tax and regulatory systems, such that it is difficult not to disadvantage some investors or beneficiaries by comparison to others. Holding the assets through an offshore structure is often designed to achieve tax and regulatory neutrality between all investors - i.e. a fair playing field. In general the beneficiaries will be fully taxed in their own jurisdictions but will not be subject to unnecessary complications arising from an unsuitable ownership structure.

Charitable Trusts

Most wealthy families make significant contributions to charitable causes, frequently through charitable trusts. This takes the ownership of the assets outside the family, whilst allowing the family some continuing influence over the way the assets are managed and the causes which they support.

So What is the Future of the Trust

Despite the bad publicity, the trust is a highly useful device which plays a very important and legitimate role in our society. Moreover, it is highly debatable whether criminals and tax evaders make use of offshore centres and trusts any more than they do mainstream bank accounts in major international cities like London and New York.

Gone are the days when commoditised trusts were sold by unskilled salesmen and the demand was for trustees who would acquiesce to every whim of the settlor/beneficiaries. And good riddance to them too because these were the very trusts that created the prejudices of journalists condemning the trust industry today.

HNW families that have trusts for legitimate goals need trusts that will stand up to scrutiny when stress tested, which calls for reputable, knowledgeable trustees who are accountable. Such families understand the price that needs to be paid, in terms of passing control over their assets to the professional trustee, so they will seek out trustees who have real business acumen, knowledge of trust law, independence and the skill to manage family trust relationships. Similarly, in the new world of transparency, companies offering trust services must worry about their reputation and can no longer afford to offer trustee services to families who still want to “have their cake and eat it”, appointing trustees who act according to their wishes and who perceive the settlor and his or her family as “clients”, rather than potential beneficiaries in accordance with the terms of the trust.

Given the myriad of potential issues HNW families face, they have never needed trusts more than they do today. But they require trusts that will stand up to attacks from creditors and tax authorities and this will only be the case if the trustees exercise their discretion and are not afraid to say, on appropriate occasion, “No.” Similarly, those families who understand the old Jersey Law adage ‘donner et retenir ne vaut’ (it is impossible both to give away yet retain) will be less equivocal about passing the necessary degree of control to their trustees, a fundamental requirement for a valid trust. And, undoubtedly, their trusts, like good ports in a storm, will be the ones most likely to pass the stress test.


1 Hon. Justice David Hayton, Reflections on the Hague Convention After Thirty years
2 Article 2 of the Hague Convention on the law Applicable to Trusts and on their Recognition, most of the provisions of which have been incorporated into English law, (by the (English) Recognition of Trusts Act 1987).
3 Garron Family Trust V Her Majesty the Queen [2009] TCC 450
4 See: Trust Ownership of the Family Owned Business: Towards a wider Perspective, Christian Stewart, Family Legacy, Asia
5 Av. A. 2007 EWHC 99(Fam)

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Holistic Risk Management for Families

The growth of the wealth management sector over the last 20 years has been fuelled by the promise to clients of a new, holistic and strategic approach. At the heart of the proposition is more intelligent risk management.

Many new risk management tools have been devised by innovative individuals and institutions, seeking to develop a competitive edge. Useful and ingenious though some of these tools are, the overall result is disappointing, in that most of the innovation has remained narrowly focused on the volatility of investment portfolios, without addressing the broader risks affecting family wealth:

  • For many clients, the investment portfolio represents only part of the family wealth. Any risk appraisal which does not take full account of wider business interests, and other assets is therefore incomplete.
  • The investment industry’s conventional approach to risk is mainly based on volatility and ignores the fact that there are many other ways of looking at investment risk, from the perspective of the family and taking into account a longer term horizon.
  • No account is taken of the intangible and unmeasurable risks, which numerous studies suggest are the main causes of family wealth destruction (refer Chart A and Chart B).

The reality is that today’s families face an increasingly complex world of potential risks. This paper suggests a broader approach to risk management, which includes those less tangible and non-financial exposures. It is not as scientific or academically well founded as established methodologies, but is essentially based on well-structured common sense combined with a simple process, which ensures all risks are addressed in their proper context.

The Risk Exposure

The inevitable follow-on question is how to define risk and to identify and prioritise key risk exposures. There is no single correct approach to this question as it depends on one’s perspective. For a portfolio manager it is legitimate to focus primarily on the risk of the investment portfolio and to manage that risk by diversifying across a range of investments. By contrast, however, the clients are frequently entrepreneurs, who often manage risk by concentrating their investments in a few sectors which they know and understand.

For the wealth manager, with a broad mandate, an analysis of risk requires an understanding of the family’s wealth objectives. If this basic foundation is omitted from the process, the result is that all subsequent considerations and planning are conducted in a vacuum.

Indeed, a recent study by Stonehage Fleming, “Four Pillars of Capital for the Twenty First Century”* found wide agreement among families that defining a clear purpose for their wealth is a crucial step for wealth preservation across generations.

The challenge, of course, is that no two family’s objectives will be the same. However, a potential hierarchy of objectives might be as follows:

  • To provide financially to ensure appropriate living standards for family members
  • To maintain a successful family business which provides significant employment and makes a contribution to the community
  • To maintain and grow the value of the overall family wealth
  • To preserve family unity and prevent dispute
  • To provide a fund which enables family members to make entrepreneurial investments or to pursue other beneficial activities
  • To provide a fund for philanthropic causes, which may or may not involve family members
  • To establish and uphold a lasting family legacy

FINANCIAL AND NON-FINANCIAL RISK

Financial risks include the possibility of an absolute loss, a failure to meet objectives or falling below minimum benchmarks. For many ultra-high net worth families, however, an absolute loss of wealth (even if a significant percentage of the whole) may not seriously damage lifestyles, nor even drastically impact on their ability to fulfil their main objectives.
Non-Financial risks, could include damage to the family reputation, a major family dispute, loss of family values and work ethic, or the destruction of a family legacy. In many senses the non-financial risks are the more important. For instance, a family dispute or lack of family leadership is far more likely to lead to a major destruction of financial wealth than any asset allocation mistakes in the investment portfolio, or the failure to insure a tangible asset.
It is also extremely difficult to put a price on the ‘non-financial’ benefits associated with continuing to own a successful family business, when a purely financial risk model may suggest the holding should be diversified. Equally the benefit of a united family with transparent governance is hard to quantify.
However, any analysis of long-term threats to family wealth should take account of the fact that most family fortunes are dissipated within three generations and, according to numerous studies, the principal causes of wealth destruction arise from those unmeasurable risks which are so often overlooked.
Surprisingly, many families continue to identify investment risk as their primary area of exposure, despite the fact that very few have ever lost their wealth purely through poor investment management (Chart A).
* Four Pillars of Capital for the Twenty First Century, Wealth Strategies for Intergenerational Success, 2015

CHART A: FAMILY PERCEIVED RISKS

(Source: Family Office Exchange, 2014)

On the other hand studies conducted after the event, on families whose wealth had been severely dissipated, indicate that such wealth destruction was most frequently caused by poor communication and family dynamics and a failure to prepare the next generation (Chart B).

Chart B: Actual Family Risks


(Source: Preparing Heirs: Five Steps to a Successful Transition of Family Wealth and Values, Williams & Pressier, 2003)

Of course not all risks can be avoided, but a structured and strategic approach will at least help to mitigate the risks and add to the likelihood of wealth being successfully passed from one generation to the next.

The Risk Mapping Analysis

The proposed approach to family risk management brings to families a system of analysis and control similar to the risk management processes routinely used by businesses and other commercial organisations. In some respects the discipline of such a process is even more necessary in a family than in a business, precisely because emotional considerations can easily lead to important issues being avoided.
The family risk management strategy should be developed from a hierarchy that takes into account both financial and non-financial risks:

  • Develop an awareness and understanding of the potential risk areas
  • Understand the potential impact of each risk upon family wealth and on the family itself
  • Rank risks according to perceived levels of materiality, determinability and pervasiveness
  • Consider the potential for discrepancies between the actual and perceived risks
  • Develop and implement a mitigation plan for each major risk exposure

It can be useful to distinguish those risks which are quantifiable and can be isolated, from those which cannot be quantified and are more pervasive. Risks can thus be classified into one of the four quadrants depicted in the risk universe graphic below:


(Source: Stonehage Fleming, 2016)

Assessing the family’s risk universe in this way, may impact quite significantly on the approach to individual risks:

  1. The discipline of such a process ensures all risks are considered and none avoided
  2. Risks are prioritised, so that attention is focused on those with greatest potential impact
  3. Defining risks more specifically, helps to suggest potential mitigation measures
  4. It drives documentation of a risk mitigation plan
  5. It helps identify groups of different risks which can be managed together, rather than individually
  6. Perhaps most crucially of all, since interpretations of risks can differ considerably between family members, this exercise helps to bridge such differences and develop a unified and integrated approach

The result is an intelligent assessment of the family’s risk universe to develop a risk mitigation plan which records risks, probabilities, impacts and mitigating actions.
The risk mitigation plan is ideally developed through collaboration with family members to achieve buy-in. The plan should be considered dynamic and reviewed on a regular basis.
Such an approach should lead to refinements in the investment risk appetite, asset allocations and acceptable time horizons.

Conclusion

By focusing primarily on those tangible risks for which there are ready made solutions, we believe too many families, and their advisers, fail to address the more complex, less tangible and less measurable risks which are so often the cause of family wealth destruction.
We believe a process such as this will facilitate a more comprehensive and effective approach, which will help protect family wealth and family wellbeing across the generations. Perhaps above all it will help bridge differences of understanding between family members, thus helping to avoid the biggest risk of all.

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Return of the Homme d’Affaires

​Thirty years ago the term ‘Homme d’Affaires’ was well understood, describing a true adviser with real wisdom drawn from deep and broad experience of the world. The trend towards specialisation has caused us to forget the supreme importance of an individual who is able to look at the whole picture and pull together the advice of all the specialists.

Wealthy families are rediscovering the need for such individuals and in an increasingly complex world, they are not always easy to find.​

It is not quite clear why the English had to borrow an expression from French to describe the role of a trusted adviser to the wealthy, but until thirty years ago, the term ‘Homme d’Affaires’ was well understood and in common usage. It is strange that there was no equivalent in the English language the closest being the Italian word Consilieri. ​

​The essence was that such a person was a true adviser with real wisdom drawn from deep and broad experience of the world, including business, investment, families, the law and even philanthropy. The Homme d’Affaires was thus a reliable and impartial sounding board for nearly every major decision his client had to take. This might range from business acquisitions and investment to succession and inheritance, from personal relationships to dealing with awkward situations such as divorces within the family, where the parties involved are directors and shareholders in family businesses.

This does not mean that he would advise on the technical detail of every issue, but he would know enough to apply his experience, wisdom and common sense to ensure the decisions made were not only based on sound technical advice and on a proper understanding of the overall context.​

Over the last 30 years, the term Homme d’Affaires has pretty well disappeared from our vocabulary, as the remorseless trend towards specialisation has caused us to overlook the generalist. This generalist is someone who pulls it all together, is able to look across all aspects of a situation and make judgments and recommendations which bring together the advice of all the specialists.​

​It can indeed be argued that the focus of the specialists has become so narrow that they are less able to appreciate the broader context in which they operate or the relevance of their advice to the overall picture. By their nature, specialists tend to complicate their own fields of activity to the point where they create barriers to entry for newcomers, thus increasing their own market value. This makes it more and more difficult for their advice or their contribution to be evaluated by others.

It is therefore argued that the trend to specialisation has gone far enough. In the words of the late Kenneth Williams specialists “know more and more about less and less and eventually someone will earn their living from knowing everything about nothing!”​

This is indeed one of the many lessons of the banking crisis, where the boards of great banking groups have allowed armies of specialists to develop huge areas of business which are far beyond the understanding and control of the board itself. In the past, the boards of banks had some direct understanding and appreciation of ALL the major risks to their business, but this can never be the case again.​

​To some extent, the same applies to wealthy individuals and families. Their affairs are complex by nature, because they frequently mix the highly sensitive issue of family relationships, succession and inheritance with the ownership of one or more businesses, the management of investment portfolios, property and leisure assets, all overlaid with tax planning and efficient holding structures.

​Complexity is increasing as tax authorities become more aggressive and we live in an increasingly regulated and litigious society. The cost of professional advisers is thus rising at a rate which is simply unsustainable. The complexity of risk means all major decisions are inter-related and it is almost impossible to give sensible advice about one part of a client’s assets, without considering the knock on impact elsewhere.

​In other words, it is now not just desirable, but increasingly essential that all advice on major issues is channelled through someone who really understands the whole picture. Not only is this essential for proper coordination and risk management, it can also help reduce costs as the sophisticated generalist can much better commission, coordinate and evaluate the more detailed advice required from specialists.

​Take, for example, the case of a family which owns a substantial family business, where the cash flow has been under pressure and bank finance hard to come by during the recent crisis. Do they sell investments in a bad market to finance the business or are those investments intended precisely as a nest egg for a rainy day when the company ran into trouble? Furthermore, if you use family investments to support the business, how do you protect the interests of family members not involved in the business?

​Of course, ideally, the wise man and his advisers will anticipate these problems and have put in place structures and governance designed to achieve the right balance of risk and ensure all family members are treated fairly. The wise man will also have looked at the detailed risk correlations between the family business and the investment portfolio, to ensure that the market risks in the business are not replicated in the portfolio and that the potential liquidity needs in a downturn are fully assessed and anticipated, before committing to long-term equity investments.

There are however many other types of risk. Some are ongoing, such as monitoring the success and direction of the business, the performance and calibre of family directors and keeping an eye on family relationships, looking for potential sources of friction which might turn into major disputes, with catastrophic consequences. Then there are the one off occurrences, such as an acquisition of a new business, perhaps financed by significant debt, or a divorce where the ‘in-law’ is chief executive of a family company.​

Increasingly the management of risk means looking at the interrelationship between all aspects of the family finances and of the family itself – segregating risk into different compartments each overseen by a specialist is no longer enough.​

Then there is the matter of ‘strategic vision’. Who helps the family decide where it is heading, what the purpose of the wealth is and what their broad objectives are over the next generation. And again, how to pass on the baton from one generation to the next, ensuring that healthy rivalries in the business or other family concerns (such as a philanthropic foundation) do not spill over into family relationships, or vice versa.​

The notion of resurrecting the Homme d’Affaires is not entirely new. Very rich businessmen have usually found an individual from among their advisers or employees who steps up to the role. Lower down the market, private banks and wealth managers have for a long time been marketing the concept of a trusted adviser (often using the medical analogy of general practitioner), but they have too often undermined their own promotional literature by fielding relationship managers who lack the experience or gravitas for the trusted adviser role and are clearly trained and motivated as salespeople rather than advisers.​

It is one thing to articulate a need and another to meet it. Partly because of the product sales approach of many private banks and wealth managers, there is a massive shortage of people who genuinely merit the Homme d’Affaires title. It is not just a case of re-inventing a role that existed 30 years ago – in a much more complex world, the knowledge and experience requirements to fit this role have expanded dramatically, so they are likely to be outstanding individuals who command a very high price.​

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