Summary of Key Points
The Announcement No. 21 issued by the Ministry of Finance and the State Taxation Administration on July 24th has completely shattered the "tax avoidance myth" surrounding offshore trusts. By applying the principle of "looking at the essence behind the legal form of the trust," it has clarified the individual income tax obligations in three key stages of an offshore trust:
1. At the time of establishment: Tax must be paid when assets are placed into the trust.
2. During the existence of the trust: Income generated, whether distributed or not, is subject to taxation.
3. Upon termination of the trust: Taxes must be paid on the proceeds from the liquidation of the assets.
This announcement also closes loopholes such as those related to proxy holding arrangements. However, some intermediary agencies have taken advantage of the situation to create panic and promote an alternative solution involving "domestic civil trusts" (where a son is appointed as the trustee), claiming they can achieve "zero-tax avoidance." In reality, these schemes are riddled with flaws—such as misusing legal concepts, ignoring the principle of tax transparency, and hiding potential legal risks. The real motive behind these agencies is to earn consulting fees during the industry's restructuring. Wealthy individuals should understand that the purpose of a trust is primarily for inheritance, not tax avoidance, and remain vigilant against deceptive tactics while adhering to regulatory requirements.
Announcement No. 21: The "Tax Avoidance Backdoor" for Offshore Trusts Is Completely Shut Down
The core of Announcement No. 21 is to focus on the actual controller of the assets, rather than the legal structure of the trust. The tax rules for each stage are straightforward:
- At the time of establishment: Tax is due whenever assets (such as stocks or real estate) are transferred into an offshore trust. Even if a shell company is used to make the transfer, the tax will still be imposed.
- During the existence of the trust: Any income generated from the trust (e.g., stock dividends or rental income) must be declared and taxed annually. There are three items that cannot be deducted from taxes: losses from one year cannot be offset against taxes in the following year; different types of income cannot be combined for deduction; and management fees or legal expenses incurred by the trust cannot be deducted.
- Upon termination of the trust: A final tax payment is required based on the proceeds from the liquidation of the assets, at a rate of 20%.
The Intermediary's "Domestic Civil Trust" Solution: Full of Flaws
The intermediaries' suggestion of using a son as the trustee seems to offer cost-saving options but actually leads to three major pitfalls:
- Pitfall 1: Misuse of legal concepts. They refer to the exemption from tax on equity transfers between close relatives (as stipulated in Document No. 67), which applies only when the transfer is directly from one individual to another (e.g., you giving the shares directly to your son). Since a trust is a separate legal entity, this exemption does not apply. The intermediaries are betting that the tax authorities will not investigate.
- Pitfall 2: Ignoring the principle of tax transparency. Although the announcement emphasizes the importance of the actual controller's role, even in a domestic trust, if you remain the ultimate controller (e.g., your son manages the trust under your instructions and the income goes to your family), the authorities can still consider the income as yours and require you to pay taxes.
- Pitfall 3: High risk of anti-tax avoidance measures. Even if no tax is paid at the time of establishment, taxes may be due on income generated during the trust's existence. For example, if the trust owns stocks that lose value while other investments generate dividends, you must still pay tax on the dividends.
Why Do Intermediaries Use Deceptive Tactics?
With the introduction of Announcement No. 21, agencies that relied on offshore trusts for tax avoidance no longer have a valid argument. They resort to the following tactics:
- Creating panic: They exaggerate the impact of the announcement, claiming it will result in significant financial losses, to make wealthy individuals anxious and eager to adopt new solutions.
- Promoting alternative schemes: They offer "domestic civil trusts" and charge high consulting fees, knowing that the risks lie with the clients, while they themselves profit from the advice.
- Shifting responsibility: They include a statement like "compliance is essential" in their schemes, hoping to avoid liability if the tax authorities investigate.
Three Tips for Wealthy Individuals to Avoid Pitfalls
Don't be misled by intermediaries. Keep these points in mind:
- The purpose of a trust is inheritance, not tax avoidance: If you need a trust for the smooth transfer of family business or asset protection (e.g., to prevent debt issues), Announcement No. 21 may only increase tax costs, but the trust can still be useful. However, if your goal is solely tax avoidance, this route is no longer viable.
- Don't believe in "zero-tax" solutions: Any scheme claiming to circumvent the new regulations relies on luck—either hoping the authorities won't investigate or exploiting legal loopholes. If you fail to comply, you will have to pay additional taxes and fines.
- Ask critical questions before investing: Before accepting an intermediary's proposal, ask:
1. Does the exemption from tax in Document No. 67 apply to trusts? Do you have a written confirmation from the tax authorities?
2. If the tax authorities examine your domestic trust, will income generated during its existence be taxed?
3. Who will be responsible for any additional taxes that may arise if you need to pay adjustments?
If you can't answer these questions confidently, it's best to move on.
The Signal Behind the Policy: The Era of Compliance in Wealth Management
Announcement No. 21 is not aimed at eliminating trusts altogether but at shifting the industry from a tax avoidance-driven model to one based on compliance. For entrepreneurs who truly need trusts for inheritance purposes, this is a positive development. The market will no longer be dominated by tax avoidance strategies; only professional institutions that focus on risk management and inheritance planning will thrive.
The legal principle is simple: You must pay taxes on the money you control. Trying to evade taxes through clever tricks is becoming increasingly difficult. Stay focused on compliance for long-term success.