By Summer Zhen, Selena Li and Xinghui Kok
HONG KONG/SINGAPORE, Aug 20 (Reuters) - A growing campaign to tax offshore wealth is forcing wealthy Chinese people to rethink their trust structures and investment holdings, lawyers and advisors say, as Beijing sharpens its focus on capital outflows and rule enforcement amid growing fiscal strains.
In late July, authorities overhauled rules to impose a 20% income tax on offshore trusts, while tax offices in major cities like Beijing and Hangzhou have started
to enforce taxation on returns from offshore insurance policies.
Those measures have triggered a scramble among some wealthy individuals to assess their liabilities, raise cash to meet them and revamp investment holdings. They have also fuelled concern that Beijing may widen its tax crackdown and scrutiny of offshore wealth.
At stake is a collection of capital worth up to $1.2 trillion held by mainland Chinese ultra-high-net-worth individuals, according to a report from consulting group BCG earlier this year, that is parked in markets including Hong Kong, Singapore and other low-tax jurisdictions.
More than half of China's super-rich individuals use offshore family trusts to manage their wealth, reports from Julius Baer and KPMG showed, translating into hundreds of billions of dollars in assets.
Taxes on offshore trusts, popular tools for top shareholders of overseas-listed Chinese companies to park their riches outside the country, will "create massive burdens" to maintain trust structures, said David Luo, a tax partner at Zhonghua Certified Public Accountants.
Offshore trusts have gained popularity in recent years as a growing number of Chinese companies listed in Hong Kong. This unlocked billions of dollars for their founders, who aimed to tap into a pool of dollar-denominated investment options.
UNWINDING TRUSTS
Before the introduction of the new rules in late July governing the taxation of offshore trusts, such structures operated in a regulatory grey area without a standardized and dedicated regime.
The new rules apply a tax of 20% on the appreciation in value at the time of a transfer of shares, property or other assets into offshore trusts. Income from such trusts and offshore entities that they control will also be taxed annually at 20%.
Unpaid taxes on assets placed in trusts since January 2023 and on trust income received before 2026 must be reported within 90 days.
"For those preparing for a listing, they are considering unwinding trusts," said Shanghai-based Luo, who provides cross-border tax advice to clients.
A Hong Kong-based executive at a state brokerage who declined to be named due to the sensitivity of the matter said some clients were avoiding setting up trusts and investing through smaller offshore asset managers instead.
Some may be forced to dispose of assets to meet obligations, lawyers and wealth advisors said.
"There's no running away from this; no way to restructure," said Singapore-based Ryan Lin, a lawyer who advises high-net-worth clients. "The only way is to not declare and unwind the trust."
Out of the more than 50 trust clients that Lin advises, more than half are prepared to declare assets and pay taxes, while the remainder are considering unwinding their trusts.
"Many are considering liquidating mainland A-shares to raise cash amid recent market volatility," he said.
An executive at a Chinese tech billionaire's family office in Hong Kong said some wealthy individuals may need to borrow money to pay their tax bills because much of their wealth is tied up in illiquid assets like real estate. The executive spoke on the condition of anonymity because of the sensitivity of the topic.
SCRUTINY BEYOND TAX COMPLIANCE
For many wealthy Chinese, however, the larger concern is not their immediate tax bill but what might come next.
Within a couple of weeks of unveiling the imposition of taxes on assets in offshore trusts, media reports said Chinese authorities had begun levying taxes on insurance policy income earned offshore.
China "treats all residents' overseas income equally ... all income must be declared and taxed according to law," a local tax official was quoted as saying by a Chinese news outlet on August 7.
Bank of America analysts wrote in a research note this month that tax enforcement could eventually expand to overseas employment income, following moves last year to tax gains from offshore stock trading.
The new measures "signal broader tax reforms as authorities seek diversified revenue sources," said Carlos Casanova, senior economist for Asia at UBP, a Swiss private bank, as China's real estate downturn weighs on provincial governments' ability to generate revenue from land sales.
"Near term, that dynamic may slow southbound flows into Hong Kong and other Asian wealth centres," he said.
A Shanghai-based family office partner who declined to be named due to the sensitivity of the matter said some clients feared scrutiny beyond tax compliance, especially by being subjected to a probe into how they got money out of China in the first place.
The tax push is also supported by Beijing's expanding data-gathering capabilities.
The Common Reporting Standard, implemented in 2017, gave Chinese authorities greater visibility into offshore financial accounts. Combined with the Golden Tax Phase Four system, they can cross-check information across multiple jurisdictions.
"The enforcement campaign is unprecedented and appears here to stay," said Christopher Beddor, deputy China research director at Gavekal Dragonomics, adding that most investors likely never paid tax on offshore income due to lax rule enforcement.
"It's easy to imagine how this could merge into other goals, such as tougher enforcement of capital controls."
(Reporting by Summer Zhen and Selena Li in Hong Kong, Samuel Shen in Shanghai, Xinghui Kok and Yantoultra Ngui in Singapore and Ziyi Tang in Beijing; Editing by Sumeet Chatterjee and Thomas Derpinghaus)
