Asset protection in the post-lockdown environment
In this Q&A Keith discusses how choosing the right jurisdiction for your assets is as important as ever.In your last article we discussed the risks of exchange controls and other risks to capital protection. Some of the examples you cited sounded quite alarming for example waking up one morning and finding out your assets are trapped in a country or finding that some of your savings have been lost. What lessons from history can be applied in today's environment?
Although I said 'never say never' because some of those examples are more recent than others there are some decisions clients can make to mitigate the risks. I have spoken a lot about the Crown Dependencies in my articles so far but I want to cast the net wider into PraxisIFM's network to find some answers.
Briefly I will give an example which is just as relevant today as it was that unforgettable day for trust practitioners and the wider financial service industry 24 October 1979 when Margaret Thatcher suspended UK exchange controls note the emphasis on 'suspended'. This meant the legislation was not repealed until sometime later the exchange controls took the form of a series of Orders in Council which could quite easily have been reintroduced so professional trustees and private client advisers immediately set to work to protect trust assets against a reintroduction of exchange controls.
Quite simply this meant moving the trusteeship (and possibly also the trust fund) to a jurisdiction which would not be subject to UK exchange controls and therefore if UK exchange controls had been reintroduced the trustees (and ideally the trust assets) would be outside the sterling area ('Scheduled Territories' as they were then called). Trusts not only moved from the Crown Dependencies but from the UK itself to jurisdictions that would not be subject to UK exchange controls in the event of their reintroduction.
This gave me my first introduction to the British Virgin Islands (BVI) as a jurisdiction free of UK exchange controls in 1980 however the BVI story did not stop there and this is a further example of how we can use our combined expertise and resources in the PraxisIFM Group to adapt to changed circumstances in our quest for protection of client assets.
The other reason for selecting BVI as a jurisdiction in 1979/80 was not only because it was beyond the scope of UK exchange controls it also had a Double Taxation Treaty (DTT) with the USA whereby the withholding tax on US source company dividends was reduced to 15% instead of the standard 30% when paid to a BVI company. However later in 1980 the US repealed its DTTs with virtually all offshore financial centres including the BVI. This led to an initiative in BVI to create the International Business Company (IBC) legislation in 1984.
In the late 1980's BVI became the favoured company incorporation jurisdiction for Asian clients and advisers benefitting also from being one of the earliest jurisdictions to adopt company migration legislation which for the first time recognised the ability of companies to move their corpus from one jurisdiction to another provided both the departure and arrival jurisdiction had enacted legislation enabling the migration.So the selection of jurisdiction is crucial how can it be guaranteed that a jurisdiction would never introduce measures which might be damaging to capital protection?
Good question. The answer is as I have already said 'never say never'. However as we know a lot of our clients globally and their advisers already have very specific criteria in selecting jurisdictions in which to domicile and administer their assets. Risks such as forced heirship are traditionally mitigated by the classic advice that if the trust is designed to benefit from the forced heirship provisions in that jurisdiction's law the trust fund should also be in the jurisdiction to enjoy the protection of that jurisdiction's Courts.
Clients living in politically unstable countries also factor in political stability in their choice of financial centre so the exchange control/capital protection risk has to be managed as one of a series of risks which clients and their advisers will seek to mitigate in their choice of jurisdiction. There are some established criteria which are applied in the choice of jurisdiction:
- Political and financial stability
- Effective and respected financial regulatory regime meeting international standards
- Modern financial legislation to meet the needs of international clients
- Respected judiciary and court system
- Well-resourced service providers meeting international standards
There could be a whole range of problems that might develop. The interesting point about this is the risk mitigation which professional advisers and practitioners have applied for decades now when selecting jurisdictions in which to domicile their client's structures and assets arguably correspond closely to potential COVID-19 scenarios.
The exchange control risk is one example of a real possibility in a country where the government has lost control of its finances and sees capital fleeing out of the country to safer jurisdictions with a catastrophic effect on the exchange rate to name but one risk:
- Taxation. In this age of FATCA/CRS and other reporting the concept that clients use international financial centre domiciles for their wealth planning structures based on lower taxation rates in those jurisdictions is outdated. What is far more relevant is tax neutrality where the jurisdiction does not seek to tax for example income capital gains or profits and the client is already paying domestic taxes in their country of residence. However what if the government in that jurisdiction gets into a parlous state with its finances and changes the tax neutral structure to tax non-residents in order to address budget deficits or excessive borrowings which it cannot service out of existing resources? Some might say this would be economic suicide for an international financial centre but we keep being told these are unprecedented times. COVID-19 is a once in a century pandemic but the depth of economic problems it causes could also develop into once in a century issues. The financial standing of governments in these jurisdictions has always been a consideration however in these troubled times is maybe deserving of closer scrutiny.
- There are other recent live examples such as onshore countries which have introduced taxes on certain classes of resident assets owned by non-residents which have had in some cases a retrospective effect. The motivation for some of these measures might have been political and prompted by international transparency initiatives but with unanticipated financial consequences for clients if not closely monitored.