15 April 2009

Challenges Ahead For Wealthy Families

Patricia Milner
Partner | UK

Significantly wealthy families face a growing number of choices and challenges concerning how to manage their assets, ensure smooth succession planning and develop and maintain a shared vision for the family’s future.

So there is a need to examine issues facing high net worth families looking to preserve and grow their family’s wealth and standing, whilst always ensuring they safeguard their fundamental beliefs and vision. In particular the areas to be addressed will include family offices, governance and notable recent changes to tax legislation.

Family offices continue to grow in popularity as the number of high net worth families across the globe multiplies.

However, issues connected with family offices such as succession planning, investments, taxation and governance are becoming more complex. The decision even to establish a family office is a daunting one but following this it is necessary to decide just what type of family office is best suited for the family. A large number of factors, such as the size of the family, its goals and its net worth, all contribute to determining which model of family office is the most appropriate.

Single-family offices can deal with a range of issues, including management of investment portfolios and real estate holdings, tax and succession planning and in some cases concierge services. It can serve as a central contact point for distant branches of a family, making communication among members more efficient and helping all members of the family remain involved.

Often such an office is staffed by professionals who can act as strategic advisors, overseeing investments and monitoring tax reporting and compliance issues. Loyalty and trust are paramount. In such an office, the staff will be completely dedicated to the family’s needs and the privacy of a family’s affairs will be guarded closely. Because of the significant expense involved, a single-family office is normally only economic or suitable for families with a net worth of $500 million or more.

Given the scale of assets required for such a single family office, for many families a multi-family office is often more appropriate. In this model a number of families with similar goals and values join together to take advantage of the economies of scale that their combined resources can bring to the management of investments and procurement of services. Examples of such multi-family offices in the UK include SandAire and Fleming Family & Partners.

Finally, for those families that seek the privacy and focus of a family office, but might not wish to make the significant financial commitment involved in running a full service office, an alternative might be a virtual family office.

In this model, a team of experienced professionals manage the functions of a family office, providing the infrastructure and the expertise, keeping records, and serving as the co-ordinators of the family’s advisory team on a range of legal and fiduciary issues. Most services are outsourced and there are normally only a few trusted advisors employed by the family who are entrusted with overseeing and managing all of the delegated work.

Governance is an abstract concept in this context but relates to creating a common understanding about the family’s vision for the future. As this can seem less of an immediate and tangible issue than, say, the nuts and bolts of investing, many families will found family offices that initially only focus on fixed issues they can quantify.

However, as the high net worth families start to address issues associated with succession planning and potentially varying interests of the different generations, articulating and recording a common vision for the family’s future is of paramount importance to protect a family’s assets for present and future generations.

Family office staff will agree that a governance structure can be hugely helpful in dealing with family disputes, or in handling sensitive issues such as succession. Indeed, some families assume the family office staff will serve as a de facto governance structure which, given their need to deal with all the family members evenly, is not a position some family office staff are keen to find themselves in.

Whilst still a relatively new area, there is a growing body of professionals who are experienced in guiding a family through the process of articulating its own vision and its own form of governance. Whilst each family’s structure is unique, most workable governance structures will include common elements:

  • A statement of the family’s vision and values
  • Ground rules for discourse
  • A system of representation
  • Delegation of authority, with the consent of those being represented
  • Succession provisions
  • A dispute resolution mechanism
  • A commitment to educating the family about its wealth and their stewardship role

All of this should be in writing as it is well established that families which take the time to record formally their vision are much more likely to achieve it. However, like many forms of constitution, flexibility is key, thereby enabling the system of governance to evolve as the family does.

Some family offices will be overseen by a corporate board, including non-family members, who can bring an objective perspective to the system. Such an entity can also be used to provide a role for junior family members looking to become involved in the stewardship of the family’s assets and vision.

The protection of wealth via trusts has for many years been a cornerstone of planning for many wealthy families. But recent changes to the taxation of trusts has made estate planning more complicated in two key European jurisdictions, the UK and Italy. Both the UK Finance Act of 2006 and the Italian Finance Act of 2007 (which came into effect on 1 January 2008) have created new legal landscapes for estate planners.

In Italy, trusts are now treated as companies. The new law is designed largely to catch tax avoidance schemes that locate trusts with an Italian settlor, Italian beneficiaries and Italian assets outside the country. Italian law specifies that companies, and now trusts, are treated for tax purposes as residing in Italy if their place of administration is in Italy or if their principal object is carried out there. Trusts established in countries that do not appear on Italy’s “white list” of approved jurisdictions are automatically deemed to be resident in Italy.

What this means for the taxation of trusts in Italy is that when property is transferred to a trust, the transfer is subject to the newly reintroduced gift/succession tax. However, the tax only applies to transfers from the settlor to the trustee, not on distributions to beneficiaries. In addition, the rates are relatively moderate at 4 per cent to 8 per cent.

In contrast, in the UK trusts are not treated as companies.

In what has been widely considered as a two-pronged attack on trusts, the UK Finance Act of 2006 changed the inheritance tax rules concerning trusts, so that most trusts (whether life interest trusts or discretionary trusts) are subject to an entry charge of 20 per cent, and are subsequently taxed 6 per cent (with limited exceptions) every 10 years and on distributions.

The second attack came in the form of the 2007 Pre-Budget Report and subsequently the 2008 Finance Bill, which seek to change the income tax and capital gains tax regime affecting offshore trusts as well as adversely affecting the tax treatment of non-UK domiciled residents.

These tax changes in both jurisdictions have led to increased complexity. Whilst the application of some of these new rules is unclear, what is clear is that going forward they will affect any high net worth family who is concerned with managing their assets and dealing with succession planning issues.

Category: Article