Cases of major shareholders of overseas listed companies holding shares through family trusts has been quite common for some time, with relatively famous cases being those of Longfor Properties and SOHO China. Due to the restrictions imposed by relevant regulatory rules, the shareholders cannot, in the course of getting listed on A-stock markets, directly hold shares of companies in the form of trusts.
In recent years, with the increasing number of high net worth individuals (HNWIs), certain shareholders of listed companies have requested that they be permitted to place the listed company stock that they hold in a family trust. The author believes that is feasible, despite certain restrictive requirements in laws and in practice, and there are now some examples of success.
In terms of the design of the trust structure, the shareholder of the listed company may initiate a trust as sole trustor, and such a trust may invest into one or two levels of special purpose vehicles (SPV). It would be ideal and easier for the operation to entrust the negotiable shares of listed companies into the trust directly. However, the establishment of a trust does not satisfy the conditions for the transfer of shares without floor trade or off-board trade.
The trustee still needs to place the listed company stocks it holds into the trust through securities trading. And securities trading means that the trustor is required to obtain initial trading funds and entrust such funds to the trustee, which the trustee will use to purchase the listed company stock through call auction, block trading or negotiated transfer.
In terms of the design of other factors of the trust, if the trustor’s objectives include maintaining control of the listed company, it is recommended that a family committee is established simultaneously with the trust, and the committee should exercise the decision making on such matters as the holding or sale of the listed company stocks, voting at shareholders’ meetings of the listed company and other management decisions.
In terms of the design for the beneficiaries, the trustor may design for the beneficiary candidates the beneficiary right units and benefit sequence based on the arrangement for the departure from is his or her position and succession.
Once the trust is established, the core question will be how to place the tradable shares under the trust. The transfer of title to listed company stock is a matter requiring registration. Pursuant to the rules for the registration of the transfer of title to securities of the China Securities Depository and Clearing Corporation Limited, the two means available to place the tradable shares of a listed company into a family trust include transfer of title by trading and negotiated transfer, which is identified as transfer of title without trading. However, as mentioned above, the trustor is required to prepare substantial trading funds during the transaction process.
First, regarding the initial trading funds, the trustor may consider obtaining the fund through sale of a portion of his or her tradable shares on the secondary market. Second, if the trustor is the controlling shareholder of the listed company, a major shareholder who holds at least 5% of total shares of the company, or a director, supervisor or senior officer of the listed company, he or she is required, when transferring his or her title of equity in the listed company, to comply with the various regulations on restriction of selling the shares held by such shareholders of a listed company, so as not to exceed the maximum percentage of listed shares that is sellable in a time limit.
Additionally, the family trust, as the transferee in a negotiated transfer or block trade, is also required to comply with the requirements of the restrictive rules on the reduction of shareholding when subsequently selling the shares. Therefore, under the restrictions of the rules on the reduction of shareholding, if the trustor is a major shareholder of a listed company, the placement of the stocks that he or she holds into the family trust is a lengthy process involving repeated trading.
Third, the trustor is required, in the course of the transaction, to comply with the regulations on the disclosure of information by listed companies. If the transferor is a major shareholder of the listed company, he or she is required to inform, at his or her own initiative, the board of directors of the listed company before a transaction occurs, and co-operate with it in performing its information disclosure obligation.
Fourth, if the number of shares that the trustor proposes to place in the family trust might reach at least 5% of its outstanding shares, he or she is required, in the course of the transaction, to comply with the relevant provisions of the Administrative Measures for the Acquisition of Listed Companies.
Fifth, the tax costs involved in the trading of listed company stock are also an important issue in such a family trust. Pursuant to the Notice on Issues Relevant to the Levy of Individual Income Tax on the Income Derived from the Transfer by an Individual of Restricted Shares of a Listed Company, the transfer of restricted shares is subject to individual income tax, as for “income on the transfer of property”, at the rate of 20%, regardless of whether the transfer is accomplished by way of a call auction, block trade or negotiated transfer. Accordingly, if the listed company stocks that the trustor proposes to transfer into the family trust are restricted shares, substantial individual income tax costs will be involved in the course of placing the stock into such trust.
Due to the complex process and substantial costs that can be faced when directly placing listed company stocks into a family trust, there are also transactions by means of entrusting the right to benefit from listed stocks into family trusts. The trustor entrusts the trust company to establish a property rights trust directly with the right to benefit from the listed company stocks that he or she holds, and once the stocks are cashed, such income will be transferred into the family trust account.
In this manner, the difficulty of injecting the assets at the time of establishment of the trust can be avoided. However, the right to benefit from equity is not a complete and independent property right, and by this means it may make the trustor’s original intent, namely risk isolation and inheritance of the equity by means of establishing the family trust, impossible to attain.
Ouyang Fangfei is a partner at Merits & Tree Law Offices