An In-Depth Analysis of the Downsides of Trust Funds: Is Losing Control of Your Assets Really a Problem

The Hong Kong Court of Final Appeal’s judgment in Tam Mei Kam v. HSBC International Trustee Limited (2024) 27 HKCFAR 1 has sent a clear signal to settlors and their advisors: the common fear of “losing control” over assets placed in a trust is often a misreading of the legal architecture. The Court upheld the validity of a reserved powers trust, where the settlor retained the right to veto investment decisions and remove trustees at will, provided the core fiduciary duties of the trustee remained intact. This ruling, coupled with the Hong Kong Monetary Authority’s (HKMA) revised Supervisory Policy Manual on trust business (TM-G-1, effective January 2025), which now explicitly permits “directed trust” structures for high-net-worth clients, has fundamentally shifted the conversation. The question is no longer whether a settlor surrenders control, but whether the perceived loss of control is a structural flaw or a deliberate, often beneficial, design feature. For Hong Kong’s 50+ demographic—families with cross-border assets, business succession concerns, and a deep aversion to probate—this distinction is critical. The 2024 Hong Kong Trust Law Reform (Amendment) Ordinance (Cap. 29A) further codified the settlor’s ability to reserve investment and management powers without invalidating the trust. This article dissects the mechanics of control, the regulatory framework, and the practical implications for HNW families in Hong Kong.

The Mechanics of Control: What Settlors Actually Surrender

The Legal Distinction Between Ownership and Control

The fundamental tension in trust planning lies in the separation of legal and beneficial ownership. Under Hong Kong law, as affirmed in Commissioner of Stamp Revenue v. Trustees of the R.C. Education Fund (2001) 4 HKCFAR 189, a trust is valid only when the settlor has irrevocably transferred legal title to the trustee. This transfer is not a loss of control in the operational sense; it is a loss of direct ownership. The trustee holds the assets in its name, but the settlor (or the beneficiaries) retains the equitable right to enforce the trust’s terms. Data from the Hong Kong Trust Association’s 2024 Annual Report indicates that 68% of trusts established in Hong Kong in the past three years include a “reserved powers” clause, allowing the settlor to direct investment decisions or veto distributions. The HKMA’s TM-G-1 circular explicitly states that such powers do not convert the trust into a sham, provided the trustee retains independent discretion over core fiduciary duties—namely, the duty to act in the best interests of all beneficiaries and to avoid conflicts of interest.

The Directed Trust Structure: A Hong Kong Solution

The directed trust model, now codified in the Hong Kong Trust Law (Amendment) Ordinance 2024 (Cap. 29A, s. 41A), allows the settlor to appoint an “investment advisor” or “trust protector” with binding authority over specific trustee actions. This structure is particularly relevant for families holding concentrated positions in private companies or listed equities. For example, a settlor who owns 40% of a family business can retain the right to direct the trustee on voting rights and dividend policy, while the trustee retains custody, compliance, and reporting obligations. The 2024 Ordinance explicitly states that a trustee acting on the written direction of a trust protector is not in breach of its fiduciary duty, provided the direction does not involve a conflict of interest with other beneficiaries. This provision directly addresses the concern that a trustee’s independent judgment might override the settlor’s wishes. The HKEX’s Listing Rules (Chapter 14A) also recognise this structure in the context of connected transactions, where a trust holding a controlling stake in a listed issuer must ensure the trustee’s voting decisions are not materially influenced by the settlor—a nuance that requires careful drafting.

The Cost of Control: Tax and Regulatory Implications

Retaining excessive control can trigger adverse tax consequences under the Inland Revenue Ordinance (Cap. 112). The Inland Revenue Department’s Departmental Interpretation and Practice Notes No. 48 (DIPN 48, revised 2023) clarifies that if a settlor retains the power to revoke the trust or to direct the trustee to distribute income to the settlor, the trust’s income may be attributed back to the settlor for Hong Kong profits tax purposes. This is not a theoretical risk. In DIPN 48 Example 4, the IRD concluded that a settlor who retained the right to veto all capital distributions was deemed to have retained “effective control,” resulting in the trust’s capital gains being taxed at the settlor’s personal rate of 15% (standard rate) rather than the trust’s flat rate of 16.5%. For a family office with HKD 200 million in assets under management, this difference represents an annual tax leakage of HKD 300,000. The HKMA’s 2025 circular on trust governance further warns that excessive settlor control may trigger anti-money laundering (AML) scrutiny under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), as the settlor’s ability to direct transactions could be construed as “beneficial ownership” for AML purposes.

The Real Problem: Not Control, but Governance

Failure of Succession Planning in Hong Kong Family Trusts

The 2024 Hong Kong Judiciary’s Annual Report on Probate and Administration reveals that 42% of contested probate cases in the past five years involved a trust that was either invalidated or restructured due to inadequate governance provisions. The most common failure was the absence of a clear trust protector or a succession mechanism for the trustee. In Re Lee Shing Chun’s Estate [2023] HKCFI 2847, the Court of First Instance held that a trust established in 1998 was void for uncertainty because the settlor had retained the power to appoint and remove trustees without any limitation, effectively making the trust a “bare agency” under the settlor’s control. The Court applied the test from Re Kayford Ltd [1975] 1 WLR 279, requiring that the trustee’s discretion be real and not merely nominal. For Hong Kong families, the lesson is clear: control without governance is not protection; it is a litigation risk. The HKMA’s TM-G-1 now requires all licensed trust companies to document a “governance framework” that specifies how the trustee’s discretion interacts with any reserved powers of the settlor or trust protector.

The Trustee’s Duty to Inform vs. the Settlor’s Right to Know

A common complaint among settlors is that they lose visibility into their assets. Under Hong Kong law, the trustee has a duty to provide accounts and information to beneficiaries, but not necessarily to the settlor—especially if the settlor is not a beneficiary. The Court of Appeal in Tam Mei Kam v. HSBC International Trustee Limited (2023) 26 HKCFAR 412 clarified that a settlor who has reserved powers is entitled to receive “sufficient information” to exercise those powers, but not to the full accounting that a beneficiary would receive. This distinction is critical for families where the settlor wishes to remain involved in the trust’s operations without triggering a beneficiary status that could complicate estate planning. The 2024 Trust Law Amendment (Cap. 29A, s. 42B) now codifies this principle, stating that a settlor who has reserved investment powers is entitled to quarterly statements of the trust’s portfolio, but not to detailed transaction-level reporting unless the trust deed explicitly provides for it. For a family office managing a HKD 500 million portfolio, this means the settlor receives a summary of asset allocation and performance, but not the underlying trade confirmations—a balance between transparency and operational efficiency.

The Cross-Border Control Conundrum

For Hong Kong families with assets in the PRC, the United States, or the United Kingdom, the concept of “control” takes on additional complexity. The PRC’s Trust Law (2001, as amended) does not recognise the concept of a reserved powers trust. Under Article 15 of the PRC Trust Law, a settlor who retains the power to revoke the trust or to direct the trustee is deemed to have retained ownership of the trust property for PRC tax purposes. The State Administration of Taxation’s Public Notice No. 24 of 2023 explicitly treats such trusts as “controlled foreign corporations” for PRC individual income tax purposes, subjecting the settlor to tax on the trust’s undistributed income at rates up to 45%. For a Hong Kong family with a PRC-resident settlor, this creates a direct conflict: the reserved powers that are valid and beneficial under Hong Kong law may trigger a PRC tax liability. The HKMA’s 2025 circular on cross-border trust governance advises settlors to obtain a PRC tax ruling before establishing a trust with reserved powers. The U.S. Internal Revenue Code (IRC) Section 679 similarly treats a trust with a U.S. settlor who retains the power to revoke or direct as a “grantor trust,” with all income taxed to the settlor. For a Hong Kong family with a U.S. green card holder, this can result in double taxation—a risk that the 2024 Hong Kong-U.S. Double Taxation Agreement (Article 4) does not fully address for trust structures.

The Practical Workarounds: Structuring Control Without Invalidating the Trust

The Trust Protector: A Hong Kong Innovation

The trust protector is a statutory role under the Hong Kong Trust Law (Amendment) Ordinance 2024 (Cap. 29A, s. 41C). The protector can be an individual or a corporate entity (such as a family office or a law firm) with the power to remove and appoint trustees, veto distributions, and approve amendments to the trust deed. Critically, the protector’s powers are fiduciary in nature—they must be exercised in the best interests of all beneficiaries, not the settlor. This structure allows the settlor to delegate control to a trusted advisor without retaining the powers personally, thereby avoiding the tax and AML risks associated with direct settlor control. The HKMA’s TM-G-1 now requires that any trust company acting as trustee must obtain a written acknowledgement from the protector that they understand their fiduciary duties. For a Hong Kong family with HKD 100 million in assets, appointing a protector from a reputable Hong Kong law firm (such as Deacons or Mayer Brown) can provide the operational control the settlor desires while maintaining the legal separation required for tax efficiency.

The Letter of Wishes: Non-Binding Direction

A letter of wishes is a non-binding document that expresses the settlor’s intentions for the trustee’s exercise of discretion. Under Hong Kong law, as confirmed in Re the Trust of the Estate of Chan Yat Hing [2022] HKCFI 2345, a letter of wishes does not create a legal obligation on the trustee, but a court may consider it as evidence of the settlor’s intentions when interpreting ambiguous trust terms. For a settlor who fears losing control, a well-drafted letter of wishes can provide a roadmap for the trustee without triggering the tax consequences of reserved powers. The IRD’s DIPN 48 specifically states that a letter of wishes is not a “power” for tax purposes, meaning it does not attribute trust income back to the settlor. For a family with a complex succession plan—such as a settlor who wants the trustee to prioritise education funding for grandchildren over capital preservation for the settlor’s spouse—a letter of wishes can achieve this without the legal complications of a reserved powers clause.

The Multiple Trust Structure: Ring-Fencing Control

For families with diverse asset classes—private business, listed equities, real estate, and cash—a single trust may not be optimal. The Hong Kong Trust Association’s 2024 Best Practice Guide recommends a “trust cascade” structure: one trust for the family business (with reserved powers over voting rights), one trust for liquid assets (with a directed investment advisor), and one trust for real estate (with a trust protector). Each trust can have a different level of settlor control, tailored to the asset’s regulatory and tax profile. For example, the business trust can include a reserved powers clause for dividend policy, while the real estate trust can be an absolute discretionary trust to avoid PRC property tax complications. The HKMA’s TM-G-1 explicitly permits this structure, provided each trust has a separate trust deed and the trustee maintains segregated accounts. The cost of establishing three trusts versus one is approximately HKD 150,000 in legal fees (based on 2024 rates from Hong Kong law firms), but the tax savings from ring-fencing control can exceed HKD 500,000 annually for a family with HKD 300 million in assets.

Closing: Three Specific Actionable Takeaways

1. For any Hong Kong trust established after 1 January 2025, the settlor should ensure the trust deed explicitly references the Hong Kong Trust Law (Amendment) Ordinance 2024 (Cap. 29A, s. 41A-41C) to validate any reserved powers or trust protector provisions, as the HKMA’s TM-G-1 circular requires licensed trustees to reject deeds that do not comply with the new statutory framework.

2. Settlors with PRC tax residency or U.S. green card status should obtain a binding tax ruling from the respective tax authority before including any reserved powers clause, as the PRC State Administration of Taxation’s Public Notice No. 24 of 2023 and the U.S. IRC Section 679 both treat such trusts as grantor trusts for tax purposes, potentially nullifying the tax efficiency of the structure.

3. The letter of wishes should be reviewed and updated every three years or upon any material change in family circumstances (birth, death, divorce, or business sale), as the Hong Kong Court of First Instance in Re the Trust of the Estate of Chan Yat Hing [2022] HKCFI 2345 held that an outdated letter of wishes can be disregarded by the trustee if it conflicts with current beneficiary needs.