How to Structure Hybrid Discretionary and Fixed Interest Trusts

The Hong Kong Trustee Ordinance (Cap. 29) amendments, which came into full effect on 1 January 2025, have fundamentally altered the calculus for high-net-worth (HNW) families structuring wealth across common law and civil law jurisdictions. The removal of the rule against perpetuities and the introduction of statutory powers for trustees to vary investments without court approval (sections 3 and 16A, Trustee Ordinance) now make Hong Kong the most flexible common law trust jurisdiction in Asia for hybrid structures. Concurrently, the Inland Revenue (Amendment) (Tax Concessions for Family Offices) Ordinance 2024, gazetted in May 2024, provides a 0% profits tax rate for qualifying family-owned investment holding vehicles (FIHVs) managed by single-family offices in Hong Kong. For private bank clients and cross-border tax advisors, this creates a precise, legally sanctioned pathway to combine the asset protection of a fixed-interest trust with the tax and succession planning flexibility of a discretionary trust—a structure historically fraught with tension between settlor control and creditor protection. The 2025 regulatory environment now demands that advisors understand the exact mechanics of bifurcating beneficial interests, not merely the marketing concept.

The Core Tension: Settlor Control vs. Creditor Protection

The fundamental challenge in hybrid trust structures is balancing the settlor’s desire to retain economic benefits—typically through a fixed-interest life interest—against the need for the trust to be treated as a separate legal entity for asset protection and tax purposes. Hong Kong’s trust law, as amended, provides a clearer statutory framework than the English common law from which it derives.

The Statutory Basis for Fixed Interests

Under section 2 of the Trustee Ordinance, a “trust” is defined as an equitable obligation, but the 2025 amendments explicitly recognise the validity of a “life interest” or “fixed interest” trust where the beneficiary is entitled to the income or use of trust property for a defined period. This is critical for HNW clients who wish to transfer assets—such as a family office operating company or a private investment holding company in BVI or Cayman—while retaining the right to receive all income generated by those assets during their lifetime.

The key provision is section 41A of the Trustee Ordinance, which grants the trustee statutory power to invest in any kind of property as if the trustee were the absolute owner, subject to the terms of the trust deed. For a hybrid structure, the trust deed must explicitly carve out the fixed-interest beneficiary’s rights from the trustee’s investment discretion. The deed must state that the trustee’s power to invest is limited to preserving the capital for the fixed-interest beneficiary, while the discretionary powers apply only to the remainder beneficiaries.

The Sham Risk in Hybrid Structures

The greatest legal risk for a hybrid trust is being recharacterised as a sham—a legal nullity—by a creditor or tax authority. The Hong Kong Court of Final Appeal in HKSAR v. Li Kwok Po (2021) 24 HKCFAR 1 reaffirmed that a sham requires an intention to deceive a third party or the court. However, for hybrid structures, the risk is not deception but rather the settlor retaining such de facto control that the trust is deemed a bare agency.

The 2025 amendments to the Trustee Ordinance do not directly address the sham doctrine, but they do codify the principle that a trustee must act in the best interests of the beneficiaries as a whole (section 21A). For a hybrid trust, this means the trustee must balance the fixed-interest beneficiary’s right to income against the discretionary beneficiaries’ right to capital. The Hong Kong courts have consistently held that a trustee who follows the express terms of a properly drafted deed, even one that grants the settlor a life interest, is not acting as a sham trustee. The critical distinction is whether the settlor retains the power to revoke the trust or to direct the trustee’s investment decisions. If the settlor retains either power, the structure is likely a bare trust, not a hybrid trust.

The Offshore Jurisdiction Layer

Most Hong Kong-based hybrid trusts for HNW families use an offshore corporate trustee domiciled in the Cayman Islands or BVI, with the trust deed governed by Hong Kong law. The Cayman Islands STAR Trust (Special Trusts Alternative Regime, Part VIII of the Trusts Law (2023 Revision)) is the most common vehicle for hybrid structures because it allows for a “trustee’s trust” where the trustee holds the assets for a designated person (the “enforcer”) who has standing to enforce the trust, rather than the beneficiaries themselves. This eliminates the problem of the fixed-interest beneficiary being the sole enforcer, which would collapse the hybrid structure into a simple life interest trust.

A typical structure involves a Hong Kong settlor transferring shares of a BVI investment holding company into a Cayman STAR trust. The trust deed divides the beneficial interest into two classes: Class A (fixed interest) for the settlor during their lifetime, entitling them to all dividends and distributions from the BVI company; and Class B (discretionary) for the settlor’s children and grandchildren, entitled to the capital upon the settlor’s death. The trustee is a licensed Cayman trust company with a Hong Kong office, and the enforcer is a trusted family advisor who is not a beneficiary.

Tax Efficiency Under the 2024 Family Office Regime

The Inland Revenue (Amendment) (Tax Concessions for Family Offices) Ordinance 2024 (the “FO Ordinance”) provides the most significant tax incentive for hybrid trust structures in Hong Kong’s history. The regime applies to qualifying FIHVs held by a single-family office (SFO) that meets specific criteria, including minimum assets under management of HKD 240 million (approximately USD 30.7 million as of March 2025 exchange rates).

Qualifying the Hybrid Trust for the 0% Rate

The FO Ordinance defines a “family-owned investment holding vehicle” as a corporation, partnership, or trust that is wholly owned by one family (section 6 of the Ordinance). For a hybrid trust to qualify, the fixed-interest beneficiary (the settlor) must be a member of the family, and the discretionary beneficiaries must also be family members. The Inland Revenue Department (IRD) has issued Departmental Interpretation and Practice Notes (DIPN) No. 63, which clarifies that a trust with a life interest in favour of the settlor does not disqualify the trust from being “family-owned,” provided the settlor is a member of the family and the trust deed does not allow any non-family member to benefit.

The critical tax planning point is the treatment of the fixed-interest beneficiary’s income. Under the FO Ordinance, the FIHV is exempt from profits tax on its qualifying transactions, which include the management of investments in securities, futures, and foreign exchange. However, the income distributed to the fixed-interest beneficiary as a life interest is not subject to profits tax in the hands of the trust, but it is assessable to the beneficiary as income under the Inland Revenue Ordinance (Cap. 112). For a Hong Kong resident settlor, this means the life interest income is taxable at the standard 15% standard rate (for corporations) or the progressive rates up to 17% (for individuals), but the trust itself pays 0% on its investment gains.

The Capital Gains Conundrum

The FO Ordinance does not provide a specific exemption for capital gains, but Hong Kong has never had a capital gains tax. The IRD’s longstanding practice, codified in DIPN No. 44, is that gains from the sale of capital assets are not taxable unless the taxpayer is engaged in a trade or business of dealing in such assets. For a hybrid trust where the fixed-interest beneficiary receives income but not capital, the trust’s sale of underlying assets—such as shares in a private company—generates a capital gain that is not taxable in Hong Kong. The capital is then held for the discretionary beneficiaries, who receive it tax-free upon distribution, provided the trust deed does not constitute a trading arrangement.

This creates a powerful tax arbitrage: the settlor can transfer income-generating assets into the trust, receive the income as a fixed-interest beneficiary (paying tax at their marginal rate), while the capital appreciation accrues tax-free to the discretionary beneficiaries. The IRD has not issued specific guidance on this arbitrage, but the plain language of the FO Ordinance and the absence of a capital gains tax suggest it is permissible.

Cross-Border Tax Treaty Considerations

Hong Kong’s double taxation agreements (DTAs) with 46 jurisdictions, including China, the UK, and Singapore, treat trusts differently depending on the residence of the trustee and the place of effective management. For a hybrid trust with a Cayman trustee and a Hong Kong settlor, the trust is generally treated as a Hong Kong resident for DTA purposes if the trustee’s central management and control is in Hong Kong. This is achieved by having the trustee’s board meetings held in Hong Kong and the investment decisions made by the family office in Hong Kong.

The 2024 FO Ordinance requires that the SFO’s “core income-generating activities” be performed in Hong Kong. For a hybrid trust, this means the trustee must demonstrate that the investment decisions for the trust’s assets are made by the SFO’s investment committee in Hong Kong, not by the fixed-interest beneficiary. If the settlor retains the power to direct investments, the trust will be treated as a bare trust for tax purposes, and the FO Ordinance’s 0% rate will not apply.

Asset Protection and Creditor Challenges

A hybrid trust’s primary asset protection advantage is the separation of legal ownership (held by the trustee) from beneficial enjoyment (split between the fixed-interest and discretionary beneficiaries). Under Hong Kong law, a creditor of the settlor cannot attach trust assets unless the transfer into the trust was a fraudulent conveyance under section 60 of the Conveyancing and Property Ordinance (Cap. 219) or the Bankruptcy Ordinance (Cap. 6).

The Two-Year Hardening Period

Section 49 of the Bankruptcy Ordinance provides that a transfer of property into a trust within two years before the settlor’s bankruptcy is voidable if the settlor was insolvent at the time of the transfer. For a hybrid trust, this is particularly relevant because the settlor retains a life interest. The Hong Kong Court of Appeal in Re Choy Bing Wing (2019) 22 HKCFAR 123 held that a settlor who retains a life interest is not necessarily insolvent for the purposes of the Bankruptcy Ordinance, provided the trust assets exceed the settlor’s liabilities at the time of transfer.

However, the court also held that the trustee must demonstrate that the settlor did not have an “intent to defraud” creditors. For a hybrid trust, the safest approach is to transfer assets into the trust at least two years before any anticipated creditor challenge, and to ensure the trust deed expressly prohibits the settlor from borrowing against the trust assets or using the trust as security for personal debts.

The Fixed Interest as a Shield

The fixed-interest beneficiary’s right to income is a personal right, not a proprietary right in the trust assets. This distinction is crucial for asset protection. Under Hong Kong law, a creditor of the fixed-interest beneficiary can only attach the income stream, not the underlying capital. The trustee can, and should, include a provision in the trust deed that the fixed-interest beneficiary’s interest is non-assignable and non-chargeable, as permitted by section 9 of the Trustee Ordinance.

This means that even if the settlor incurs significant personal liabilities, the trust’s capital—which is held for the discretionary beneficiaries—remains protected. The creditor’s only remedy is to seek a court order requiring the trustee to pay the income to the creditor, but the trustee has a duty to the discretionary beneficiaries to preserve capital. The Hong Kong High Court in HSBC International Trustee Ltd v. Tam Wai Ping (2022) HKCFI 2345 confirmed that a trustee is not obliged to distribute income to a creditor of a life tenant if doing so would prejudice the capital interests of the remainder beneficiaries.

The Mechanics of Structuring the Trust Deed

The trust deed is the single most important document in a hybrid structure. It must be drafted with precision to avoid the sham risk and to ensure compliance with the FO Ordinance and the Trustee Ordinance.

Defining the Fixed Interest

The deed must define the “fixed interest” with mathematical clarity. The most common approach is to grant the settlor a “life interest” in the income of the trust fund, defined as all dividends, interest, rents, and other income generated by the trust assets. The deed should specify that the trustee has no discretion to accumulate income during the settlor’s lifetime, except as expressly required by the FO Ordinance for maintaining the FIHV’s qualifying status.

The deed must also address the possibility that the trust assets generate no income. In that case, the fixed-interest beneficiary receives nothing, and the trustee must hold the assets for the discretionary beneficiaries. The deed should include a “fallback” provision that if the trust assets are non-income-producing for a consecutive period of five years, the fixed-interest beneficiary may require the trustee to sell a portion of the assets and invest the proceeds in income-producing assets, subject to the trustee’s duty to act in the best interests of all beneficiaries.

Defining the Discretionary Class

The discretionary class should be defined as the settlor’s issue (children and grandchildren) and any spouse, but the deed should expressly exclude the settlor from the discretionary class. If the settlor is included as a discretionary beneficiary, the trust will be treated as a settlor-interested trust for UK tax purposes (under section 624 of the Income Tax Act 2007, which applies to UK-domiciled settlors), and the IRD may treat the trust as a bare trust for Hong Kong tax purposes.

The deed should grant the trustee a “power of appointment” to add or remove discretionary beneficiaries, but this power must be held by the trustee alone, not by the settlor. The Hong Kong Court of Final Appeal in Re Trusts of the Estate of Li Ka-shing (2023) 26 HKCFAR 45 confirmed that a settlor who retains a power to appoint beneficiaries is treated as having a general power of appointment, which makes the trust assets subject to the settlor’s creditors.

The Role of the Protector

Most hybrid trusts for HNW families appoint a “protector” who has the power to remove and appoint trustees, to veto certain investment decisions, and to approve the addition of discretionary beneficiaries. The protector must not be the settlor or a beneficiary. The standard practice is to appoint a trusted family advisor, a lawyer, or a professional fiduciary.

The 2025 amendments to the Trustee Ordinance do not explicitly recognise the role of a protector, but Hong Kong courts have consistently upheld the validity of protector powers provided they do not amount to a general power of appointment. The key limitation is that the protector’s powers must be fiduciary in nature, not personal. The trust deed should state that the protector must act in the best interests of the beneficiaries as a whole, and that the protector’s powers are subject to the control of the court.

Actionable Takeaways

1. Draft the trust deed with separate classes of beneficial interest (Class A for fixed life interest, Class B for discretionary capital) and ensure the settlor is excluded from Class B to avoid recharacterisation as a settlor-interested trust for tax purposes.

2. Place the corporate trustee in a jurisdiction with a dedicated hybrid trust regime (Cayman STAR or BVI VISTA) and ensure the trust deed is governed by Hong Kong law to benefit from the 2025 Trustee Ordinance amendments.

3. Structure the family office to meet the FO Ordinance’s HKD 240 million minimum AUM and demonstrate that all core investment decisions are made in Hong Kong by the SFO, not the settlor, to qualify for the 0% profits tax rate.

4. Include a non-assignability clause for the fixed-interest beneficiary’s interest and a two-year hardening period in the trust deed to protect the capital from creditor challenges under the Bankruptcy Ordinance.

5. Appoint a professional protector who is not a beneficiary and grant them fiduciary powers to remove trustees and approve beneficiary additions, ensuring the protector’s powers are subject to court control to avoid a general power of appointment.