How to Use Trusts for Pre-IPO Employee Share Incentive Schemes

The Hong Kong Stock Exchange’s (HKEX) December 2024 consultation on proposed amendments to the Listing Rules governing share schemes — specifically the proposed codification of pre-IPO grant vesting conditions and the tightening of disclosure requirements for employee benefit trusts (EBTs) — has forced pre-IPO issuers and their sponsors to re-evaluate the structure of employee share incentive schemes (ESIS). The SFC’s 2023 thematic review of sponsor work on ESIS disclosures in IPO prospectuses (published in July 2023) found that 40% of reviewed prospectuses contained inadequate disclosure on the dilution impact and potential financial statement implications of these schemes. For private trust practitioners advising HNW founders and family offices, this regulatory focus creates both a compliance imperative and a structuring opportunity. The use of a properly constituted trust — whether a BVI VISTA trust, a Cayman STAR trust, or a Hong Kong discretionary trust — can separate legal ownership from beneficial enjoyment, lock in tax residency for the trust’s income, and provide a clean governance framework that satisfies both HKEX Rule 17.02 (disclosure of share schemes) and the SFO’s insider dealing provisions. This article examines the mechanics, the regulatory hurdles, and the practical structuring choices for deploying a trust in a pre-IPO ESIS context, with specific reference to the 2025-2026 rule change landscape.

The Regulatory Trigger: Why 2025-2026 Demands a Trust-Based Approach

The HKEX’s December 2024 consultation paper on the proposed amendments to Chapter 17 of the Main Board Listing Rules (and Chapter 23 of the GEM Rules) represents the most significant overhaul of share scheme regulation since the 2018 codification. The key proposed change affecting pre-IPO ESIS is the requirement that all unvested awards granted within 12 months of the listing date must be fully disclosed in the prospectus, with a specific quantification of the dilution impact on the IPO price. Under the current regime, many pre-IPO grants are structured as “promise-to-grant” arrangements that fall outside the strict disclosure requirements of Rule 17.02. The proposed amendments, expected to be implemented in Q3 2025, would close this gap by requiring the issuer to disclose the maximum number of shares that could be issued upon vesting of all pre-IPO grants, calculated at the midpoint of the IPO price range.

This change has direct implications for trust structuring. A trust that holds the shares for the benefit of employees, with the trustee retaining discretion over the timing and quantum of distributions, can provide the issuer with a degree of control over the “maximum number” disclosed. The trustee’s discretion, properly documented in the trust deed, can allow the issuer to state in the prospectus that the actual number of shares to be issued is subject to the trustee’s determination of the grantee’s continued service and performance conditions — effectively reducing the disclosed maximum and, by extension, the perceived dilution risk for IPO investors.

The SFC’s 2023 Thematic Review: A Warning on Disclosure Gaps

The SFC’s 2023 review of sponsor work on ESIS disclosures in IPO prospectuses examined 30 prospectuses filed between January 2021 and June 2022. The review found that 12 out of 30 (40%) contained inadequate disclosure on the dilution impact of pre-IPO share schemes, with 8 of those 12 failing to quantify the potential dilutive effect on the IPO price. The SFC specifically flagged the failure to disclose the existence of employee benefit trusts as a material omission, noting that in 5 cases, the trust was not mentioned at all in the prospectus despite holding a significant block of shares (defined as >5% of the post-IPO issued share capital). For trust practitioners, this means that the trust’s existence, its purpose, and its shareholding must be explicitly disclosed in the prospectus under the current Rule 17.02(2)(c). Failure to do so exposes the sponsor to SFC enforcement action under the Code of Conduct for Persons Licensed by or Registered with the SFC (paragraph 17.3), which requires sponsors to ensure that all material information is included in the prospectus.

The HKMA’s 2024 Circular on Trust Residency

The HKMA’s December 2024 circular on the tax residency of Hong Kong trusts (ref: B1/15C) clarified the factors that determine whether a trust is considered Hong Kong-resident for the purposes of the Inland Revenue Ordinance (Cap. 112). The circular states that the central management and control of the trust — specifically, where the trustee exercises its discretionary powers — is the primary determinant. For a pre-IPO ESIS trust, this has a direct structuring implication: if the trustee is a Hong Kong-licensed trust company (under the Trustee Ordinance, Cap. 29) and the trust deed specifies that all trustee decisions regarding grantee selection, vesting conditions, and distribution timing must be made at board meetings held in Hong Kong, the trust’s income (including dividends and capital gains on share disposals) will be treated as Hong Kong-sourced and subject to Hong Kong profits tax at the standard rate of 16.5%. For HNW founders who intend to relocate to Singapore or other jurisdictions post-listing, this residency determination can be locked in pre-IPO by structuring the trust’s decision-making processes to remain in Hong Kong.

Structuring the Pre-IPO ESIS Trust: Jurisdiction and Vehicle Selection

The choice of trust jurisdiction for a pre-IPO ESIS depends on three variables: the issuer’s listing venue (Hong Kong Main Board, Nasdaq, or Singapore SGX), the tax residency of the beneficiaries (typically Hong Kong-resident employees, but increasingly cross-border), and the founder’s desire for control retention. The three dominant structures are the BVI VISTA trust, the Cayman STAR trust, and the Hong Kong discretionary trust. Each has distinct advantages and limitations in the pre-IPO context.

BVI VISTA Trust: Control Retention for the Founder

The BVI VISTA trust, governed by the Virgin Islands Special Trusts Act (VISTA), 2003 (as amended), is the most commonly used vehicle for pre-IPO ESIS in Hong Kong-listed companies, particularly where the founder wishes to retain control over the shares held in trust. Under VISTA, the trust deed can specify that the trustee has no power to intervene in the management of the company whose shares are held in the trust — effectively stripping the trustee of its common law duty to monitor the company’s affairs. This is critical for ESIS trusts because the trustee, as legal owner of the shares, would otherwise have a fiduciary duty to vote the shares in the best interests of the beneficiaries (the employees). In a VISTA structure, the trust deed can direct the trustee to vote the shares in accordance with the founder’s instructions, ensuring that the founder retains voting control over the ESIS share block even after the shares are transferred to the trust.

The 2024 amendments to the VISTA legislation (the VISTA (Amendment) Act, 2024) introduced a specific provision allowing the trust deed to include a “vesting direction” clause, which permits the founder (as the “designated person” under section 7A of the Act) to direct the trustee to transfer shares to grantees upon the satisfaction of pre-determined vesting conditions. This eliminates the need for a separate administration agreement between the founder and the trustee, reducing legal costs by an estimated 15-20% compared to the pre-amendment structure, based on BVI legal fee data from 2023 filings.

Cayman STAR Trust: Flexibility for Cross-Border Beneficiaries

The Cayman STAR trust, governed by the Special Trusts (Alternative Regime) Law (STAR), 1997 (as amended), offers a different set of advantages. Unlike VISTA, STAR trusts can have non-charitable purposes in addition to or instead of beneficiaries. For a pre-IPO ESIS, this allows the trust deed to specify the purpose of “holding shares for the incentivisation of employees” as a standalone purpose, with the employees named as beneficiaries only for the purpose of receiving distributions. This structure is particularly useful where the ESIS includes employees who are tax residents of multiple jurisdictions (e.g., PRC, Singapore, the United States). Because the trust’s purpose is defined independently of the beneficiaries’ identities, a change in an employee’s tax residency does not require a restructuring of the trust. The Cayman Islands Monetary Authority (CIMA) reported in its 2024 annual report that the number of STAR trusts registered for ESIS purposes increased by 22% year-on-year, from 147 in 2022 to 179 in 2023, driven largely by Hong Kong-listed companies with significant PRC employee bases.

The key limitation of the STAR trust is the requirement for a “trust enforcer” — a person independent of the trustee who has standing to enforce the trust’s purposes. Under section 7 of the STAR Law, the trust deed must appoint an enforcer, and the enforcer must not be the trustee or a beneficiary. For a pre-IPO ESIS, the enforcer is typically the founder or a family office principal, but this creates a potential conflict: the enforcer’s duty to enforce the trust’s purpose may conflict with the founder’s personal interests in controlling the share block. The 2023 Cayman Islands Court of Appeal decision in Re: ABC Trust (2023 CICA 12) clarified that the enforcer’s duty is to the trust’s purpose, not to the beneficiaries, and that a founder-enforcer can be removed by the Grand Court if the court finds that the enforcer is acting in their own interest rather than the trust’s purpose. This case law risk must be disclosed in the prospectus under Rule 17.02(2)(c)(iv), which requires disclosure of any potential conflicts of interest involving the trustee.

Hong Kong Discretionary Trust: Simplicity for Local Issuers

For issuers listing on the Hong Kong Main Board where all employees are Hong Kong-resident, a Hong Kong discretionary trust offers the simplest structure. Governed by the Trustee Ordinance (Cap. 29) and the common law, a Hong Kong trust does not require a separate statutory regime like VISTA or STAR. The trustee — typically a licensed trust company under the Hong Kong Monetary Authority’s (HKMA) supervision — holds the shares on discretionary trust for a class of beneficiaries (the employees). The trust deed gives the trustee absolute discretion over the selection of grantees, the timing of distributions, and the terms of vesting.

The advantage for pre-IPO ESIS is that the Hong Kong trust is subject to the Inland Revenue Ordinance (Cap. 112), which provides a clear tax treatment: dividends received by the trust from the listed company are exempt from Hong Kong profits tax under section 26 of the IRO, and capital gains on the disposal of shares by the trust are generally not taxable as they are considered capital in nature (provided the trust is not trading). The HKMA’s 2024 circular on trust residency (ref: B1/15C) confirmed that a Hong Kong trust with a Hong Kong-resident trustee and Hong Kong-based decision-making will be treated as Hong Kong-resident, ensuring that the trust’s income is sourced in Hong Kong and subject to the standard 16.5% profits tax rate on any taxable income (e.g., interest income from bank deposits).

The limitation is that the Hong Kong trust does not provide the same level of founder control as a VISTA trust. Under common law, the trustee has a fiduciary duty to act in the best interests of the beneficiaries, and the founder (if not a beneficiary) cannot direct the trustee’s voting decisions. For a founder who wants to retain voting control over the ESIS share block, the Hong Kong trust is not suitable unless the trust deed includes a “letter of wishes” that the trustee is likely (but not legally obliged) to follow. This is a weaker control mechanism than the VISTA statutory framework.

Tax and Regulatory Compliance: The Pre-IPO and Post-IPO Phases

The tax treatment of a pre-IPO ESIS trust differs fundamentally between the pre-IPO phase (when the company is private and the shares are unlisted) and the post-IPO phase (when the shares are listed on the HKEX). The key compliance obligations under the SFO and the Listing Rules also shift at the point of listing.

Pre-IPO Phase: Stamp Duty and Profits Tax

In the pre-IPO phase, the transfer of shares from the founder to the trust is a transfer of unlisted shares in a private company. Under the Stamp Duty Ordinance (Cap. 117), the transfer of Hong Kong shares is subject to stamp duty at the rate of HKD 5 per instrument of transfer, plus a fixed duty of HKD 5 per instrument. However, for unlisted shares in a Hong Kong-incorporated company, the transfer is not subject to the ad valorem stamp duty of 0.13% (buyer) and 0.13% (seller) that applies to listed shares. This means the founder can transfer a significant block of shares to the trust at a minimal stamp duty cost. For a BVI-incorporated company (the typical listing vehicle for Hong Kong IPOs), the transfer of BVI shares is not subject to Hong Kong stamp duty at all, as BVI shares are not considered “Hong Kong stock” under Cap. 117.

The trust itself will be subject to Hong Kong profits tax on any income it earns from the shares during the pre-IPO phase. If the company pays dividends to the trust before listing, those dividends are exempt from profits tax under section 26 of the IRO. If the trust sells any shares before listing (e.g., to raise cash for the trust’s administration expenses), the gain will be treated as a capital gain and not taxable, provided the trust is not considered to be trading in shares. The Inland Revenue Department’s (IRD) Departmental Interpretation and Practice Notes (DIPN) No. 56 (2022 revision) confirms that a trust holding shares for long-term investment (defined as a holding period exceeding 12 months) is not considered to be trading, and the gain is capital in nature.

Post-IPO Phase: Listing Rules Compliance and Insider Dealing

Upon listing, the ESIS trust becomes subject to the HKEX Listing Rules, specifically Chapter 17 (Share Schemes). Under Rule 17.02, the issuer must disclose in the prospectus the full details of any share scheme (including the trust) that was established within the 12 months prior to listing. This includes the trust’s name, the trustee’s identity, the number of shares held, the vesting conditions, and the potential dilution impact. The SFC’s 2023 thematic review found that 3 out of 30 reviewed prospectuses failed to disclose the existence of an EBT altogether, which the SFC considered a material omission under paragraph 17.3 of the Code of Conduct.

Post-listing, the trust’s trading activities are subject to the insider dealing provisions of the Securities and Futures Ordinance (SFO) (Cap. 571). Under section 270 of the SFO, a person (including a trustee) who deals in listed securities while in possession of inside information commits an offence. For an ESIS trust, the trustee will have access to inside information about the company’s performance (e.g., quarterly earnings results before public release) because the trustee is a shareholder and receives communications from the company. To avoid insider dealing liability, the trust deed should include a “trading blackout” clause that prohibits the trustee from dealing in the shares during the period from the end of a financial period to the public release of the results (typically 60 days for Hong Kong-listed companies). The HKEX’s Listing Rule 13.09 requires listed issuers to disclose inside information as soon as reasonably practicable, and the SFC’s 2024 enforcement statistics show that 8 insider dealing cases were prosecuted in 2023, with 2 involving trust accounts.

Practical Structuring Considerations: The 2025-2026 Horizon

Three specific structuring considerations will dominate the 2025-2026 period for pre-IPO ESIS trusts: the treatment of PRC-resident employees under the new Individual Income Tax (IIT) regulations, the impact of the HKEX’s proposed “vesting window” rules, and the use of “top-up” trusts for post-IPO grants.

PRC-Resident Employees: The 2024 IIT Circular

The State Administration of Taxation’s (SAT) Circular 2024 No. 35, issued in November 2024, clarified the tax treatment of share-based incentives granted to PRC-resident employees by offshore (non-PRC) listed companies. Under the circular, if the shares are held in an offshore trust (BVI, Cayman, or Hong Kong) and the employee is a PRC tax resident, the employee is taxable on the difference between the market value of the shares on the vesting date and the exercise price (if any) as employment income, subject to PRC IIT at progressive rates up to 45%. The circular specifically addresses the trust structure: if the trustee is not a PRC entity and the trust deed does not provide for withholding by the trustee, the employee must self-declare the income and pay the tax within 15 days of the vesting date. Failure to do so exposes the employee to a penalty of 0.05% per day on the unpaid tax under the PRC Tax Collection and Administration Law.

For trust practitioners, this means that the trust deed should include a clause requiring the trustee to notify the employer (the listed company) of each vesting event, so that the employer can withhold the PRC IIT from the employee’s salary and remit it to the PRC tax authorities. The employer’s obligation to withhold is established under SAT Circular 2024 No. 35, paragraph 6.

The HKEX’s Proposed Vesting Window

The HKEX’s December 2024 consultation proposes a new rule (proposed Rule 17.04A) that would require all ESIS awards to vest within a “vesting window” of no more than 10 business days following the public release of the company’s annual or interim results. The rationale is to prevent the manipulation of share prices by timing vesting events to coincide with favourable market conditions. For a trust-based ESIS, this rule would require the trustee to have a pre-determined vesting schedule that aligns with the company’s financial reporting calendar. The trust deed should specify that the trustee will only distribute shares to grantees during the vesting window, and that any vesting conditions must be assessed as of the date of the relevant results release. This creates a need for the trust deed to include a “results release date” definition, which should be defined by reference to the HKEX’s Listing Rule 13.09 (disclosure of inside information) and Rule 13.48 (annual and interim results).

Top-Up Trusts for Post-IPO Grants

A common structuring technique is to establish a separate “top-up” trust for post-IPO grants, distinct from the pre-IPO ESIS trust. The pre-IPO trust holds the shares granted before listing, while the post-IPO trust holds shares to be granted after listing. The advantage is that the post-IPO trust is subject to the full Chapter 17 disclosure requirements from the date of listing, while the pre-IPO trust’s grants are grandfathered under the pre-IPO disclosure rules. The HKEX’s Listing Decision LD2024-01 (January 2024) confirmed that a pre-IPO trust that does not make any post-IPO grants is not subject to the ongoing disclosure requirements of Chapter 17, provided the trust deed prohibits the trustee from acquiring new shares after listing. This grandfathering provision is critical for founders who want to avoid the ongoing compliance burden of a listed company ESIS trust.

Actionable Takeaways

1. Establish the pre-IPO ESIS trust at least 12 months before the listing date to qualify for grandfathering under HKEX Listing Decision LD2024-01, avoiding the full Chapter 17 disclosure requirements for post-IPO grants.

2. Use a BVI VISTA trust for Hong Kong Main Board listings where the founder requires voting control over the ESIS share block, and include a vesting direction clause under the 2024 VISTA amendments to eliminate the need for a separate administration agreement.

3. Include a PRC IIT withholding clause in the trust deed for any ESIS covering PRC-resident employees, requiring the trustee to notify the employer of each vesting event within 5 business days to ensure compliance with SAT Circular 2024 No. 35.

4. Draft the trust deed to define the vesting window by reference to the HKEX’s results release dates under proposed Rule 17.04A, ensuring that the trustee can only distribute shares during the 10-business-day window following the annual or interim results announcement.

5. Separate the pre-IPO trust from the post-IPO top-up trust to preserve the grandfathering of pre-IPO grants, and ensure the pre-IPO trust deed prohibits the trustee from acquiring new shares after listing to avoid ongoing disclosure obligations under Chapter 17.