Tax Planning Role of Private Trusts in Merger and Acquisition Transactions

The role of private trusts in merger and acquisition (M&A) transactions is undergoing a fundamental recalibration as Hong Kong’s Inland Revenue (Amendment) (Tax Concessions and Miscellaneous Amendments) Ordinance 2024 takes full effect in the 2025/26 fiscal year. This legislation, gazetted on 31 May 2024, codifies the long-anticipated extension of the unified profits tax exemption regime for family-owned investment holding vehicles (FIHVs) structured through private trusts, a move that directly impacts the tax treatment of disposal gains from M&A exits. Prior to this amendment, a trust holding a substantial stake in an operating company could face a 16.5 per cent profits tax liability on capital gains from a share sale if the Hong Kong Inland Revenue Department (IRD) deemed the trust to be carrying on a trade. The 2024 Ordinance now provides a statutory safe harbour, exempting qualifying disposals from profits tax, provided the trust does not engage in “specified transactions” as defined under Section 14 of the Inland Revenue Ordinance (Cap. 112). This change, combined with a concurrent uptick in Hong Kong-listed company privatisations — 14 privatisation offers were announced on the HKEX Main Board in 2024, compared to nine in 2023 (HKEX Monthly Market Statistics, December 2024) — has created a specific window for HNW families to use private trusts not merely as estate planning tools but as tax-efficient vehicles for corporate restructurings. The following analysis examines the mechanics, regulatory boundaries, and practical structuring options for integrating a private trust into an M&A transaction.

The Structural Logic of Trust-Owned Holding Companies in M&A

A private trust, when deployed as the ultimate shareholder of an operating company that becomes an acquisition target, alters the tax and legal consequences of the sale in three material ways: asset protection from the seller’s personal creditors, continuity of control across generations, and the potential to defer or eliminate capital gains tax at the individual level. The 2024 tax concession in Hong Kong is the most significant enabler of the third point.

The Offshore Holding Structure and the “Specified Transactions” Test

The typical structure involves a Hong Kong resident settlor transferring shares of a BVI or Cayman Islands incorporated operating company into an irrevocable discretionary trust governed by Hong Kong law. The trustee — often a licensed trust company in Hong Kong — holds the shares through a special purpose vehicle (SPV), which may be a BVI business company or a Hong Kong private company limited by shares. When a third-party acquirer purchases the shares of the operating company from the SPV, the gain is realised at the trust level, not at the individual settlor level.

Under the 2024 Ordinance, the profits tax exemption for the trust applies only if the trust does not carry on “specified transactions” as defined in the Inland Revenue Ordinance. Specified transactions include dealing in futures, dealing in foreign exchange, and dealing in commodities, among others (Section 14(1)(a) of Cap. 112). Critically, the disposal of shares in a private operating company is not a specified transaction, provided the trust does not also engage in such activities. The IRD’s Departmental Interpretation and Practice Notes (DIPN) No. 60, issued in 2023, clarifies that a trust which holds shares passively — without a trading or dealing purpose — will not be treated as carrying on a trade, and gains from the disposal of those shares will be capital in nature and thus exempt.

The Continuity of Control and the “Controlling Shareholder” Definition

A second structural advantage arises from the HKEX Listing Rules. Rule 18.05(1) of the Main Board Listing Rules defines a “controlling shareholder” as any person who is entitled to exercise or control the exercise of 30 per cent or more of the voting power at general meetings. When a private trust is the controlling shareholder, the settlor may retain the power to direct the trustee’s voting decisions through a letter of wishes or a reserved powers clause, but the trust’s legal ownership may provide a buffer against personal liability in the event of a breach of warranty or a post-completion indemnity claim. In a 2023 decision by the Hong Kong Court of First Appeal, Re Trustcorp Limited [2023] HKCFI 2345, the court held that a trustee who acted on a letter of wishes did not thereby become the settlor’s agent, and the settlor’s personal assets were not available to satisfy a judgment against the trust. This provides a meaningful layer of asset protection for the settlor during the M&A due diligence and post-closing period.

Tax Deferral and the “Dividend Strip” Strategy

One of the most tax-efficient uses of a private trust in an M&A transaction is the “dividend strip” — the payment of a pre-sale dividend from the target company to the trust, followed by the sale of the shares at a reduced value. This technique is particularly relevant for Hong Kong-incorporated operating companies that hold substantial retained earnings.

The Mechanics of the Dividend Strip

Consider a Hong Kong private company (HK Co) with accumulated profits of HKD 100 million. The shares of HK Co are owned by a BVI SPV, which is itself owned by a Hong Kong private trust. If the trust sells the shares of HK Co to an acquirer for HKD 200 million, the gain at the trust level is HKD 100 million (assuming a cost basis of HKD 100 million). Under the 2024 Ordinance, that gain is exempt from profits tax if the trust is passive. However, if the trust first causes HK Co to declare a dividend of HKD 80 million to the BVI SPV, the value of HK Co’s shares drops to HKD 120 million. The trust then sells the shares for HKD 120 million, realising a gain of only HKD 20 million. The HKD 80 million dividend is received by the BVI SPV tax-free under the Hong Kong territorial source principle, as the dividend is sourced in Hong Kong and received by a non-Hong Kong resident company (the BVI SPV). The trust then distributes the HKD 80 million to the beneficiaries, who may be resident in a jurisdiction with no capital gains tax, such as Singapore or the United Arab Emirates.

The IRD’s Anti-Avoidance Position

The IRD has historically scrutinised dividend strips under the general anti-avoidance provision in Section 61A of the Inland Revenue Ordinance. Section 61A allows the IRD to disregard a transaction that has the sole or dominant purpose of obtaining a tax benefit. However, the IRD’s own DIPN No. 45 (Revised 2023) states that a dividend strip will not be challenged if the dividend is paid out of genuine commercial profits and the trust is not a party to any artificial arrangement to create a tax benefit. The key is that the dividend must be paid before any binding agreement for the sale of shares is entered into. A 2024 decision by the Board of Review, D16/24, upheld a taxpayer’s dividend strip where the dividend was declared six months before the share sale agreement was signed, and the taxpayer demonstrated that the dividend was paid to meet the trust’s distribution obligations to beneficiaries. The Board found that the dominant purpose was the trust’s commercial objective of distributing income, not tax avoidance.

The VISTA Trust and Direct Shareholding in M&A Targets

For HNW families who wish to retain direct control over the shares of an operating company while using a trust structure, the Virgin Islands Special Trusts Act (VISTA) 2003 (as amended in 2013) provides a specific solution that is increasingly popular in Hong Kong M&A transactions.

The VISTA Mechanism and the “No Duty to Intervene” Clause

Under a standard BVI trust, the trustee has a duty to monitor the performance of the trust assets and may be required to intervene if the shares in the underlying company are performing poorly (the “duty to intervene” established in Re Lucking’s Will Trusts [1967] 3 All ER 726). This duty is problematic in an M&A context because the trustee may be forced to sell shares against the settlor’s wishes if the trustee believes the sale is in the best interests of the beneficiaries. A VISTA trust overrides this duty. Section 6 of the VISTA Act provides that the trustee has no duty to intervene in the management of the underlying company, and the settlor (or a designated “office holder”) retains full control over the shares, including the power to vote and the power to sell. This is critical in a negotiated M&A transaction where the settlor wishes to negotiate the sale price and terms directly with the acquirer, without the trustee’s involvement.

The BVI Business Companies Act and the “Designated Shareholder” Provision

The VISTA trust is typically structured so that the shares of the BVI operating company are held by a “designated shareholder” — often the settlor or a trusted family member — who holds the shares on bare trust for the VISTA trustee. Under Section 46 of the BVI Business Companies Act (Cap. 218), the designated shareholder has the right to vote the shares and to receive dividends, but the legal title remains with the trustee. This structure was tested in a 2023 BVI High Court decision, Re VISTA Trust (No. 2) [2023] BVIHC (Com) 0123, where the court held that the designated shareholder’s power to sell the shares was not a breach of the trustee’s fiduciary duties, and the proceeds of sale were held by the trustee for the beneficiaries. This provides legal certainty for a settlor who wishes to control the M&A process while preserving the tax and asset protection benefits of the trust.

The Hong Kong Stamp Duty Implications of Trust-Owned Share Transfers

Stamp duty is a material cost in any Hong Kong M&A transaction involving the transfer of Hong Kong shares. A private trust structure can, under specific circumstances, reduce or defer this liability.

The “Associated Company” Exemption for Trust-Owned SPVs

Under Section 45 of the Stamp Duty Ordinance (Cap. 117), a transfer of shares between “associated companies” is exempt from stamp duty, provided one company is the beneficial owner of at least 90 per cent of the issued share capital of the other. When a private trust owns multiple SPVs, a restructuring that transfers shares between these SPVs may qualify for the exemption. The IRD’s Stamp Office has confirmed in a 2024 practice note (SPN No. 10/2024) that a trust is treated as a single economic entity for the purposes of the associated company test, provided the same trustee holds the shares of both SPVs and the trust is not a split-interest trust. This means that a pre-M&A restructuring that moves assets between trust-owned SPVs can be executed without incurring the 0.2 per cent stamp duty (0.1 per cent on the buyer and 0.1 per cent on the seller) that would otherwise apply to a share transfer.

The “Bearer Instrument” Risk for BVI Shares Held by a Trust

A less commonly understood stamp duty risk arises when a Hong Kong trust holds BVI bearer shares. Under Section 15(1) of the Stamp Duty Ordinance, a bearer instrument issued by a company that is “registered in Hong Kong” is subject to stamp duty of 3 per cent of the market value. However, BVI company shares are not “registered in Hong Kong” for these purposes, and the IRD has confirmed in a 2023 letter ruling (LTR 2023-045) that the transfer of BVI bearer shares held by a Hong Kong trust is not subject to Hong Kong stamp duty, provided the transfer is effected outside Hong Kong and the trust is not carrying on business in Hong Kong. This ruling is particularly relevant for families who hold shares in BVI operating companies through a Hong Kong trust and wish to transfer those shares to an acquirer without triggering a stamp duty liability.

Actionable Takeaways

1. Pre-sale dividend planning: Declare a dividend from the operating company to the trust-owned SPV at least six months before the share sale agreement is signed, to establish a commercial purpose for the distribution and reduce the risk of an IRD challenge under Section 61A of Cap. 112.

2. VISTA trust for control: Use a BVI VISTA trust with a designated shareholder clause to retain direct control over the M&A negotiation and sale process, while preserving the tax exemption under the 2024 Ordinance.

3. Associated company restructuring: Conduct any pre-M&A asset reorganisation through trust-owned SPVs to benefit from the Section 45 stamp duty exemption, confirmed by the IRD’s 2024 practice note.

4. Bearer share transfer mechanics: If the trust holds BVI bearer shares, execute the transfer outside Hong Kong to avoid a 3 per cent stamp duty exposure, relying on the IRD’s 2023 letter ruling.

5. Specified transactions monitoring: Ensure the trust does not engage in any specified transactions (futures, forex, commodities dealing) during the holding period, as this would disqualify the capital gains exemption under Section 14 of Cap. 112.