Discretionary vs. Fixed Trusts in Hong Kong: Choosing the Right Structure

Introduction

When establishing a trust in Hong Kong, one of the most fundamental decisions is whether to create a discretionary trust or a fixed (or fixed interest) trust. The choice has significant implications for asset protection, succession planning, tax efficiency, and the flexibility with which the trustee can respond to changing family circumstances.

This article compares the two structures and identifies the scenarios in which each is most appropriate.

What Is a Fixed Trust?

In a fixed trust, the beneficial interests of each beneficiary are determined at the outset—specified in the trust deed—and the trustee has no discretion to vary those interests. For example, a fixed trust might provide that the trust fund is to be held on trust for three named children in equal shares, with each child entitled to their share on reaching the age of 25.

The trustee's role in a fixed trust is primarily administrative: to manage the trust assets, maintain accounts, and distribute income and capital in accordance with the fixed terms of the trust deed. The trustee has no power to redirect benefits from one beneficiary to another.

What Is a Discretionary Trust?

In a discretionary trust, no beneficiary has a fixed entitlement to the trust fund. Instead, the trustee holds the assets on trust for a class of potential beneficiaries and has discretion over whether to make distributions, to whom, in what amounts, and at what times. The class of beneficiaries is typically defined broadly (for example, the settlor's descendants and their spouses) and may be capable of expansion or reduction.

Until the trustee exercises its discretion in favour of a beneficiary, no beneficiary has a proprietary interest in the trust fund—they have only a right to be considered by the trustee when it exercises its discretion. This feature underpins the asset protection and succession planning advantages of discretionary trusts.

Asset Protection

The discretionary trust offers significantly stronger asset protection than a fixed trust. Because no beneficiary has a fixed entitlement to any part of the trust fund, a beneficiary's creditors generally cannot attach or enforce against the trust assets. The trust fund is not treated as the beneficiary's property for the purpose of insolvency or divorce proceedings, provided the trust was not established to defraud creditors.

In contrast, a beneficiary's fixed interest in a fixed trust is an asset that can be reached by their creditors and may be subject to claims in divorce proceedings. In Hong Kong family law proceedings under the Matrimonial Proceedings and Property Ordinance (Cap. 192), the court has power to make orders affecting trust interests if the trust constitutes a financial resource of the spouse.

Succession Planning Flexibility

One of the primary advantages of a discretionary trust over a fixed trust is flexibility in succession planning. Family circumstances change—marriages, divorces, the birth of children and grandchildren, changes in a beneficiary's financial position, and business developments may all affect the appropriate distribution of family wealth.

A discretionary trust can adapt to these changes without requiring a formal amendment to the trust deed. The trustee can exercise its discretion to favour beneficiaries who are in need, to skip a generation if appropriate, or to accumulate income for future distribution rather than distributing it to a beneficiary who may not manage it prudently.

A fixed trust, by contrast, locks in the beneficial entitlements at the date of the trust deed. Changes in family circumstances cannot be accommodated without a formal variation of the trust (which requires court approval in certain circumstances) or a resettlement.

Tax Considerations

Hong Kong does not impose income tax on investment income, capital gains tax, or estate duty, making the direct tax treatment of trusts in Hong Kong broadly neutral as between discretionary and fixed trusts.

However, for trusts with beneficiaries or assets in other jurisdictions, the tax treatment can differ significantly. In many jurisdictions (including the UK and Australia), discretionary trusts are treated as opaque for tax purposes, meaning the trust itself may be subject to tax, and distributions may be taxed at the beneficiary level. Fixed trusts may be treated as transparent (look-through) for tax purposes in some jurisdictions, with each beneficiary taxed on their proportionate share of trust income as it arises.

Cross-border tax advice is essential for settlors and beneficiaries with connections to multiple jurisdictions.

Trustee Obligations

The fiduciary obligations of the trustee differ somewhat between the two structures. In a fixed trust, the trustee's obligations are largely defined by the trust deed: administer the assets, collect income, and distribute in accordance with the fixed terms. There is less scope for trustee error in relation to distributions.

In a discretionary trust, the trustee has a more active role. It must exercise its discretion in good faith, having regard to the interests of all beneficiaries (not just the most vocal or highest-profile), must not act capriciously, and must take into account relevant considerations when making distribution decisions. A trustee that fails to properly exercise its discretion may be in breach of trust.

Which Structure Is Right for Your Needs?

The choice between a discretionary and fixed trust will depend on the settlor's objectives:

• Asset protection: Discretionary trust is generally preferred.
• Certainty for specific beneficiaries: Fixed trust (e.g., providing a guaranteed income for a surviving spouse).
• Flexibility for changing family circumstances: Discretionary trust.
• Simplicity of administration: Fixed trust may be simpler where the beneficial interests are clear and unlikely to need adjustment.
• Cross-border tax planning: Professional advice is required in each relevant jurisdiction.

Many sophisticated structures combine elements of both, for example by creating a discretionary trust with a letter of wishes setting out the settlor's preferences for how the trustee should exercise its discretion.

Conclusion

Discretionary and fixed trusts serve different wealth planning purposes in Hong Kong and are not interchangeable. Understanding the legal, tax, and practical differences between these structures is essential to selecting the right vehicle for a particular client's objectives.

Alan Wong LLP advises high net worth individuals and families on trust structures, estate planning, and private wealth management in Hong Kong. We help clients navigate the complexities of discretionary and fixed trusts and design bespoke solutions that meet their succession and asset protection goals. Contact us for a consultation.