A Billion Dollar Balancing Act

A Billion Dollar Balancing Act

How ultra-rich stay rich; their world of trusts, private bankers and offshore destinations.

A zero can make all the difference. It turns thousands to lakhs and lakhs to crores. But for the uber-rich it is 'just another zero'. On a humid Saturday afternoon in Gurgaon, a private banker-turned-entrepreneur who runs a family office relates to the writers an incident about a family which sold off one of their businesses and grew their financial assets of Rs100 crore to Rs1,000 crore. When they approached him to explore exciting investment avenues, he advised, "Your track record has been quite good for the last five years, why change it now? Follow the simple philosophy that just one zero has been added."

Another wealth manager, a Bollywood buff, when quizzed about ultra high net worth individuals (HNIs) losing money in commercial paper (CP) of debt-ridden IL&FS, brushes off the question. Without missing a beat, he quotes a popular Hindi movie dialogue: "Bade bade deshon me chhoti chhoti batein hoti rehti hain." Two days later, the Sensex slumped 1,500 points on account of liquidity crunch post-ILF&S firesale.

Money begets money, but not without some assistance. Money management for 'the haves' of the world means preserving their personal or family wealth and ensuring that it multiplies. As most nations tax the rich, this often involves a lot of balancing, finding loopholes and at times dodging taxes. A tight-knit group of professionals - from lawyers, chartered accountants (CAs) to wealth managers - help the ultra-rich stay rich.

In the 1960s and '70s there were 'munshis' to assist the rich with financial matters. Hindi movies from that era often had a subservient, bespectacled munimji with a black pouch to help the seth in money matters. Things changed with liberalisation. Lawyers and CAs became the new confidants of rich families. Now, it is private bankers and wealth managers.

But expert advice comes at a cost. A top lawyer, when probed about loopholes that help ultra-rich manage money, asks the writers for a fee in jest. "The day you have $100 million, come to me I will take $10 million to advise you," he says light-heartedly.

Though globally, the wealth management industry is organised, in India it is yet to find a firm footing. In the early years of this decade, many foreign banks wound up their wealth management businesses in India. But in recent years positive trends have been witnessed. "We see the trend changing, as the next generation has seen how wealth is managed outside the country and families have seen the importance of having dedicated wealth managers. Also, people from smaller towns are coming to organised players for aspirational reasons," says Srikanth Subramanian, Senior Executive Director, Kotak Wealth Management.

The numbers, too, are reassuring. According to a report from Credit Suisse, total wealth in India increased four-fold between 2000 and 2017, reaching $5 trillion in 2017, and is expected to reach $6 trillion in real terms by 2022. Kotak Wealth Management pegs the total number of ultra high networth households (UHNHs) in India, to be at 160,600, with an accumulated net-worth of Rs153 lakh crore. The report says that FY17's growth in the number of HNHs at 10 per cent was higher than FY16's 7 per cent.

Keeping it in the family

Besides hiring wealth managers, rich families have started showing a preference to keeping their houses in order. Many set up family offices, which help conserve family wealth but also assist in succession and investment planning. In the west, the Rockefeller and Rothschild family offices have existed for more than a century now. Infosys co-founder N.R. Narayana Murthy's Catamaran, Ratan Tata's RNT Associates and Wipro Chairman Azim Premji's Premji Invest are some of the older single-family offices in India. "Indian family office space is in its nascent stage and is expected to evolve rapidly," says Aditya Gadge, founder of Priwexus, a membership community of single family offices, prominent business families and wealthy individuals. According to a report by the firm, which surveyed about 50 family offices in the country, it was found that about 43 per cent has served the same families for two generations, 28 per cent for three generations and 29 per cent for one generation.

About 16.67 per cent of these families reported more than $1 billion in assets under management (AUM) in family offices, 33.33 per cent had $100 million-1 billion as AUM, 33.33 per cent reported $25-100 million and 16.67 per cent had less than $25 million. Though the exact number of family offices in India remains unknown, it is estimated to be around 105-120.

A look at the asset allocation split of these single family offices also gives an idea about the broader HNI investment patterns in India. All families surveyed said they had invested in equity, 66.67 per cent in real estate, 50 per cent in international real estate, 83.33 per cent in alternative investment funds (AIFs), 66.67 per cent in absolute return/hedge funds, 66.67 per cent in direct venture capital and Private Equity and 83.33 per cent in fixed income.

Abhijit Bhave, CEO, Karvy Private Wealth Management, says the shift from physical assets to financial assets has mostly emerged post-demonetisation. "It is no longer gold that is charming the rich people, and the property cycle has gone down, so more of financial assets," he says.

A Karvy report reveals Indian HNIs are increasingly looking beyond plain vanilla investment options, and alternate investments such as hedge funds, infrastructure funds, and venture capital funds attracted almost double the investments in FY17 as compared to FY16. Bhave says student housing and warehousing has also emerged as popular investment avenues in India and abroad among the ultra-rich. All in all, in the debt segment, tax-free bonds, debt mutual funds and high-yield structured debt products are popular. Equity mutual funds remain core to the portfolio. People are also going for portfolio management schemes (PMS), where minimum invested amount is Rs25 lakh and Alternative Investment Funds (AIFs), where a minimum Rs1 crore can be invested.

Private equity and venture capital investments are also areas of interest. Himanshu Kohli, co-founder of Client Associates, says, "Earlier, the fashion statement amongst HNIs was 'my son is an exporter', today it's 'he is an angel investor'."

With the average age of the ultra-rich falling, there is divergence in investment and spending patterns of the old and new rich. A 40-something nouveau rich, believes in a flashy lifestyle and spends on experiences. A British concierge company helped an Indian client propose to his girlfriend on top of the Sydney Harbour Bridge. A private banker organised a trip to NASA for the children of some Indian clients. A second generation rich person spends his money differently - on collecting wine, art, watches, stones, etc. Most third and fourth generation rich are not that flamboyant.

Investment patterns differ too. The neo-rich tend to make riskier bets and invest in structured products, PE funds, and make angel investments. Investing on international realty is a big trend amongst Indian HNIs. They are acquiring holiday homes in destinations such as Cyprus, Greece, Spain, etc. In contrast, the old rich tend to put money into capital protection debt instruments.

Foundation of Trust

For the uber-rich, succession planning not only means preserving their wealth for the coming generations, but also safeguarding their business from extravagant successors and family feuds. The Indian Trusts Acts of 1882 has been used for years but lately there is interest among Indian HNIs to form Trusts.

After the introduction of the Insolvency and Bankruptcy Code (IBC), there was growing apprehension among rich businessmen that the authorities might take control of the firms and assets against non-performing assets (NPAs). This drove many towards Trusts and they started transferring their assets to irrevocable Trusts. Under IBC, all transfers made two years before IBC proceedings could be held void. "Many people resorted to this method to protect their assets," reveals a tax expert.

Kohli of Client Associates says his firm received 45 requests to form Trusts last year, of which about 20 were processed.

"There was a time we used to get only one or two clients a month to form Trusts. Now we get requests for almost 4-5 a month," says Prem Rajani, Managing Partner of Rajani Associates. The government's crackdown on unaccounted wealth and its Robin Hood economics has spooked the ultra-rich, and there have been news reports of bringing back estate duty tax or introducing Inheritance Tax. This, too, has made HNIs in the country to look towards Trust structures.

But for years now Trusts have been a multi-solution approach for complicated situations. According to a tax expert, spouses often transfer their wealth to Trusts before a divorce to avoid paying hefty alimony. Similarly, with families going global, Trusts have emerged as a solution for tax-efficient transfer of wealth and inheritance.

"If the successor is a green card holder in the US and inherits wealth which is to be transferred from India to the US or the UK, they will have to pay taxes as per the law of that country. If there is a Trust, better tax planning can happen. If the wealth is in a Trust, then beneficiaries don't need to pay taxes," Bhave explains.

The Grey Areas

There is more to wealth management than what meets the eye. Time and again wealth managers across the globe have been accused of adopting shady practices to help the ultra-rich dodge taxes. When prodded about this, the lawyers, tax experts and wealth managers often turn cagey. "After studying the existing tax regime, professionals think of the loopholes. There are specialised experts who do that," a lawyer confides. "It's a cat-and-mouse game, where the mouse is running faster than the cat." The government focuses on black and white but dodgers are experts at reading between the lines.

Despite the efforts of the current government to prevent money laundering, wealth is being parked at offshore destinations and being round-tripped to India. A tax expert says that new tax havens have not come up but a Delhi-based lawyer mentions a case that involves money laundered in a tiny island near Malaysia, called Labuan.

Located 8 km off the Borneo coast in East Malaysia, Labuan has its own stock market - the Labuan Financial Exchange (LFX). The world's elite are drawn to this quiet island as it taxes profits at just 3 per cent. The lawyer confirms that even Indian businessmen have companies set up in Labuan. "Labuan gives out a special kind of treatment. If a company is registered in Labuan and a third party wants to access its information, it is barred from doing so. There could be criminal prosecution," the lawyer says.

On the condition of anonymity, he shows the page of a Singapore-based wealth management site, claiming to be Asia's largest wealth manager. The company, allegedly acting as fiduciary formed a Trust for its India client, which was used to create a shell company and launder funds to Labuan. A look at the firm's website reveals that it has oversees offices and directors posted in tax havens such as British Virgin Islands, Cayman Islands, Seychelles, Cook Islands, Hong Kong, Samoa, and Labuan.

Dubai is another route being frequently tapped. Money is sent to Ajman Free Trade Zone through hawala, and after forming a shell company, is deposited there. Since the Indian citizen is a major shareholder in the company, he can round-trip it back to India in the form of a loan. If needed in cash, the loan can be paid back legitimately, then sent to Hong Kong to a shell company and re-routed to India via Hawala at a 1 per cent fee. The Hong Kong route is also used to send hawala money to China, to pay for imports.

There are new ways to round-trip money back to India. A company is established in an offshore jurisdiction having low tax incidence and Rs100 crore is sent via hawala to that jurisdiction for depositing in that company. Now, the money can be transferred back to India in the form of loans such as external commercial borrowing (ECB), foreign currency convertible bonds (FCCBs) or preference shares allotted to entities, which are redeemed after a certain period of time.

The Reserve Bank of India's (RBI) Liberalised Remittance Scheme is also being used for round-tripping. Under LRS, Indians are allowed to transfer abroad up to $250,000 per person per financial year for overseas education, travel, medical treatment, buying property, etc. However, some manage to use it for other purposes. As per RBI, a company set up in a tax haven under LRS route cannot invest in other companies, be it abroad or in India. Experts who the writers spoke to, accepted that there have been instances of overseas shell firms having made a killing by investing in Indian companies against LRS norms.

Many Indian second- and third-generation rich families are sending one family member abroad to become a foreign resident. In India capital gains on an unlisted company is 20 per cent. If an investor has to avoid paying 20 per cent, all she has to do is move abroad, where capital gains could be 10 per cent.

With growing interest in financial instruments, wealth managers now come up with bespoke structured products as well for the rich to reduce tax liability. For example, in India, short-term capital loss (STCL) can be set off against short- or long-term capital gains in the same year. Wealth managers use this via bonus or dividend stripping. Many HNIs know when a company will declare bonus shares, and buy shares before the announcement. After bonus, the value of those shares falls. Shares are sold at a loss and that loss is set off against capital gains. Dividend stripping in mutual funds is similar. Income Tax department is well aware of the loopholes, say experts, but nothing has been done so far to fix those.

The implementation of General Anti Avoidance Rules (GAAR) has instilled some fear. Under GAAR, sleuths can question the method of tax reduction if the quantum of tax advantage exceeds Rs3 crore. "What is not to be broken is the letter of the law. So, if you are earning, you should pay tax, but there is nothing wrong in arranging one's affairs in such a way that taxes are as low as possible. That's where professionals play," says Mohit Chaudhary, Managing Partner at law firm Kings & Alliance LLP.

With billions of dollars at their disposition, the rich can buy the best of minds to manage their wealth and find the gaps in regulations, multiplying wealth is just sleight of a hand.

@devikasingh29, @apri_sharma

Published on: Oct 01, 2018, 9:12 AM IST
Posted by: Jatin Kumar, Oct 01, 2018, 9:12 AM IST