Discretionary Trusts vs Fixed Trusts in Hong Kong: Choosing the Right Structure for Wealth Protection

Introduction

When establishing a trust for family wealth protection, succession planning, or asset holding purposes, one of the most fundamental choices a settlor faces is whether to establish a discretionary trust or a fixed trust. The distinction goes to the heart of the relationship between the settlor, trustees, and beneficiaries — determining who controls what, when, and how much.

Both discretionary and fixed trusts are well-established vehicles under Hong Kong law, but they operate differently and are suited to different objectives. Understanding the key differences, advantages, and disadvantages of each structure is essential before committing to a trust design that will govern the administration of family wealth for years or decades.

This article provides a comprehensive comparison of discretionary and fixed trusts under Hong Kong law, examining beneficiary rights, trustee powers and duties, asset protection features, tax implications, and the circumstances in which each structure is most appropriate.

What Is a Fixed Trust?

A fixed trust (sometimes called a "bare trust" in its simplest form, or more commonly a trust with fixed beneficial interests) is a trust in which the beneficial interests of each beneficiary are defined and fixed by the trust deed at the outset. The trustee has no discretion as to how trust income or capital is to be distributed: each beneficiary is entitled to a specified share of income and/or capital as set out in the trust instrument.

Examples of fixed trust interests include:

• "The income of the trust shall be held for A and B in equal shares"
• "Upon the death of the settlor, the trust fund shall be divided equally among the settlor's children"
• "The trustee shall hold 40% of the fund for X and 60% for Y absolutely"

In a fixed trust, the beneficiaries have ascertainable, enforceable rights to their specified portions of the trust fund. A beneficiary can demand that the trustee account for and pay over their share in accordance with the trust instrument.

What Is a Discretionary Trust?

A discretionary trust is a trust in which the trustees have a discretion — conferred by the trust deed — as to how to distribute trust income and/or capital among the beneficiaries. The trust deed specifies a class of potential beneficiaries (often widely drawn to include the settlor's family and their descendants), but no beneficiary has a fixed or pre-determined entitlement. The trustees may distribute income and capital to any one or more beneficiaries within the class, in such proportions and at such times as they see fit.

In a discretionary trust, beneficiaries have a mere expectation of benefit, not a fixed right. They cannot demand distribution, but may bring proceedings if the trustees fail to exercise their discretion at all or exercise it improperly.

Key Differences: A Comparative Overview

Beneficiary Rights

In a fixed trust, each beneficiary has a defined, proprietary interest in the trust fund. This interest may be assignable, and in some cases may be available to the beneficiary's creditors or spouse upon divorce. The certainty of entitlement is both the primary strength and the potential vulnerability of a fixed trust from an asset protection perspective.

In a discretionary trust, no individual beneficiary has a fixed proprietary interest. Each beneficiary holds only a right to be considered for distribution — a personal right enforceable against the trustees if they fail to consider exercise of their discretion. Because no single beneficiary has an ascertainable interest, it is generally more difficult for a beneficiary's creditors or divorcing spouse to claim against the trust assets.

Trustee Powers and Flexibility

A fixed trust limits trustee discretion. The trustees must administer the fund in accordance with the fixed beneficial interests and cannot redirect income or capital to meet changing family circumstances without a variation of the trust (which typically requires court approval or beneficiary consent under the rule in Saunders v Vautier).

A discretionary trust grants trustees broad powers to respond to changing circumstances — varying distributions in light of beneficiaries' financial needs, tax positions, family events, or other factors. This flexibility is particularly valuable where the family's circumstances (employment, health, geography, marriage) are likely to change over the trust's lifetime.

Asset Protection

The asset protection advantages of a discretionary trust are well-established:

• Since no beneficiary has a fixed interest, it is generally harder for a beneficiary's creditors to attach or execute against their "share" of the trust
• In matrimonial proceedings, discretionary trust assets may be considered by a court as a financial resource, but the court's ability to make orders directly affecting trust assets varies depending on the degree of control the beneficiary exercises over the trustees
• A carefully structured discretionary trust with an independent trustee provides stronger asset protection than a fixed trust, particularly against unforeseen creditor claims or matrimonial claims

However, asset protection trusts must be established genuinely and not as a device to defraud creditors. Transfers to a trust within certain periods before insolvency may be set aside under the Bankruptcy Ordinance or the Companies (Winding Up and Miscellaneous Provisions) Ordinance.

Certainty and Predictability

A fixed trust offers certainty and predictability to beneficiaries. They know exactly what they will receive and when. This may be desirable in family contexts where the settlor wishes to treat all beneficiaries equally and avoid family conflict over trustee discretion.

A discretionary trust may generate family tensions if beneficiaries resent the trustees' distribution decisions, particularly if one beneficiary receives a larger share than another. Clear communication of the settlor's wishes (through a letter of wishes) and the selection of experienced, independent trustees help to mitigate this risk.

Letters of Wishes in Discretionary Trusts

Because a discretionary trust grants wide powers to trustees, settlors often write a letter of wishes — a non-binding expression of the settlor's intentions regarding how trustees should exercise their discretion. A letter of wishes may address:

• The relative priority of different beneficiaries
• The settlor's wishes regarding distributions for education, health, housing, and business ventures
• Whether certain beneficiaries should be excluded in specified circumstances (e.g., a beneficiary who becomes bankrupt)
• Investment objectives and risk tolerance
• Succession of trustees and advisers

The letter of wishes is not legally binding but provides important guidance. Trustees must take it into account but retain the discretion to depart from its terms where circumstances warrant. The letter should be reviewed and updated periodically to remain relevant to the family's evolving circumstances.

Tax Considerations

Hong Kong does not impose inheritance tax, gift tax, or capital gains tax, which makes it a relatively tax-benign trust jurisdiction compared to many others. However, profits tax implications should be considered where the trust carries on a business in Hong Kong, and the tax treatment of trust distributions in the beneficiaries' country of residence must be assessed for beneficiaries subject to foreign tax.

In jurisdictions with comprehensive trust taxation regimes (such as the UK, US, or Australia), the choice between a discretionary and fixed trust may have significant tax implications — particularly for beneficiaries who are tax resident in those jurisdictions. An international tax analysis is essential for any trust structure involving non-Hong Kong resident beneficiaries.

Bare Trusts: A Special Case of Fixed Trust

The simplest form of fixed trust is the bare trust, in which the trustee holds assets absolutely for one or more identified beneficiaries with no active management role. A bare trust beneficiary who is of full legal capacity may at any time call for the assets to be transferred to them under the rule in Saunders v Vautier. Bare trusts are commonly used as nominee arrangements, where the registered holder (nominee) holds shares or property on behalf of the beneficial owner, or for asset holding within corporate group structures.

Choosing the Right Structure

The choice between a discretionary and fixed trust depends on the settlor's objectives, the family circumstances, and the nature of the trust assets. As a general guide:

Discretionary trusts are typically preferred where:

• Asset protection is a primary objective (against creditors, matrimonial claims, or forced heirship)
• The family's circumstances are uncertain or likely to change (young beneficiaries, entrepreneurial family members)
• The settlor wishes to retain flexibility to respond to future events
• Tax efficiency in the beneficiaries' country of residence can be achieved through discretionary distributions

Fixed trusts are typically preferred where:

• Certainty of entitlement is important (e.g., in commercial arrangements, nominee structures, or where equal treatment of beneficiaries is paramount)
• The trust assets are to be held for a specific, limited purpose
• The settlor wishes to minimise trustee discretion and avoid potential disputes over trustee decision-making
• The trust is being used as a vehicle for asset holding rather than succession planning

Hybrid Structures

In practice, many trusts combine fixed and discretionary elements. For example, a trust may provide fixed income entitlements to a surviving spouse during their lifetime, with discretionary distribution of capital among children and more remote descendants after the spouse's death. Alternatively, a discretionary trust may include mandatory distribution requirements (e.g., requiring distribution of at least a minimum income annually) alongside the general discretionary power.

Careful drafting by experienced trust lawyers is essential to ensure that the trust instrument accurately reflects the settlor's intentions and achieves the desired balance between certainty and flexibility.

How Alan Wong LLP Can Help

Our private wealth and trusts practice advises settlors, trustees, and beneficiaries on the design, establishment, and administration of trust structures in Hong Kong and across the region. We work closely with clients to understand their family circumstances, wealth planning objectives, and cross-border considerations, and design bespoke trust structures that achieve their goals.

If you are considering establishing a trust and would like advice on whether a discretionary or fixed trust is appropriate for your circumstances, please contact our team for a confidential discussion.