Your PRC Clients – The Trailing Baggage Of Community Property Rules

Another issue that affects PRC clients who emigrate abroad (and indeed, immigrants from many other jurisdictions) is the continuing application of PRC community property rules which can affect the ownership of a client’s assets brought over from the PRC and which continue to apply even after they have seemingly cut their ties with the PRC and established a permanent connection with their new jurisdiction. More worrisome is the continued application of the PRC community property regime to assets acquired by a married couple even after they have seemingly severed their ties with the PRC and established their new home in another jurisdiction.

The PRC community property regime is one of the most confusing aspects of PRC laws that potentially apply to immigrants from that country. That said, such a regime is common in many civil law (and some common law) jurisdictions, and so these concerns generally apply more widely to immigrants from many other countries besides the PRC. However, the specific statutory provisions of the original countries involved will vary. This article therefore focuses on the PRC regime by way of illustration.

Under the PRC community property regime, all assets acquired by either spouse during a marriage form the common “community property” of both spouses. This means that such assets are effectively co-owned by both spouses, and both spouses must therefore consent before such assets are disposed of. There are exceptions to this rule (e.g., inherited assets as well as gifts to a spouse that are expressed by the donor to be for the benefit of the donee alone), but the general proposition holds true. Also, the community property regime does not apply to assets owned by a spouse prior to marriage (there remains an open issue whether a couple’s community property includes gains that accrue during a marriage on a spouse’s pre-marriage assets).

The PRC community property regime raises a number of issues about which advisers need to be aware when dealing with immigrants from the PRC. For example, if one of the spouses wishes to acquire real estate or invest in funds or settle a trust in their own name, their adviser needs to probe the source of the funds. If those funds arose during the course of the marriage, then the other spouse technically owns one-half of those assets and must consent to the disposition of those funds. It would not even be correct to say that a spouse has the right to deal with one-half of the couple’s community property – the consent of the other spouse is needed to deal with any portion of the community property (this proposition applies generally, but there are exceptions).

Failure to question the source of funding and to obtain the other spouse’s consent makes the arrangement vulnerable to challenge by the other spouse. The PRC Civil Code generally protects a third party who receives assets from a spouse out of the couple’s community property, but only if the third party has provided consideration (which in this context probably means full consideration). A settlement by a spouse into a trust could therefore be challenged by the other spouse by making a claim against the trustee for the return of those funds.

There can also be income tax implications in the new country arising from the community property regime. If the assets belong to both spouses, any income from those assets belongs to both spouses and should be reported as such for tax purposes, rather than being treated as the income of one of the spouses alone. Also, capital gains should be divided and taxed to both spouses.

Upon a spouse’s death, if the community property regime applies, the surviving spouse already owns one-half of the deceased spouse’s post-marriage assets. Probate and distributions under the deceased’s will, or under intestacy rules, would apply only with respect to the remaining one-half of the deceased’s assets.

Upon divorce, when formulating the division of assets and maintenance payments, regard should be had to the fact that each spouse already owns one-half of the couple’s post-marriage assets. This would need to be taken into account when deciding how the assets are to be divided up and what maintenance provisions should be ordered.

Couples may agree that the community property regime does not apply to them. This should be an issue to consider when planning pre- and post-nuptial agreements.

The general rule is that the community property regime applies to a couple who are both habitually resident in the PRC. A person who has left the PRC on a temporary basis and intends to return (e.g., a student) would continue to be regarded as habitually resident in the PRC. By way of example, if a PRC student in Australia returns to the PRC to get married, or marries in Australia a fellow student from the PRC, then the PRC community property regime would likely apply to them.

The application of the community property regime is relatively straight-forward when both spouses are based in the PRC, but cross-border elements can complicate the analysis, e.g., if one or both of the couple emigrate. With respect to assets acquired by a spouse whilst the couple habitually resided in the PRC, those assets are already vested in both spouses from the date of acquisition, and therefore those assets remain the joint property of the couple even after they emigrate to another country and change their habitual residence (and even their domicile).

There remains an open issue about the application of the community property regime to a couple who were both habitually resident in the PRC when they married and subsequently emigrate to another country. If they both become habitually resident in (let’s say) Australia, a question is whether the community property regime continues to apply to them and to the assets that are acquired thereafter in Australia by one of them. It is arguable the answer is yes, because they were both habitually resident in the PRC at the time they married and therefore the community property regime applies to them throughout the whole of their marriage. This would mean that the PRC community property regime would apply to assets acquired by one of them while they reside in their new country.

The other argument is that the PRC community property regime ceases to apply with respect to property acquired by one of them after they both cease to be habitually resident in the PRC. However, it’s not that simple. Dicey & Morris in their pre-eminent work on conflicts of law take the position that the application of community property rules depends on a couple’s matrimonial domicile, and that remains the PRC even after they emigrate permanently abroad.[1] One can envisage interesting legal challenges ahead.

Complications arise if a person domiciled in another country (again, let’s say Australia), who remains a PRC citizen, marries a person based in the PRC. Because they do not have a common place of habitual residence, PRC law prescribes that the law of their common nationality applies. Thus, the PRC community property regime would apply to the couple, at least for the purposes of PRC law.

If a spouse who is domiciled in Australia acquires real estate in the PRC, that property will constitute the couple’s community property. However, the community property regime does not apply to real estate acquired by one of the spouses outside the PRC. This is expressly recognised in the PRC legislation. In this case, the ownership rules in the country in which the real estate is located would generally prevail.

Where such cross-border elements exist, the simplest technique to avoid community property arising would be for the couple to expressly agree to apply the law of the place of habitual residence of one of them, or of the country of nationality of one of them, or of the place where the main property of either spouse is located. This is expressly provided for in the PRC legislation.

Advisers who prepare tax returns or prepare wills or handle their clients’ financial affairs would be well advised, when dealing with PRC immigrants, to identify what assets of the couple constitute community property, and to ensure that both spouses consent to dealings with such assets.

Footnotes:

[1] Dicey, Morris & Collins on Conflict of Laws, 15^th ed (see chapter 28 and commentary on Rule 165).

Michael Olesnicky
Based in Hong Kong. Olesnicky previously served as head of Baker McKenzie’s Asia regional tax group many years, and also was Senior Advisor at KPMG in Hong Kong. He has more than 30 years’ experience advising on corporate tax, wealth management, trust planning and estate succession matters. Olesnicky was until recently the Chair of STEP in Hong Kong. He chairs its China sub-committee and is the Hong Kong representative on STEP's Worldwide Council. He is an honorary lecturer in the Law Faculty of Hong Kong University.