The Middle East is home to an estimated 528 family offices, which collectively manage an estimated US$500 billion in assets under management (which are expected to surpass US$1 trillion by 2030). As a number of traditional family businesses are looking to transition from first to second or second to third generation, succession planning is a major challenge and consideration for these family offices. Having the right framework, governance and succession planning in place is vital to ensuring the legacy of these family businesses not only remains intact but allows for the family business to adapt to the new environment, technological advancements and economic framework. Here are 5 things family offices should be considering:
One
Family Constitution and Governance
The most common method to govern family businesses is to put in place a family constitution. Family constitutions are governance documents (similar but not identical to shareholder’s agreements) and should clearly set out: (i) the role of the various family members; (ii) the composition of any family council / board representatives; (iii) voting arrangements; (iv) investment thesis and risk appetite (including factoring in any ethical values and boundaries); (v) capital allocation; (vi) exit rules; (vii) conflict resolution mechanisms; (viii) reputation and confidentiality; and (ix) succession planning. To begin with, start with a clear strategy on what the family office seeks to achieve: is it simply legacy? Or, is there a role for growth through, for example, M&A and strategic investments? Well thought through and carefully drafted family constitutions are more than just governance documents, they can align generations, prevent disputes, set a clear strategy and support smarter investment, M&A and capital allocation decisions. Such considerations are vital to ensuring the ongoing legacy of the family business.
Two
Decision-making
A key consideration for any family office in the context of succession is how decisions are currently made and how they should be made going forward. Family offices should clearly allocate decision-making authority to named individuals or bodies. Decisions on matters such as values and structural changes may be taken by a family assembly, whereas decisions on governance matters more generally may be taken by the family council. Similarly, the family office may delegate portfolio, capital allocation and M&A decision-making to an investment committee, the members of which should possess the necessary skills and experience to take such decisions. Decision-making could also be categorised by materiality and thresholds (i.e. reserved matters) – for example, a high value M&A or investment decision may not be taken without the prior approval of a certain percentage of the investment committee or family members.
Appropriate deadlock resolution mechanisms should also be built in to resolve any disputes or disagreements. This is to ensure the family business is not stuck in lasting dispute, potentially impacting the growth of the underlying businesses.
Three
Structuring and Regulatory considerations
Family businesses should undertake a review of their existing trading and corporate structure with a view to putting in place more flexible and suitable business vehicles. Consideration should be given to local law corporate vehicles, such as Dubai International Financial Centre ("DIFC") or Abu Dhabi Global Market ("ADGM") companies, backed up by a trust structure. In the Middle East, the DIFC and ADGM offer robust legal frameworks (based on English common law), resulting in them becoming the preferred domicile for many family offices.
The structuring will also be driven by the types of investments or businesses held by the family office. For example, some investments may be more regulated than others and so may require bespoke structuring at different levels. Consideration should also be given to Sharia principles, to the extent these are relevant for the family in question.
Further consideration should also be given to how ownership, control and beneficial entitlement are separated within the structure. In practice, a combination of foundations, holding companies or Special Purpose Vehicles ("SPVs") may help ring-fence risk across operating businesses, investment assets, real estate and philanthropic activities, while also making succession easier to implement. In addition, the chosen structure should be aligned with the activities that will actually be carried on in or from the jurisdiction. Questions such as whether the office is acting only for the family, whether any external capital or third-party services are contemplated, and whether foundations or SPVs will be used can materially affect the licensing and compliance analysis. In both DIFC and ADGM, beneficial ownership and data protection considerations should also be built in from the outset, particularly where sensitive family information and layered holding structures are involved.
Four
Succession planning
Consideration should be given to who gets what and when. Shared principles and rules should be put in place to guide the succession planning and ensure the family office is flexible enough to adapt to changes in the family business or investments. The process should also take into account any wills and estate documentation to ensure there is no conflict between the family office succession and broader inheritance planning.
Succession planning should be seen as an ongoing continuous process as opposed to a single event. It is often left too late and the most successful family offices are those which begin the process early.
Five
Tax considerations
As a family office develops, and potentially expands its investment strategy, tax considerations can become increasingly important. Particularly where there are international investments, a range of different tax issues and leakages can arise. These include: (i) direct taxation; (ii) withholding taxes; and (iii) managing the process for the exchange of tax information.
Of further importance are the impact of recent international tax developments. Two notable developments are the introduction of the Organisation for Economic Co-operation and Development Pillar II initiative (introducing a global minimum corporate tax of 15% for certain multinational groups) and the increasing scrutiny around questions of beneficial ownership and access to double tax treaties (for example, see the recent "Tiger cases"). Ensuring a family office is both on top of these developments, and preparing for the future, can be critical.
In short, this requires an evaluation of the current and future structure of the family office from a tax perspective. In the context of re-evaluating an existing structure, the use or introduction of a trust or foundation may be very important. The use of such a trust or foundation may yield a range of tax related benefits, including managing Pillar II issues and assisting with compliance with exchange of tax information regimes.
In addition, the use of a family foundation can be a very effective arrangement from a general direct tax perspective. By reference to the UAE tax considerations, we consider below the use of a UAE family foundation.
Whilst the family foundation is a separate legal entity, it can elect to be treated as an "unincorporated partnership" for UAE corporate tax purposes. Such an election can also extend to wholly owned subsidiaries of the foundation. This election results in no UAE corporation tax at the level of the foundation (and relevant underlying subsidiaries), with income and gains directly flowing through to beneficiaries. As there is no UAE personal income tax, this arrangement can result in a very efficient tax structure.
In practice, the election can be very helpful in connection with investing in a range of asset classes, including UAE real estate. However, it should be noted that care will often be needed when both implementing and operating such a structure. For example, care is needed to ensure the activities of the foundation (and underlying subsidiaries) are managed so as to ensure that the conditions for the election continue to be met. Further, it is often still necessary to consider non-UAE taxes, such as withholding taxes.
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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.
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