July 2017

Any thoughtful understanding of the vintage wine domain begins in the vineyard, on the vines themselves.  Recent severe frosts in many areas of Bordeaux have all but destroyed the entire, or at best, the vast majority of the productions of numerous properties.  This is disheartening and in some cases, devastating to the chateaux.  How it affects the vintage wine trade and market in the months and years ahead will come to light only gradually.

While the 2017 vintage is just entering the flowering stage, the 2016 vintage is much feted as being high quality and having good volumes.  As managers of vintage wine collections, it is important for us to look several years ahead when making buying decisions today.   We also have to understand the current market dynamics when collectors look to sell some of their collections.   Strategy is driven by a number of factors: general trends in the wine trade; the en primeur market for both just-released and recent vintages; the auction market as well as developments which directly impact current and future demand.   We believe a longer-term strategy, based on fundamental issues, has a greater weight than shorter-term tactical decisions.

The steady price increases in 2016 and the first part of 2017 convinced us that the price increases have been supported by stronger volumes.  It does not seem to be a speculative market, but rather one that is consolidating after the recent shocks brought by significant pound weakness following the Brexit vote as well as four years of weak prices and low volumes.  Not surprisingly, Bordeaux continues to command most attention, making up between 55-75% of traded volumes, with Burgundy at 10-17% and Champagne at 3-11%, depending on the trading platform.

Although we rarely buy en primeur, we do follow each year’s campaign closely, to better understand the strategic implication of other vintages that are approaching drinking maturity and which we expect will exceed expectations.

The dynamics of the traditional French distribution system that uses courtiers, Bordeaux-based negociants and international distributors is changing due to new internet-based trading platforms and global economic trends and developments.  Last year’s Brexit vote and the subsequent weakening of the pound resulted in a market where profits were made in sterling terms but losses incurred in USD or Euro terms.  This will complicate this year’s en primeur campaign since even small increases in Euro prices, where the producers are based, will translate into large increases in the UK-based wine trade, which trades in sterling.   It is just a matter of time before this sterling shock works its way through vintage wine pricing.

Results from 2016 and more recent auctions, such as Christie’s Hong Kong Week on May 26 and 27 and the Hart Davis Hart in Chicago in early April, indicate that demand is solid with Asian buyers accounting for a large portion of sales.  The stars of the auction world remain the usual names – Petrus, Bordeaux first-growths and of course Domaine de la Romanée Conti.

In June 2016, Le Monde had a full-page article highlighting how high-profile Chinese, such as Alibaba founder Jack Ma and movie star Zhao Wei, have been buying not only Bordeaux wine properties but also distribution companies.  It was recently announced that wine writer and critic, James Suckling, established a joint venture with China’s COFCO which will increase fine wine exposure to the growing wine-drinking population in China.   These along with other developments should have a significant positive impact on the vintage wine market in the coming years.

The OECD has championed a framework for the multilateral automatic exchange of financial account information amongst participating countries.  This framework is referred to as the Common Reporting Standard (or “CRS”).  Nearly every country that has a significant financial sector has endorsed the CRS with the notable exception of the US. [Some commentators suggest that, as a result, the role of US institutions in providing sanctuary for undeclared savings is likely to increase – a charge to be evaluated in a later Note.]

If you, or a passive holding company that you control, has a bank account, or investment account held in custody, in a foreign country then it is the CRS’s intention that your home tax authorities will receive annual reports detailing (in general) account balances, income earned and distributions made from those accounts, beginning this year in some countries and in 2018 in many others.

Under the CRS mechanisms, financial institutions will report, to their own tax authorities, information about the financial accounts that they maintain on behalf of non-residents that are resident in a country that is a CRS participant.  These tax authorities will, in turn, provide that information to the tax authorities of those other participating countries.

If the account holder is another financial institution then in most cases the bank does not have to report on that account.  As a result, some entities may prefer to be treated as a financial institution rather than a passive, non-financial entity, so that they can better manage their own reporting.

CRS provides numerous reporting exemptions for entities that are a type that do not tend to be used for tax evasion.  These include some pension funds, trusts where the trustee is reporting on behalf of the trust and certain collective investment schemes.

However, the unique nature of trusts and their role in offshore tax and estate planning, present challenges when applying definitions and rules more suitable for companies and individuals. The CRS regime treats trusts as legal entities for the purposes of establishing reporting obligations.  As a result, there is the potential that trust assets will be attributed to each of the settler (even if an irrevocable trust), each mandatory beneficiary, any discretionary beneficiary receiving a current distribution, protectors and any other persons seen as controlling the trust.

By the end of 2017, most financial account holders will have been asked to complete self-certification forms addressing CRS reporting requirements.  While in our view such forms are not as complicated as the FATCA driven W8-BEN-Es, they remain confusing and difficult for most clients.  However, there is no question that a reasonable comprehension of the CRS regime, and the resultant reporting obligations, is a challenging proposition.

Many private banks and custody banks are now preparing CRS self-certification forms, for their account holders, that consolidate the information required under each of the CRS and FATCA regimes.  This provides some relief vis-à-vis the existing W8-BEN-E and CRS self-certification forms.

Personal holding companies, often registered in off-shore jurisdictions, that simply hold financial assets managed by a financial institution on behalf of a family or individual can present difficult practical issues.  These entities may well be classified as financial institutions (under a “managed by” test) under CRS.  The practical consequence of this classification is that the company itself may be required to file local country reports with respect to its “Controlling Persons”, which may come as quite a surprise to their owner.  We will discuss this in more detail in a later Note.

Vancouver’s new foreign buyer tax did not really come as a surprise.  For many local Vancouverites, it was a necessary measure long overdue.  For some, it was unwarranted and brash as the tax didn’t “grandfather” existing deals (i.e. contracts signed that are set to be closed after the tax becomes effective).  Thus, thousands of unfortunate buyers had to finance additional 15% to close their purchases.   Regardless of how you see it, the tax is here to stay and who knows if any other policies will be put in place to cool down Vancouver’s hot real estate market.

So, what is the foreign buyer tax?   It is 15% of the property value payable by “foreign” buyers, such as foreign citizens, foreign companies and taxable trustees, in addition to the province’s regular property transfer tax.   The tax is only applicable in the Greater Vancouver Regional District and nowhere else in BC; and is targeted at foreign buyers purchasing residential property on or after August 2^nd 2016.  The purpose of the tax is essentially political.  The former Liberal government realized there had been a growing concern vis-a-vis foreign buyers causing housing market prices to inflate.  In politically-correct Vancouver, the term “foreigners” or “Asian” are code words for “Mainland Chinese”.   After years of neglecting what was an escalating affordability crisis, the Liberals decided to show local Vancouverites that they intend to tackle this issue.  The tax was their response.

Despite the government’s attempt at tackling the unaffordability issue, there remains a significant amount of confusion regarding who is “foreign” in this context.   In reality, most of the Mainland Chinese players are not “foreigners” as defined in the legislation for they are already immigrants or Canadian citizens.  It is estimated there are at least 50,000 wealthy Mainland Chinese families, roughly 200,000 people, who are either immigrants or citizens of Canada.   Consequently, they are not impacted by the tax.   Additionally, there are approximately 3 million Canadian citizens living outside Canada, 300,000 in Hong Kong alone, who are not tax residents. They too are not subject to the tax.

So, who are subject to the foreign buyer tax?  Nearly 350,000 international students (or rather their parents) living and studying in Canada (120,000 of them from Mainland China) together with tens of thousands of foreign nationals residing in and tax residents of Canada are considered “foreign” and are subject to the tax.

The general view is that the Vancouver foreign buyer tax will not have a tremendous long-term impact on the Vancouver real estate market as there will continue to be influxes of “foreign” money from China arriving in the pockets of non-“foreign” Chinese citizens and immigrants.  However, there were, and will continue to be, significant reactions to the tax’s implementation.  Prices decreased 6% in Q4 2016 compared to Q3 2016, mostly affecting single detached homes (condos decreased only 0.6%), while sales have plummeted 21% in the same period across all residential properties.

How does Toronto’s new foreign buyer tax compare to Vancouver’s?   On April 20^th, 2017, the Ontario government announced their initiative to cool down the hot real estate market in Canada’s largest city.  The new policies include a 15% foreign speculation tax targeting foreign buyers as well as expanding rent control rules.  Majority of the greater Toronto area will be subject to the tax as it applies within the Greater Golden Horseshoe area.  The Toronto Real Estate Board announced that prices in March increased 33% compared to the same period last year while condo rents increase 8.3% in Q1 2017 compared to Q1 2016.  However, similar to Vancouver, the number of pure foreign investors is relatively small, only at about 4-5%.   So, is the rapid increase in real estate prices fueled by foreign buyers or by local Canadian residents and citizens?

More time is needed to assess the full effect of both taxes, as they are still relatively new and different.  Toronto’s tax was implemented while the market was red-hot, whilst in Vancouver it was executed during a period of cooling.   In the month following the new policies, the Toronto market experienced a 26% drop in house sales.  Vancouver also experienced a period of drastic decrease in sales, especially in the single-detached homes priced above $2mn CAD, but an increase in pre-sale activity and in condo prices.   In Q2 of 2017, the sales slump stopped and the market is picking up again.   Similar to other major markets in the world, such as Hong Kong and London, following each new policy implementation there is a period of reassessment, which is often mistaken for cooling or consumer hesitation.   Sales drop significantly after new policies are put in place, not because the tax is preventing investors from buying, but because investors like to step back and evaluate the policy’s impact on the market.   After a period of assessment, investors usually deem the pros of purchasing significantly outweigh the cons, and consequently sales re-emerge.

Like every other government policy implementation, one can never be absolutely certain of its longer-term impact.   In the case of the foreign buyer tax, the Toronto and Vancouver markets are different and can react to the policy differently.   However, the two markets have enough similarities for one to confidently predict the same outcome.   If Toronto follows Vancouver’s path, we can expect to see increase in sales activity and prices after a period of consumer withdrawal and analysis.  Will these taxes prevent prices in Toronto and Vancouver from going up further?    Probably not, as these markets are so attractive that foreign money will continue to find legal means of entering them.  Montreal, being the largest market where there is no foreign buyer tax, may experience a spark of interest.   The new question ahead is whether governments will implement follow-up policies In Vancouver and Toronto if prices and sales reach or exceed levels previously experienced.