Overhaul of mind and management requirements for offshore funds managed by Hong Kong managers
Most Hong Kong managers manage offshore funds that are formed and regulated (or exempt from regulation) in the Cayman Islands or other similar locations. For some time now the Government of the Hong Kong Special Administrative Region has grappled with how to create greater certainty for investors as to the tax neutrality of these structures in order to bolster the asset management industry in Hong Kong. More change is in the air, this time in some part owing to necessity.
In a gazette publication dated 7 December 2018, the Government circulated its proposed changes to the existing profits tax exemption for qualifying private funds in the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Bill 2018 (the Bill).
The Bill intends to modify and improve Hong Kong’s current funds tax treatment, on both the fund and the investment level. The implementation of these suggested amendments is expected to come into force in April 2019.
The need for change
The Bill comes following concerns expressed by the Council of the European Union surrounding certain ring-fencing features in the current Hong Kong tax treatment for funds: from a fund perspective, the current profits tax exemption is only applicable to offshore, and not onshore funds (except in the cases of onshore Open-ended Fund Companies (OFCs)); and on the investment level, the concern is that offshore funds cannot qualify for a profits tax exemption for investments in Hong Kong-domiciled private companies.
In the case of OFCs, exemption is only gained if they meet the minimum threshold of the “non-closely held” test, which is considered by many to be an unrealistic standard to meet. As a result, the current tax concession for funds is considered to be both unclear and geographically discriminative.
Current tax concessions for funds
Public funds exemption is currently granted to: (i) Hong Kong-domiciled public funds; (ii) offshore public funds which are authorised under section 104 of Securities and Futures Ordinance (Cap. 571) by the Securities and Futures Commission (SFC); (iii) publicly offered OFCs; and (v) mutual funds, unit trusts or similar investment schemes that are “bona fide widely held and regulated in an acceptable regulatory regime” by the SFC.
With regard to private funds, exemption is currently granted to: (i) non-resident investment vehicles (offshore funds) in respect of the proceeds resulting from Qualifying Transactions, as well as Incidental Transactions (transactions incidental to carrying out Qualifying Transactions); (ii) onshore OFCs. The current definition of a Qualifying Transaction includes transactions that are common to most funds, such as transactions in securities and other kinds of financial products. Qualifying Transactions, however, do not include investments in Hong Kong-domiciled private companies.
Presently, onshore privately offered funds do not qualify for profits tax exemption, unlike their offshore counterparts and onshore OFCs.
Lastly, funds are presently subject to what is known as a “Tainting” effect, whereby tax exemptions are lost in entirety if one or more investments fall out of the scope of Qualifying Transactions or Incidental Transactions.
The Bill seeks to address the above concerns through a number of key changes at both the fund and investment level.
At the fund level, tax exemption will be available to all funds, regardless of the location of their central management and control. This is due to the redefinition of the term “fund”, whereby all funds operating in Hong Kong that are able to satisfy the definition and meet the requirements will be entitled to a profits tax exemption.
At the investment level, due to a redefining of the term “qualifying transactions”, funds with investments in Hong Kong private companies will soon be able to qualify for tax exemption, regardless of the locations of incorporation and the nature of assets the companies hold. This exemption is, however, subject to a few criteria that are to be met by the fund, for example: (i) the immovable property test; and (ii) the holding period test.
Finally, the Tainting effect has been removed from the Bill, meaning that funds will only be taxed on profits derived from non-qualifying transactions, and not on all transactions.
The above changes are seen to create a less discriminatory playing field, from which all funds can clearly ascertain and understand their tax position.
With the implementation of the Bill, not only is Hong Kong likely to become a more competitive and integral player in the asset management industry, but funds operating in Hong Kong will reap significant benefits due to a clearer, fairer and more transparent profits tax system. We look forward to further steps being taken by legislature in this positive direction.
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