28 December 2018

The Government of Hong Kong SAR introduces expanded profits tax exemption for funds

Authors: Sheldon Tse, Cindy Shek

On 7 December 2018, the Government of the Hong Kong Special Administrative Region (HK Government) gazetted the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Bill 2018 (Bill) to introduce changes to the existing profits tax exemption for eligible privately offered funds. The Bill purports to address concerns identified by the Council of the European Union (EU) in relation to the ring-fencing features in Hong Kong’s tax regimes for funds. Currently at the fund level, profits tax exemption is only available to offshore, but not onshore funds (except for onshore open-ended fund companies (OFCs)). At the investment level, offshore funds with investment in private companies may enjoy tax exemption only if those companies are incorporated overseas but not locally.

In light of this, the Bill amends and unifies the profits tax exemptions for all privately offered funds, regardless of their size, type and location of central management and control (CMC). Industry players widely perceive the Bill as a significant step in reforming and clarifying the tax regimes for eligible funds operating in Hong Kong and enhancing the city’s position as an international and regional asset and wealth management centre. The Bill was introduced into the Legislative Council on 12 December 2018 and it is expected that the amendments will come into operation in April 2019.

Overview of existing tax treatment for funds

Presently, profits tax exemption is granted under the Inland Revenue Ordinance (Cap. 112) (IRO) to Hong Kong domiciled and offshore publicly offered funds authorised by the Securities and Futures Commission (SFC) under section 104 of Securities and Futures Ordinance (Cap. 571) (SFO) or similar bona fide widely held investment schemes which comply with the requirements of a supervisory authority within a regulatory regime accepted by the SFC. The same profits tax exemption extends to publicly offered OFCs.

With respect to private funds, offshore funds (i.e. funds with their CMC located outside Hong Kong) may be exempt from profits tax in respect of profits derived from qualifying transactions and transactions incidental to carrying these transactions (incidental transactions) prescribed under the IRO. In broad terms, the scope of qualifying investments covers transactions in securities and other kinds of financial products that a fund would commonly engage in, but does not include investments in Hong Kong private companies. Except for onshore OFCs, which may enjoy profits tax exemption like the offshore OFCs under separate profits tax exemption arrangements, other onshore privately offered funds cannot enjoy profits tax exemption like their offshore counterparts.

Key features of the new profits tax exemption for funds

New definition of “fund”

To create a level playing field for all types of funds operating in Hong Kong, a new self-contained definition of fund (similar to the definition of “collective investment scheme” in Part 1 of Schedule 1 of the SFO) is introduced to the IRO so that all funds operating in Hong Kong that satisfy the definition and meet certain conditions would be entitled to enjoy the profits tax exemption, regardless of their structure, location of CMC, size or purpose that they serve.

Redefined scope of qualifying transactions

Pursuant to the Bill, a fund would be able to enjoy tax exemption on its profits generated from transactions in (i) qualifying assets (qualifying transactions); (ii) incidental transactions, subject to a 5% limit; and (iii) if the fund is an OFC, transactions in non-qualifying assets (non-qualifying transactions). The list of qualifying assets covers relevant interests in or issued by a private company, regardless of whether such company is incorporated in Hong Kong or overseas.  

Separately, tainting features of the existing profit tax exemption arrangement are removed so that the tax-exempt profits of a fund would not be tainted even if such fund is taxed on its non-qualifying transactions.

The profits tax exemption under the Bill also applies to privately offered OFCs. Further, it is provided not only to the fund level but also to special purpose entities (SPEs) set up by the fund for the sole purpose of holding and administering investment in private investee companies, to the extent which corresponds to the percentage of shares or interests that the fund holds in the SPE.

Anti-tax avoidance measures

To minimise the risk of tax evasion, certain measures will be put in place, including requirements on a fund’s investment in private companies in relation to holding of immovable property and assets, as well as a holding period. Moreover, the current anti-round tripping provisions for resident persons will be retained to prevent a person resident in Hong Kong from using the exemptive relief available for offshore private funds to shelter otherwise taxable profits through a fund that is not bona fide widely held.

What this means for you

The Bill is a welcome development to the tax environment of the funds industry in Hong Kong. It not only widens the application scope of the profits tax exemption but also resolves the initial uncertainties and discriminatory features inherent in the Hong Kong tax regime for funds. We believe these remarked changes will attract more fund managers to set up or expand their business in Hong Kong.

Next step forward, private funds should assess whether the profits tax exemption under the Bill applies to them, and whether they can streamline or improve their operations in Hong Kong in light of these changes. For a deeper discussion on how the Bill might affect your business or any assistance on restructuring of your funds or asset management companies, please do not hesitate to contact us.

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