Oversight March 2019 - Hong Kong tax regime for funds set to change

Introduction

On 07 December 2018 the government of Hong Kong (HK Government) gazetted the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Bill 2018 (Bill). The Bill introduces material changes to the existing profits tax exemption for non-resident funds. The stated intention of the Bill is to address concerns identified by the Council of the European Union (EU) in relation to certain ring-fencing features in Hong Kong’s tax regime for funds. Currently, at the fund level, a profits tax exemption is only available to either funds authorised by the Hong Kong Securities and Futures Commission (SFC) under section 104 of the Securities and Futures Ordinance and for certain offshore, but not onshore, funds. At present, there is also a separate tax regime for Hong Kong incorporated open-ended fund companies (OFCs).

The Bill will amend and unify the profits tax exemptions for all non-SFC authorised funds, regardless of their size, type and location of central management and control (CMC). The Bill is therefore widely viewed as a significant step in reforming and clarifying the Hong Kong tax regime for eligible funds operating in Hong Kong.

The Bill was introduced into the Legislative Council (LegCo) on 12 December 2018 and the amendments will come into operation on 01 April 2019. By Hong Kong standards the HK Government has moved quickly bearing in mind that the consultation on the preliminary proposals occurred between April and May 2018. This demonstrates the HK Government commitment to the development of Hong Kong as an international asset management centre.

Existing Hong Kong tax regime

Currently, a profits tax exemption is given to all SFC authorised (ie publicly offered) funds. This applies irrespective of where such a fund’s CMC is located. Accordingly both Hong Kong domiciled unit trusts and Luxembourg UCITS, if authorised by the SFC, have always enjoyed the same Hong Kong tax treatment. In addition a profits tax exemption is given to offshore non-SFC authorised (ie privately offered) funds under the Inland Revenue Ordinance (IRO) following changes made in 2006. This offshore funds tax exemption in essence permits non-resident funds (such as those incorporated in the Cayman Islands) a profits tax exemption where a SFC licensed manager is appointed to manage the fund, subject to the fulfilment of certain conditions. This exemption has been relied upon by most alternative fund managers in Hong Kong and by providing much needed certainty has strengthened the offshore fund market in Hong Kong.

Except for onshore privately offered OFCs which meet the conditions specified in section 20AH of the IRO, other onshore privately offered funds (ie with their CMC exercised in Hong Kong) currently cannot enjoy profits tax exemption under the IRO.

Under section 2(1) of the IRO, an OFC is defined to have the meaning given by section 112A of the SFO. Under section 112A of the IRO, an OFC is defined to mean a collective investment scheme constituted as a corporation that holds a certificate of incorporation issued by the Registrar of Companies under section 112C of the SFO. OFCs are the recently introduced fund vehicles created under the SFO to permit both public and private Hong Kong corporate funds. These are similar in concept to Singapore variable capital companies. See the Oversight of August 2018 for more information.

As mentioned above, the EU has identified Hong Kong's tax regime for offshore funds to be problematic on account of its ring-fencing features, namely the preferential tax treatment for funds is partially or fully isolated from the domestic economy. Ring-fencing may take different forms, for example excluding Hong Kong resident taxpayers from taking advantage of the preferential tax treatment; and prohibiting qualifying Hong Kong resident taxpayers from operating in the domestic market. Qualifying Hong Kong resident taxpayers can be implicitly excluded from operating in the domestic market if the applicability of the preferential tax treatment is limited to transactions carried out with foreign parties such as Cayman Islands funds. Hong Kong's tax regime was thus considered harmful because the IRO only provides profits tax exemption to offshore, but not onshore, funds and only allows offshore funds to have profits tax exemption in respect of investment in private companies incorporated overseas but not locally. To further consolidate Hong Kong's competitive edge in the manufacturing and management of funds and in order not to be put on the EU's list of non-cooperative jurisdictions for tax purposes, the HK Government announced in the 2018-19 Budget that a review would be conducted on the existing tax concession arrangements applicable to the fund industry with regard to the international requirements on tax co-operation in order to address the EU's concerns. The Bill, when enacted, will thus provide a profits tax exemption to eligible funds operating in Hong Kong.

Read this edition of Oversight in full.