The Financial Secretary announced in the 2017-18 Budget a proposal to extend the Profits Tax exemption to Hong Kong privately offered open-ended fund companies (OFCs). On 23 June 2017, the Hong Kong Government published a Bill to implement this exemption. This is part of a wider initiative to promote Hong Kong as an investment asset management hub.
Under the Bill, a privately offered OFC will be exempt from Profits Tax in respect of profits from qualifying transactions where the following conditions are satisfied:
The exemption will apply to OFCs that are resident in Hong Kong. Residence for this purpose is determined by the OFC’s place of central management and control. (If the OFC is resident outside Hong Kong, it may nevertheless qualify for the existing offshore funds exemption, where the required criteria for that exemption are met.)
The Bill also proposes strict qualifying conditions pertaining to investors in the OFC. The qualifying conditions differ depending on whether or not the OFC has a “qualifying investor”.
A “qualifying investor” in relation to an OFC means any of the following (subject to meeting certain requirements):
If the OFC has at least one qualifying investor, the OFC will not be closely held where:
If the OFC does not have a qualifying investor, the OFC will be considered not closely held where:
The permissible investment classes include securities, futures contracts, foreign exchange contracts, deposits made with a bank, foreign currencies, certificates of deposits, cash and OTC derivatives products. Trading receipts from “incidental” transactions are limited to 5% of the total trading receipts of the OFC.
The Bill also contains the following anti-avoidance measures to prevent potential abuse.
The legislative process may take a few months to complete.
The Bill will enable asset managers to set up a privately offered fund as an OFC in Hong Kong which will not be subject to tax. This is an encouraging policy initiative to promote the asset management industry in Hong Kong, although we would highlight that there are some areas of uncertainty under the Bill which could impact its effectiveness.
In particular, we note the following items in the Bill:
Of more concern, the Bill includes a provision that deems dividends from a non-exempt OFC to be taxable to the extent they are regarded as consideration or remuneration for services rendered in Hong Kong. This is a simplistic approach to address the issue of carried interest and performance fees in Hong Kong.
The proposed treatment in the Bill does not take into account the circumstances giving rise to a carry distribution in connection with an investment in the OFC. Whether or not a carried interest is a genuine investment return or remuneration for services rendered is a fact specific question that has to be considered on a case-by-case basis. There is also no mention of the right of an OFC to deduct dividends that are taxed in the hands of the manager or advisor.
The taxation of carried interest and fees in Hong Kong has been a contentious issue. There are obvious concerns that this new rule could have broader implications for the asset management industry in Hong Kong.
On a final note, asset managers can consider setting up a non-resident fund that will qualify for the somewhat broader offshore funds exemption. Also, a publicly-offered fund (registered with the SFC) would qualify for a blanket tax exemption. The new exemption is designed to enable a particular type of fund (an OFC) to be resident in Hong Kong, which would enable its management to be conducted in Hong Kong. Time will tell whether the Hong Kong Government will consider extending the more general offshore funds exemption to all resident funds.
KPMG has a dedicated team of tax professionals focused on servicing fund clients who have been actively involved in the Hong Kong Government consultation process and have extensive experience in assisting clients to establish fund structures. Our team would be pleased to meet with you to discuss the impact of the changes on your business and what you can look to do in the lead-up to these changes coming into effect.