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QDLP: New market for hedge fund managers

By Kenny Lam, Tax Partner

PwC Shanghai

Q4 2013


At long last, the Qualified Domestic Limited Partnership (QDLP) program in Shanghai has been implemented. The first batch six hedge fund managers have been approved to participate into the QDLP program and have started setting up the wholly foreign owned fund management company (“Onshore FMC”) and have begun RMB fund raising as well.

The QDLP allows qualified domestic private RMB funds established in Shanghai to invest into offshore securities markets. A typical investment and operational structure for the QDLP program is depicted in the below diagram.





The QDLP program is an important step forward for international asset managers to enter into the Chinese market.  Although the foreign exchange quote granted to each approved asset manager is only at US$50 million at this stage, being symbolic rather than material, it does reflect China’s long-term commitment to opening the capital account and internationalising the RMB, as well as Shanghai’s ambition of becoming an international financial centre. 

Due to the regulatory restrictions (including foreign exchange restrictions), Chinese investors are usually not able to invest in offshore securities markets other than via the Qualified Domestic Institutional Investors (QDII) program.  However, the QDII investment funds are issued to the general public and are not tailored to the needs of specific investors. The QDLP program now provides a new channel for Chinese domestic capital to be invested in offshore securities markets and this should be greatly welcomed by Chinese institutional investors and high net-worth individuals.

While the QDLP program provides a new window of opportunity for both overseas hedge funds and Chinese domestic investors, there are a number of issues that need to be managed by asset managers. Asset managers need to consider the marketing strategy on how to promote the QDLP products to Chinese investors and in this regard they need to think of different ways of marketing activities such as looking at a Chinese partner, engaging some distribution channels such as trust institutions, wealth management institutions, etc. Moreover, asset managers need to be alert that Chinese investors are far from mature as compared with investors in more developed markets like the US and UK. Asset managers should also consider how to deploy manpower in this new market, taking account of employing local Chinese residents, sending people to oversee this new market, or even using the employees of existing regional offices like entities in Hong Kong through travelling to China on frequent basis, etc. 

Chinese investors, especially individual investors, would require asset managers to set up the best structure for them to invest into the QDLP fund. Tax would be one key consideration in designing the structure to maximise the after-tax investment return. In this regard, asset managers might explore collective investment schemes allowable under the Chinese regulatory regime as an intermediary to collect the individual investors. Asset managers will need to make sure that such structures will minimise the relevant China tax implications to these individual investors.

The QDLP program is designed such that the management fee and performance fee might be collected by the offshore fund manager of the master fund under the “master-feeder” structure. Nevertheless, asset managers need to design a structure for compensating the Onshore FMC from the Chinese tax and transfer pricing perspectives. The structure should ensure tax efficiency, that is, to mitigate the Chinese tax cost at the Onshore FMC level, and mitigate the possible PRC tax authority’s challenges as well. While respective asset managers have particular management fee and performance fee arrangement with investors, a tailored tax structure for compensating the Onshore FMC should be designed in order to achieve the tax efficiency. In some situations, pre-discussions with the tax authorities could be arranged as a way to mitigate the risk of being challenged by the PRC tax authority on the structure in future.

China is implementing a program to transform from business tax (BT) to value added tax (VAT) on all industries. Currently the program has been rolled out nationwide on some industries, including the so-called modern service industry. In this context, the Onshore FMC may be subject to the VAT at 6% on its income instead of the BT at 5%.  Although the VAT is creditable, the Onshore FMC may be subject to higher overall tax cost as a result of the increased VAT rate versus the BT, as well as very limited input VAT credits. 

There are often circumstances where regional offices send their employees to support the operation of the Onshore FMC. Asset managers should be mindful of how to arrange the relationship between these people with the regional offices and the Onshore FMC.  They need to consider putting these people under dual employment of the two entities or under a secondment arrangement. Such consideration would not only help alleviate the Chinese individual income tax of these persons but also manage the risks of creating a taxable presence of the regional offices in China. Asset managers need to be careful in managing possible creation of the taxable presence of the regional offices in China, otherwise its income attributed to these persons would be exposed to the China corporate income tax of 25%.

Selecting the best location for registering the Onshore FMC and QDLP fund has also been a key concern for asset managers seeking to participate in the QDLP program. This is particularly true as Shanghai has recently initiated the Shanghai Pilot Free Trade Zone which created a new business landscape. In addition, there are also some districts in Shanghai that are aggressively promoting the hedge fund industry by providing highly favourable policies. Usually asset managers need to explore the maximised local financial subsidies and the support from the local government such as supporting in seeking the fund investors when selecting a specific location for registering the fund and fund managers. 

It is foreseeable that that the QDLP program will expand further with more and more asset managers participating in the program. The total volume as well as the individual volume for each QDLP fund will be further increased in the coming time. The QDLP program definitely provides good business opportunities for international asset managers. That being said, to achieve maximised investment return, there are various issues to be addressed beforehand. It is suggested that asset managers seeking to participate in the program take a proactive approach and actively engage in dialogue with the Shanghai financial service authority in advance and seek assistance from advisors accordingly.



This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

© 2013 PwC Consultants (ShenZhen) Ltd. Shanghai Branch. All rights reserved. PwC refers to the China member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.



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