Alternative Investment Management Association
March 1 2006 was a big day for the fund industry, fund managers and investors. This was the day that the Revenue (Profits Tax Exemption for Offshore Funds) Bill 2005 (the ‘New Law’) was enacted into law.
The New Law has been long awaited. The then Financial Secretary, Antony Leung, in giving his 2003/04 Budget Speech openly said that the Government intended to amend the tax legislation to exempt offshore funds from Hong Kong profits tax in early 2003. After three years of waiting, the tax legislation has eventually been amended to grant Hong Kong profits tax exemption to offshore funds provided that they meet the specific conditions set down in the New Law.
Provided certain conditions are met, offshore funds with Hong Kong fund managers and investment advisors may now confidently state that they are not subject to tax in Hong Kong on profits derived in Hong Kong.
The Hong Kong Government believes that the New Law will provide a fresh stimulus for growth for the investment management industry in Hong Kong by removing the uncertainty concerning the Hong Kong profits tax position of offshore funds that has existed up to now, and further underpin Hong Kong’s position as an eminent asset management centre in the Asia Pacific Region.
The New Law impacts not only on funds but also on investors. The key provisions introduced into the Inland Revenue Ordinance (‘IRO’) are outlined below:
Exemption from Hong Kong profits tax will be granted to non-resident persons (including natural persons, corporations, trustees and partnerships) in respect of profits from certain types of transaction (“specified transactions”) in any year of assessment commencing on or after 1 April 1996. There are six types of “specified transaction”; namely transactions in securities, transactions in futures contracts, transactions in foreign exchange contracts, transactions involving the making of deposits other than by way of a money lending business, transactions in foreign currencies and transactions in exchange traded commodities.
The definition of securities is widely drafted and includes most, if not all, listed and unlisted equity and debt instruments, warrants, options and derivatives commonly invested by funds. The Hong Kong Government, however, for policy reasons has specifically excluded securities issued by private companies incorporated under section 29 of the Hong Kong Companies Ordinance and insurance contracts and products from the definition of "securities". The “specified transactions” must be carried out through or arranged by “specified persons” i.e. registered authorised financial institutions or persons holding any of the types 1 to 9 licenses under the Securities and Futures Ordinance (“SFO”). Furthermore, the non-resident must not carry on any other business in Hong Kong. Other income from transactions carried out in Hong Kong which are "incidental" to the carrying out of the specified transactions will also be exempt from tax provided such income does not exceed 5% of the trading receipts of the non-resident from the exempt and incidental transactions in Hong Kong.
The residency of a corporation / trust / partnership will be the location where the entity’s “central management and control” rests. The residency of a natural person is also defined in the New Law.
Losses from Exempt Transactions
Losses sustained by a non-resident person from “specified transactions” in a year of assessment will not be available for set off against assessable profits for Hong Kong profits tax purposes.
The Deeming Provisions are anti-avoidance provisions which provide that (i) a resident person who, together with his associates, holds a direct or indirect beneficial interest of 30% or more in a tax exempt non-resident person or (ii) a resident person who holds any interest, direct or indirect, in an associated tax exempt non-resident person will be subject to Hong Kong profits tax on its share of the non-resident's tax exempt profits, regardless of whether an actual distribution has been made or not. The purpose of the Deeming Provisions is to avoid abuse of the Exemption Provisions by Hong Kong residents, and they will apply from the year of assessment 2006/07 and onwards.The Deeming Provisions will not apply, however, in the case where the beneficial interest in the non-resident fund is regarded by the Commissioner of Inland Revenue as "bona fide widely held".
The New Law provides that non-participating “management shares” without economic participation rights held by fund managers in offshore funds are outside the definition of “beneficial interest” for the purposes of applying the Deeming Provisions.
Please note the information contained in this article is for general guidance on matters of interest only and does not constitute tax advice. It should not and cannot be relied upon as tax advice from PricewaterhouseCoopers. The application and impact of laws can vary widely based on the specific facts involved. Before taking any action, please ensure you contact your regular PwC professional services team to obtain advice specific to your circumstances.