Hong Kong extends offshore funds tax exemption to private equity

Financial Secretary John Tsang announced the measures in his 2013-2014 budget statement, in which he also pledged to "provide relevant legal and regulatory frameworks, and a clear and competitive tax environment with a view to attracting more funds of various types to base in Hong Kong."

The move on tax exemption will go some way to address local concerns that Hong Kong is losing ground to Singapore, which offers greater certainty on tax treatment and clearer regulation of private equity. However, industry participants are wary of getting their hopes up before the government publishes full details of its plans.

In practical terms, it means that Cayman Islands-incorporated funds no longer have to set up complicated structures designed to avoid triggering permanent establishment in Hong Kong and thereby becoming liable for local tax. It should also make it easier for private equity firms to take full advantage of Hong Kong's tax treaty network - funds must meet certain local substance requirements to qualify for treaty benefits and this can now be done without risking local tax liability.

"It's a huge welcome for the industry and it is a little bit surprising that it has happened now," said Darren Bowdern, a tax partner at KPMG China. "We have been lobbying the government for a long time to do several things, including extend the current exemption to include private equity."

He added that encouraging more funds to domicile in Hong Kong could be a massive fillip for the local financial services industry. The industry employs 230,000 people - 6% of the total workforce - and contributes 16% of GDP.

In the last couple of years, Hong Kong's inland revenue department has been cracking down on private equity and hedge fund managers, carrying out more than 25 audits and forcing adjustments. Industry participants have expressed concern at reports of the authorities redefining capital gains - which are untaxed in Hong Kong - as business income in a few cases. At issue is the fact that Hong Kong has no legal definition of capital gains.

John Levack, managing director of Electra Partners and head of the Hong Kong Private Equity and Venture Capital Association's technical committee, welcomed the tax exemption, describing it as the first step of a wide-ranging tranche of reforms the association has been asking for.

"However, this is the easy bit," he added. "In order to get where we want to get there will need to be some in-depth changes to company law and limited partnership law."

The ultimate goal is to achieve full clarity on tax - including capital gains - and enable meaningful regulation of local private equity managers. Several firms have registered with the Securities & Futures Commission but the regulator's response has been passive. There is little interest in PE funds are domiciled in Cayman with nothing more than an advisory presence in Hong Kong.

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• Topics
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• Greater China
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• tax
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• Hong Kong (China)
• GPs