Hong Kong's FSDC makes proposals for PE tax exemption, OEICs

Financial Secretary John Tsang announced the goals in his budget statement in February as part of a broader commitment to providing the relevant legal and regulatory frameworks, plus a clear and competitive tax environment, to attract more funds to the territory.

By extending the tax exemption, private equity firms with funds domiciled offshore would 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 to access the territory'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.

The move is expected to go some way towards addressing local concerns that Hong Kong is losing ground to Singapore, which offers greater certainty on tax treatment and clearer regulation of private equity.

"With the continuing growth of increasingly competitive tax regimes in the Asian region, these recommendations are a welcome step in preserving, and importantly, growing Hong Kong's position as a pre-eminent private equity and investment hub," Conrad Tsang, chairman of the Hong Kong Private Equity and Venture Capital Association (HKVCA), said in a statement.

The FSDC recommends offshore funds operated by licensed managers should qualify for the exemption provided they - or offshore special purpose vehicles (SPVs) under their control - don't invest in "land rich" Hong Kong real estate companies or in companies that directly or indirectly rely on Hong Kong real estate for 10% or more of their net asset value.

Hong Kong-incorporated SPVs should also be exempt from the profits tax, pending a few additional disclosures. This should further open up Hong Kong's tax treaty network to funds, allowing them to use the territory as a platform for investing throughout the region.

The exemption would initially be open to managers who are licensed by the Securities and Futures Commission (SFC) but the FSDC wants to extend it to include unlicensed PE funds that constitute eligible collective investment schemes. The onus is on not forcing managers to register with the SFC.

As locally-domiciled vehicles, OEICs would require SFC-licensed managers. Those that raise capital on a private placement basis would be subject to less oversight than their public counterparts, including the freedom to invest in any asset class their remit allows. All OEICs would be tax neutral, qualifying for the same exemption as offshore funds.

Hong Kong wants more funds to domicile in the territory - of the 1,845 authorized funds as of June 2013, only 381 were locally domiciled as unit trusts - recognizing the job opportunities the industry creates. OEICs are more flexible than unit trusts and there is the added carrot of mutual recognition with the mainland, whereby Hong Kong-domiciled funds could be sold to mainland investors.

While a private equity fund could in theory be structured as an OEIC, few are expected to eschew the familiarity of the limited partnership structure. The hope is that once the OEIC beds down - first for mutual funds and then hedge funds - the government will be open to a similar update in the rules for onshore limited partnerships.

The focus has so far been on mutual funds, and even there industry participants have yet to see substantial guidelines.

The ultimate goal is to achieve full clarity on tax - including capital gains - and enable meaningful regulation of local private equity managers. As it stands, the SFC doesn't regard private equity funds that are domiciled overseas and have nothing more than an advisory presence in Hong Kong as its concern.

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• Topics
• Regulation
• Greater China
• regulation
• China
• Hong Kong (China)