Hong Kong profit tax: Breakthrough

Although few were surprised by the announcement, the small print makes for interesting reading. It suggests the Hong Kong government has taken on board representations made by various industry groups and bodes well for the regulatory battles to come; not least the proposed open-ended investment company (OEIC) structure through which managers could raise locally-domiciled funds.

The exemption means that PE firms with funds domiciled offshore no longer have to set up structures designed to avoid triggering permanent establishment in Hong Kong and becoming liable for local tax. No more will GPs have to make trips to Macau to make key decisions relating to the operation of a fund.

With a few exceptions, the exemption also applies to special purpose vehicles under the control of fund managers. This is important because it facilitates access to Hong Kong's tax treaty network: funds must meet local substance requirements to qualify for treaty benefits and this could be done without risking local tax liability.

By encouraging more activity to take place in Hong Kong, the government hopes to stimulate demand for local asset management, investment and advisory services. It would be a fillip for the financial services sector as a whole, which employs 230,000 people - 6% of the total workforce - and contributes 16% of GDP.

Evidence that policymakers have taken on board the concerns of industry participants is twofold. First, the tax exemption is enshrined in a full legislative amendment rather than regulatory guidance. The latter course may have taken less time but the practice notes commonly used are not legally binding and could be subject to differing interpretations by regulators. PE practitioners wanted certainty and now they have it.

Second, the exemption applies to managers licensed by the Securities and Futures Commission (SFC) and to "qualifying" unlicensed managers. The initial proposal was limited to licensed managers only, given the government's understandable concerns about handing an exemption to managers without retaining the ability to ensure they are who they say they are. However, only half the managers operating in Hong Kong are currently licensed.

The Financial Services Development Council (FSDC) expressed a desire for a mechanism that could include unlicensed managers as well, but many industry participants thought it would take time to put in place a system with which the government was comfortable. While certain groups, including pension funds and sovereign wealth funds, cannot undergo the qualifying test for unlicensed managers, most of those that can should be able to pass it.

Similarly, private equity firms will not enjoy a completely trouble-free existence in Hong Kong: the inland revenue department continues to carry out audits on managers and there are fears that untaxed capital gains, for which there is currently no legal definition, could be redefined as taxable business income in certain cases. But the exemption is a positive first step.

Next on the agenda are OEICs. These are unlikely to supplant limited partnerships as private equity's structure of choice, although successful implementation could lead to long sought-after adjustments to Hong Kong's limited partnership legislation. Then the territory can properly face down the challenge of Singapore, which has taken the lead in terms of tax treatment, clear regulation and fund domiciling.

At stake is not so much the opportunity to bring established offshore funds - most of which are domiciled in the Cayman Islands - onshore, as meeting the needs of mainland managers taking their first steps into international markets.

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