The Unified Fund Exemption (the “UFE”) regime introduced by Inland
Revenue (Profits Tax Exemption for Funds) (Amendment) Ordinance 2019 (the
“Ordinance”) has provided far reaching profit tax exemptions to funds offered
in Hong Kong irrespective of the fund’s domicile i.e. onshore or offshore. The
previous profit tax exemption regime for funds i.e. Offshore Fund Exemption
(the “OFE”) made distinction between onshore and offshore funds and the nature
of investments.
The below note describes what has changed under UFE and how
will it impact the fund industry.
· QUALIFYING FUNDS: A fund that fulfils the
below mentioned conditions can seek tax exemption:
o
All privately offered funds: UFE extends
the tax exemption to all privately offered funds (whose definition is
equivalent to collective investment scheme under Securities and Futures
Ordinance) in Hong Kong regardless of their place of domicile (i.e. onshore or
offshore) and legal structure. The definition of fund covers corporations or
partnerships whether Hong Kong incorporated / set-up or outside. This is a
substantial improvement over the previous tax regime where onshore privately
offered funds operating in Hong Kong did not have the tax exemption.
o
Location of central management and control:
The location from where the fund is centrally managed and controlled is not a
relevant factor for seeking tax benefit under UFE. This means, even when the
board meetings and investment decisions are made in Hong Kong the fund can
claim tax exemption benefit. This is another change from the previous regime
where the tax exemption was not available if the central management and control
of the fund was in Hong Kong.
o
Number of investors, their contribution and distribution
to sponsor: Only those funds qualify for the tax exemption which have at
least 5 investors contributing 90% of the fund’s capital. Further, the
distribution to the sponsor and its associates should be limited to 30% of the
net proceeds arising from the transactions of the fund.
o
Special Purpose Entities (SPE): SPE owned
wholly or partly by a fund for holding private equity investments only through
private companies in Specified Securities (as defined in the Ordinance) and its
derivates can also take advantage of the UFE to the extend owned by the fund.
This means if a SPE’s 40% shares are owned by an eligible fund, then the SPE
can also claim tax exemption up to 40% of the profit from transactions in Specified
Securities.
·
QUALIFYING TRANSACTIONS: The profit tax
exemption would be available when the fund undertakes the following types of
transactions.
o
Definition of transaction: the definition
of the transactions covers only buying and selling of assets (as defined in the
Ordinance). Therefore, the profit tax exemption is available only from buying
and selling of these assets.
o
Private Hong Kong company: Another change
from the existing tax exemption regime is that investment in private Hong Kong
company will qualify for the tax exemption provided the investment is held for no
less than 2 years subject to limitation on the investment in immovable property
as explained below under anti avoidance provisions.
o
Infrastructure immovable property: The
limitation with respect to immovable property does not apply for investment in
infrastructure immovable property either directly by the fund or through
private company and therefore profit from such investment will qualify for tax
exemption.
o
Incidental transaction: Transactions incidental
to the qualifying transactions not exceeding 5% of the trading receipts both
from the qualifying transaction and incidental transaction.
o
Intermediary: The transaction should be
arranged or carried out in Hong Kong by a person licensed by or registered with
Securities and Futures Commission (the SFC”).
·
Tainted issue: Under UFE, it is allowed
to separate qualifying and non-qualifying transactions and claim tax exemption
benefit only on the qualifying transactions. This is a significant change from
the OFE regime which denied tax exemption for all the transactions of the fund in
case there was any transaction which does not qualify for tax exemption.
ANTI-AVOIDANE PROVISIONS: Some substantial limitation
which would deny the tax exemption benefit to fund are as follows.
·
Investment by fund manager and its staff:
Investment in the fund by persons who have day-to-day control over the
management of the assets of the fund will deny the fund tax exemption benefit.
This means a fund manager /staff of the fund manager who also invests in the
fund will not be allowed to claim tax exemption benefit for the fund. This is a
major drawback because both for hedge and private equity funds it is common for
the fund manager to also make investment in the fund. Such an investment by the
fund manager is sometime a necessary pre-requisite to attract investors in the
fund.
·
Non qualifying transactions:
o
Investment in debt security: As per the
transaction definition, only profit derived from trading income is considered a
transaction and not the profit derived from holding of the securities. The
implication is that the debt funds and income from fixed income securities will
not fall within the UFE regime and will therefore have to pay tax.
o
Investment in Hong Kong immovable property:
Investment income from Hong Kong
immovable property held either directly or through private company is not tax
exempt. However, this limitation of tax exemption for investment in immovable
property is relaxed in case the private company holds no more than 10% of its
assets in immovable property.
o
Special purpose entity: The exemption
from profit tax for the income from investment held through SPE is available
only till the time SPE remains a private company or the investment is in
unlisted securities. As and when the SPE becomes a public company then the
exemption is not available.
·
Excluded entities: business undertakings
for general commercial or industrial purposes, group captive funds and employee
funds are excluded from the definition of the fund and therefore cannot take
advantage of UFE regime.
The benefits of the UFE regime for the fund industry are
substantial though some major limitation factors like dis-allowance in case of investment
by the fund manager, exclusion of investment in debt securities or debt fund and
exclusion if the SPE or the underlying company’s shares are listed do impose
substantial unresolved issues for the industry. At the same time, the new
substance requirement for fund managers in off-shore jurisdictions like Cayman
Islands, BVI and Bermuda may make it practically difficult for fund managers to
create substance in off shore jurisdiction by holding investment related board
meetings there. So, each fund operator should make a business call whether it
is overall beneficial for them to unify and simplify their operations locally.
