Thu, Sep 20, 2012

Hong Kong Offshore Fund Exemption

Hong Kong has become Asia’s largest hedge fund center. According to a survey conducted by the Securities and Futures Commission (SFC) of Hong Kong in March 2011, there were 538 hedge funds licensed by the SFC in Hong Kong as of 30 September 2010.

One of the contributing reasons is the introduction of the Offshore Fund Exemption by the Hong Kong Government to improve its competitiveness against other international finance centers such as London, New York and Singapore, and to encourage foreign investments.

Under the Offshore Fund Exemption, offshore funds are exempt from Hong Kong Profits Tax if they are:

1. a non resident;

2. only carrying out specified transactions and incidental transactions as permitted under the Offshore Fund Exemption rules; provided that

3. qualifying transactions are conducted by authorized persons licensed in Hong Kong.

Funds and fund managers should not be complacent as an Offshore Fund Exemption doesn’t mean that all offshore funds fall within the Offshore Fund Exemption rules.

Funds and fund managers should not be complacent as an Offshore Fund Exemption doesn’t mean that all offshore funds fall within the Offshore Fund Exemption rules.

Non resident
To be considered as a non resident, the fund’s central management and control must not reside in Hong Kong. The Offshore Fund Exemption does not clearly define the term ‘central management and control’. It depends on the actual situation of each fund and appropriate documentation is required to substantiate the offshore status.

Generally, funds need to ensure that the Investment Board of the fund is made up of persons residing outside of Hong Kong, with sufficient knowledge and experience, and who meet outside of Hong Kong.

Specified transactions
Only transactions in securities, futures contracts, foreign exchange contracts, deposits other than money-lending business, foreign currencies, and exchange-trade commodities are exempted under the Offshore Fund Exemption. As this doesn’t include trading in private companies, the Offshore Fund Exemption does not generally apply to private equity businesses.

Incidental transactions
Apart from specified transactions, the fund is also allowed to carry out transactions incidental to the specified transactions, e.g. interest, dividends, etc., but the total trading receipts from the “incidental transactions” should not exceed 5% of the total trading receipts from the total of “specified transactions” and “incidental transactions”.

Anti avoidance
To avoid round-dripping, i.e. Hong Kong residents disguising taxable income within an Offshore Fund, there are certain anti avoidance provisions in the Offshore Fund Exemption rules. Basically, if a Hong Kong investor does not directly or indirectly, alone or jointly with its associates, hold beneficial interests of 30% or more in an offshore fund, the Offshore Fund Exemption will apply provided other criteria are met. However, if the Hong Kong resident investor holds 30% or more beneficial interests in an offshore fund, (or any percentage if the Hong Kong resident is an associate of the offshore fund), then the Hong Kong resident should declare for tax any assessable profits
in respect of the trading profits derived from the offshore fund.

Hong Kong is well known for its territorial and low tax regime, the well-established SFC regulations and its favorable geographical location as a gateway for investment into business in China. With the gradual opening up of the investment platform in China and the increasing number of double tax treaties between Hong Kong and other jurisdictions, Hong Kong is still seen to be the ideal place to carry out fund management activities and fund set-up.
The Hong Kong Government has signed 25 double tax treaties with other jurisdictions to strengthen its attractiveness as an international financial center and there are also many potential jurisdictions currently under negotiation.

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