Wait­ing for the scales to tip


The gov­ern­ment on March 25 tabled in the Leg­isla­tive Coun­cil its gazetted In­land Rev­enue (Amend­ment) Bill 2015, which seeks, among other things, to amend the In­land Rev­enue Or­di­nance ( IRO) so that prof­its tax ex­emp­tion for off­shore funds may be ex­tended to pri­vate eq­uity (PE) funds as well.

Hopes are that the amend­ment can be passed within this year.

This came af­ter Fi­nan­cial Sec­re­tary John Tsang Chun­wah an­nounced in the 201314 Bud­get that the ad­min­is­tra­tion would con­sult the fund man­age­ment in­dus­try on mak­ing leg­isla­tive changes to en­cour­age PE funds to ex­pand their busi­ness in the city.

The cur­rent tax­a­tion regime for PE funds is based on the 2006 IRO amend­ment, which stip­u­lates that prof­its tax ex­emp­tion for off­shore funds can only be al­lowed when prof­its are “de­rived from spe­cific trans­ac­tions car­ried out through or ar­ranged by a spec­i­fied per­son, and trans­ac­tions in­ci­den­tal to the car­ry­ing out of the spec­i­fied trans­ac­tions”.

The gov­ern­ment has pro­posed three main ar­eas of leg­isla­tive amend­ment to boost PE in­dus­try com­pet­i­tive­ness in the city.

The first pro­posed change in­volves ex­tend­ing prof­its tax ex­emp­tion for off­shore PE funds to con­duct trans­ac­tions in pri­vate com­pa­nies in­cor­po­rated out­side Hong Kong.

This will al­low off­shore PE funds to en­joy the same ex­emp­tion un­der the IRO as those cur­rently avail­able to other off­shore funds.

Un­der the 2006 amend­ment, “spe­cific trans­ac­tions” cover fi­nan­cial trans­ac­tions in listed se­cu­ri­ties, fu­tures con­tracts, for­eign-ex­change con­tracts, for­eign cur­ren­cies, bonds, ex­change-traded com­modi­ties and de­posits — but not such trans­ac­tions in el­i­gi­ble pri­vate com­pa­nies.

In other words, off­shore pri­vate eq­uity funds that de­rive prof­its from trans­ac­tions in pri­vate com­pa­nies could be sub­jected to Hong Kong prof­its tax.

The sec­ond amend­ment pro­poses to waive the re­quire­ment for PE in­vest­ments to be ar­ranged by or car­ried out through Se­cu­ri­ties and Fu­tures Com­mis­sion (SFC) li­censed per­sons. Many off­shore PE fund firms op­er­at­ing in Hong Kong are not nec­es­sar­ily man­aged by “spec­i­fied per­sons” li­censed by the SFC un­der the Se­cu­ri­ties and Fu­tures Or­di­nance.

The amend­ment would al­low prof­its tax ex­emp­tion to be avail­able to qual­i­fied off­shore PE funds, which can be de­fined as funds that have five or more in­vestors who col­lec­tively com­mit­ted more than 90 per­cent of the fund cap­i­tal.

In ad­di­tion, the orig­i­na­tor of the funds should not be en­ti­tled to re­ceive more than 30 per­cent of the net pro­ceeds aris­ing from the fund trans­ac­tions.

“The ex­ten­sion of prof­its tax ex­emp­tion to PE will broaden Hong Kong’s fund man­age­ment busi­ness, boost­ing Hong Kong’s rep­u­ta­tion as a full-ser­vice as­set man­age­ment hub,” SAR fi­nance chief Tsang told par­tic­i­pants at the Asian Fi­nan­cial Fo­rum 2015 in Jan­uary.

“It will also ex­pand de­mand for busi­ness con­sult­ing, tax, ac­count­ing and legal ex­perts in Hong Kong.”

The ac­count­ing sec­tor wel­comed the pro­posed amend­ment, say­ing it will cre­ate a level play­ing field for PE fund man­agers com­pared with other hedge funds.

“The amend­ment will re­move tax­a­tion is­sue un­cer­tainty for PE fund man­agers. Once the new amend­ment is passed, the new leg­is­la­tion will be very sim­ple and fea­si­ble for PE fund man­agers to man­age tax-risk ex­po­sures,” David Kan Kau-hang, a tax part­ner at Price­wa­ter­house­Coop­ers Hong Kong, told China Daily.

And KPMG China Tax Part­ner Dar­ren Bow­dern said: “The leg­isla­tive pro­posal is an ex­cit­ing devel­op­ment for the in­dus­try in Hong Kong, as the pro­posed tax ex­emp­tion will make Hong Kong re­gain com­pet­i­tive­ness against Sin­ga­pore, which al­ready has tax ex­emp­tions in place for PE funds.”

“Af­ter the en­act­ment of the new leg­is­la­tion, Hong Kong is likely to be­come the pre­ferred place for PE funds be­cause of its ro­bust fi­nan­cial in­fra­struc­ture and ge­o­graph­i­cal prox­im­ity to the main­land,” Bow­dern added in speak­ing to China Daily.

A third pro­posed mod­i­fi­ca­tion aims to in­tro­duce tax ex­emp­tion for spe­cial pur­pose ve­hi­cles (SPVs), as many PE funds may use multi-level SPV hold­ing struc­tures for in­vest­ments.

SPVs are de­fined to in­clude cor­po­ra­tions, part­ner­ships, trustees and non-cor­po­rate bod­ies es­tab­lished for the sole pur­pose of in­vest­ing in pri­vate com­pa­nies and not able to carry on any other trade or ac­tiv­ity.

Al­low­ing prof­its tax ex­emp­tion for SPVs will strengthen the abil­ity of off­shore PE funds to use Hong Kong com­pa­nies as a plat­form for hold­ing off­shore in­vest­ments, thus bol­ster­ing Hong Kong’s sta­tus as an in­vest­ment hold­ing ju­ris­dic­tion and help­ing the SAR level the play­ing field with Sin­ga­pore, “Big Four” ac­count­ing firm KPMG said in its “Hong Kong Tax Alert” doc­u­ment in Jan­uary.

Hong Kong’s sound legal and fi­nan­cial in­fra­struc­ture, free­dom of cap­i­tal move­ment, a free con­vert­ible cur­rency and strong ge­o­graph­i­cal prox­im­ity to the main­land make the city one of the pre­ferred lo­ca­tions for for­eign PE in­vest­ment cap­i­tal.

Ac­cord­ing to gov­ern­ment statis­tics, there were 390 PE com­pa­nies op­er­at­ing in Hong Kong with $114.6 bil­lion of cap­i­tal un­der man­age­ment as at end-2014, ac­count­ing for 21 per­cent of Asia’s to­tal cap­i­tal un­der man­age­ment in pri­vate eq­uity.

The PE in­dus­try’s to­tal cap­i­tal un­der man­age­ment in Hong Kong grew 16 per­cent an­nu­ally last year.

Over 70 per­cent of Hong Kong’s fund busi­ness comes from non-Hong Kong in­vestors, and fund man­agers in­vest al­most 80 per­cent of clients’ funds out­side Hong Kong, gov­ern­ment statis­tics re­veal.

In the three years be­tween 2012 and 2014, PE cap­i­tal­rais­ing in Hong Kong reg­is­tered a cu­mu­la­tive an­nual growth rate of 26 per­cent. Hong Kong-based PE firms ac­counted for 23 per­cent of the to­tal PE fund-rais­ing in Asia in the same pe­riod, ac­cord­ing to the Hong Kong Ven­ture Cap­i­tal and Pri­vate Eq­uity As­so­ci­a­tion (HKVCA).

The city’s stock mar­ket is the ma­jor route of exit for PE funds, as Hong Kong PE firms have raised an amount equiv­a­lent to 67 per­cent of the cap­i­tal raised by ini­tial public of­fer­ings on the Hong Kong stock mar­ket from 2012 to 2014, HKVCA data show. Con­tact the writer at oswald@chi­nadai­lyhk.com

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