Law ends tax worries for offshore funds in HK

PUBLISHED : Tuesday, 07 March, 2006, 12:00am
UPDATED : Tuesday, 07 March, 2006, 12:00am

Legal basis for exemption brings HK in line with rival Singapore but will not encourage more locally domiciled funds

A new tax law passed by lawmakers last week has lifted a cloud of uncertainty for many Hong Kong fund managers and added a star to the city's credibility as an international investment fund centre.

The law, exempting offshore funds from paying tax on profits from transactions made in Hong Kong, had been in the works for two years. Previously, a lack of clear rules regarding the tax liability of unauthorised offshore funds left the industry in a legal grey area and put Hong Kong one step behind Singapore in the game of one-upmanship between the regional financial centres.

'There's always been a risk - and it's been more a theoretical than a practical risk - that if a fund is managed or serviced from Hong Kong, then it could be brought onshore here for tax purposes. This gets us away from that,' said Mark Shipman, a lawyer at Clifford Chance who advises funds.

While offshore funds were legally taxable, the government's generally did not tax them. Its practice has now been framed in law, two years after Singapore brought in similar legislation.

'When [fund] managers are looking at setting up in Hong Kong or Singapore, they should be able to take greater comfort now Hong Kong is not going to put them on an unequal footing in terms of tax treatment,' Mr Shipman said.

The new law, retroactive to April 1, 1996, allows a resident to own up to 30 per cent of a fund without having to pay taxes, with profits on any stake above that subject to taxation. This gives Hong Kong a slim edge over Singapore and London, where the limit is 20 per cent.

'The elimination of that risk will be very important to further foster private offerings here, especially if Hong Kong wants to be a world management hub,' said Anthony Muh, head of Asia-Pacific at Alliance Trust.

Because funds authorised by the Securities and Futures Commission for retail distribution are already tax exempt, the new law will have the biggest impact on managers such as Scotland-based Alliance Trust which manages money from Hong Kong but does not offer retail funds here.

'When we were setting up this operation, our accounting firm told us it was different shades of grey,' Mr Muh said. 'They didn't think we had a tax liability but they left it up to us to decide how conservative we wanted to be and possibly to make provision for tax liability.

'[The new law] gives people the confidence to come in and know with certainty that there isn't going to be tax liability at the end of the day.'

The new law also makes Hong Kong more attractive for start-ups that may have raised seed money from local investors.

'The impact is much more on the boutique, smaller fund managers and on the hedge fund managers, where you have small funds with seed money,' said Elisabeth Scott, managing director of Schroders in Hong Kong.

However, while the new law lays out clear rules for fund mangers, it does not on its own make Hong Kong any more attractive as a location in which to base a fund, referred to in the industry as the fund's 'domicile'.

Most funds managed in Hong Kong are domiciled in the Cayman Islands, Luxembourg, Dublin or London, although the idea of making Hong Kong an Asian fund domicile has been mooted.

While Hong Kong prides itself on its strict regulatory regime, Luxembourg and the Cayman Islands are popular fund domiciles precisely because of their relaxed regulatory systems.

Mr Shipman said that Hong Kong needed new rules on open-ended investment companies as well as more lenient tax structures if it wanted to attract more funds to domicile here.

The concept of an 'Asian passport' for funds has also been discussed as a way of making Hong Kong more attractive as a domicile.

Under such an arrangement, regional regulatory authorities would create a system whereby a fund's registration and regulation in one jurisdiction such as Hong Kong would allow it easier access to other Asian markets.

'If Hong Kong-domiciled funds were able to be sold throughout Asia freely, that would be fantastic but unfortunately because we don't have an Asian passport system it's impossible to do that,' Ms Scott said.