Industry experts fear excluding the securities of private firms could prevent managers from investing in a number of high-yield opportunities HONG KONG'S CLAIM to being the most competitive financial centre in the region has been given a boost by recent tax changes, but more can be done to attract offshore investment managers to the city, according to analysts. Amendments to profits' tax provisions passed in March were generally welcomed by the investment industry, which had lobbied to put Hong Kong-based investment managers on a level playing field with their counterparts in Ireland and, closer to home, Singapore. The tax changes were enacted by the passage on March 1 of the Revenue (Profits Tax Exemption for Offshore Funds) Bill 2005. What the new law introduced, provided certain conditions were met, meant that offshore funds with Hong Kong fund managers and investment advisers could state they were not subject to tax in Hong Kong, said Sally Wong, executive director of the Hong Kong Investment Funds Association. 'The exemption was vital to enhance Hong Kong's competitiveness because other major international financial centres, such as New York and London, all exempt offshore funds from tax,' she said. The move also helped establish Hong Kong as the most competitive financial centre in the region, according to the Hong Kong Securities and Futures Commission. The commission recently conducted a study for the Corporation of London, in which 14 competitive factors were identified as most important to a financial centre. The SFC research categorised them into six groups and examined the competitiveness of Hong Kong vis-a-vis 12 selected economies in Asia. Included in the criteria was the corporate and personal tax regime. The others were: availability of skilled personnel and access to suppliers of professional services; regulatory environment and government responsiveness; access to international financial markets and access to customers; availability of business infrastructure and a fair and just business environment; operational costs; and quality of life. The commission's research measured the performance of Asian markets 'using the rankings in other authoritative studies such as the International Institute for Management Development's World Competitiveness Yearbook, and World Economic Forum's Global Competitiveness Report'. It concluded: 'Hong Kong is clearly ahead of other markets in Asia in most of these factors.' But while acknowledging the progress, tax experts believe the changes have not gone far enough and the result may be that investment managers based in Hong Kong could be denied high-yield investment opportunities in offshore jurisdictions that do not have double-taxation agreements with the territory. PriceWaterhouseCoopers tax partner Phillip Mak said: 'There are some issues that are not clear in the new law and which need clarification.' Chief among these was the way in which 'securities' had been defined and the interpretation that Inland Revenue had adopted. 'There are six categories of transactions that qualify for exemption, and those that mainly concern the fund industry are profits derived from the transaction in securities or from making a deposit other than by way of money-lending business. 'The problem arises from the interpretation of the term securities, which have been defined in the law to exclude the securities of private companies under Section 29 of the Companies Ordinance,' Mr Mak said. The purpose of the exclusion, he said, was to prevent offshore funds from dealing in assets that were outside the scope of profits tax exemption (in particular real estate in Hong Kong), by holding these assets in a private company and then trading securities issued by the company. 'But our view is that so long as a private company is incorporated outside of Hong Kong it should not be excluded from the profits tax exemptions,' he said. The ruling could shut the door on locally based investment managers to many high-yield offshore investment opportunities. It could rule out an investment in a high-yield private company incorporated in a jurisdiction such as India - a hot favourite among investment managers in the present investment climate because of the benchmark-beating returns on offer. 'This does not seem to be the mischief that the IRD [Inland Revenue Department] wants to catch. The avoidance that the IRD wants to catch can be caught under the general anti-avoidance provision in the IRO [Inland Revenue Ordinance],' Mr Mak said. He believed the matter should be reviewed. However, in a written response to the comments, the Inland Revenue Department ruled out the prospect of such a review. The new law had been scrutinised by the Bills Committee of the Legislative Council and it was generally agreed that the specified transactions should cover the activities carried out by a typical offshore fund in Hong Kong. 'The scope of exemption had not been extended to shares in private companies,' it said, because this would 'heavily distort policy objectives', the tax department said. 'Regarding a private company under Section 29 of the Companies Ordinance, the department has obtained legal advice that the place of incorporation is irrelevant in determining whether a company is a private company under Section 29. 'Hence, it has opted for the view that the exemption should not be allowed in respect of shares in a private company, irrespective of whether it is incorporated in or outside Hong Kong.' The industry had an opportunity to comment on a Draft Departmental Interpretation & Practice Notes on the administration of the new law, it said, and this process had now been finalised.