With an aim to strengthen Hong Kong’s asset management industry, the Inland Revenue (Amendment) Bill 2015, after two rounds of industry-wide consultation, was enacted on 17 July 2015. Under the new law, offshore private equity funds (“PE Funds”) are now eligible to enjoy profits tax exemption in Hong Kong (subject to certain conditions).
Before the enactment of the new law, to qualify as an offshore fund for profits tax exemption, all of the following conditions were required to be satisfied:-
- The fund is a non-resident, i.e. its central management and control are exercised outside Hong Kong;
- Its activities in Hong Kong are restricted to “specified transactions” which are set out in Appendix C to Departmental Interpretation & Practice Notes (“DIPN”) No. 43; and
- Those transactions are carried out through, or arranged by “specified persons” which normally refer to corporations licensed with the Securities & Futures Commission of Hong Kong (“SFC”).
DIPN No. 43 explicitly excludes the investments in private companies’ shares from “specified transactions”, limiting PE Funds’ ability to rely on the exemption. Another limitation under the old law is that it is uncommon for a PE Fund to engage a “specified person” who is licensed with the SFC to manage its transactions. As such, offshore PE Funds could hardly be exempted from Hong Kong profits tax in the past.
Changes under the new law:-
1. Broadening the coverage of transactions under “specified transactions”
Under the new law, PE Funds with a portfolio of investments in excepted private company (“EPC”) can now fulfill the requirement of conducing “specified transactions”.
Schedule 16 of the Inland Revenue Ordinance (“IRO”) was amended to include transactions in shares, stocks, debentures, loan stocks, funds, bonds, or note of, or issued by EPC or a special purpose vehicle (“SPV”) (as defined below).
An EPC is defined as a private company incorporated outside Hong Kong that, at all times within 3 years before a transaction giving rise to the relevant profits is carried out, meets the following conditions:-
- Did not carry on any business through or from a permanent establishment in Hong Kong;
- Did not hold share capital (whether directly or indirectly) in one or more private companies carrying on any business through or from a permanent establishment in Hong Kong, or the aggregate value of such holding of capital is equivalent to not more than 10% of the value of its own assets; and
- Did not hold immovable property in Hong Kong or share capital (whether directly or indirectly) in one or more private companies with direct or indirect holding of immovable property in Hong Kong, or the aggregate value of such holding of the property and capital is equivalent to not more than 10% of the value of its own assets.
2. Providing profits tax exemption to SPVs
SPVs are often used by PE funds to structure investments in private companies, for the purpose of isolating financial risks and legal liability of the underlying investments from the funds. In this connection, under the new law, profits tax exemption is provided to SPVs in respect of any gains derived from holding of investments in EPCs or other SPVs (i.e. interposed SPVs).
As stated in the new law, a SPV refers to a corporation, partnership, trustee of a trust estate or any other entity that:-
- Is wholly or partially owned by a non-resident person;
- Is established solely for the purpose of holding, directly or indirectly, and administering one or more EPCs;
- Is incorporated, registered or appointed in or outside Hong Kong;
- Does not carry on any trade or activities except for the purpose of holding, directly or indirectly, and administering one or more EPCs; and
- Is not itself an EPC.
It should be however noted that the formation of an eligible SPV should be solely for the purposes of holding and administering an EPC, with no other trade or activities. More importantly, the SPV should be owned by a non-resident, whether wholly or jointly with others. In case one of the owners is a Hong Kong tax resident, the tax exemption will be limited to the profits attributable to the ownership of non-residents only.
3. Waiving the requirement of PE Funds to be managed by a “specified person”
Appointing a “specified person” to carry out or arrange transactions is no longer required for PE Funds, as long as the funds are a “qualifying fund” that falls within the following descriptions:-
- At all times after the final closing of sales of interests:-
- The number of investors exceeds 4; and
- The capital commitments made by investors, excluding the originator and its associates, exceed 90% of the aggregate capital commitments.
- The portion of the net proceeds arising out of the transactions of the fund to be received by the originator and its associates, after deducting the portion attributable to their capital contributions, is agreed under an agreement governing the operation of the fund to be an amount not exceeding 30% of the net proceeds.
4. Introducing additional anti-avoidance provision
To avoid abuse by resident investors by simply converting their taxable profits to non-taxable income via an offshore fund structure, additional anti-avoidance provision was introduced.
The original anti-avoidance provision deems profits of an exempted fund as assessable profits arising in or derived from Hong Kong if:-
- 30% or more of the beneficial interest in the exempted fund is held by a resident person; or
- any beneficial interest in the exempted fund is held by a resident person in the case where such exempted fund is the resident person’s associate.
The above thresholds also apply to the deeming provision under the new law.
It should be noted that the deeming provisions would not apply if the IRD is of the view that the beneficial interest in an exempt fund is “bona fide widely held”. The term “bona fide widely held” is not defined in the IRO but DIPN No. 20 states that a fund is “bona fide widely held” if it has:-
- more than 50 persons holding all of the units or shares in the fund; and
- more than 21 persons holding units or shares entitling, directly or indirectly, to 75%, or more, of the income or property of the fund.
To take advantage of the new profits tax exemption, offshore PE Funds and fund managers are strongly advised to review their / their clients’ investment portfolio. For a deeper discussion or any enquiry, please contact one of our members of the tax advisory team.
Joey Chan: firstname.lastname@example.org
Terence Siu: email@example.com
K.F. Yan: firstname.lastname@example.org
Disclaimer: This brochure is for reference only. Nothing herein shall be construed as legal advice to any person. Oldham, Li & Nie shall not be held liable for any loss and / or damage incurred by any person acting as a result of the materials contained in this brochure.