Executive summary
Under the current tax regime, Hong Kong’s profits tax exemption1 is only offered to non-Hong Kong resident privately-offered funds. However, to fully qualify for the profits tax exemption, non-Hong Kong resident funds are prohibited from investing in private companies incorporated in Hong Kong.
The exclusion of resident privately-offered funds and the prohibition on investing in local private companies were identified as a harmful tax practice by the European Union (EU) because of ring-fencing.
To address the ring-fencing concerns, the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Bill 2018 (the Bill) was issued on 7 December 2018 to introduce a unified exemption regime for all funds.
This Alert summarizes the key provisions of the Bill.
Detailed discussion
Removing ring-fencing features
The Bill proposes that regardless of the residence, size and type, where an entity: (i) qualifies as a “fund” as defined; and (ii) has engaged a “specified person”2 to arrange or carry out its transactions or has a “qualifying fund” status,3 the entity will be exempt from Hong Kong’s profits tax on certain transactions.
Under the Bill, a fund or a special purpose entity (SPE) will not be taxed on its profits arising from the transaction in a private company, irrespective of the country of its incorporation, if the following tests are met:
- Immovable property test: the fund or SPE does not invest in a private company that holds directly or indirectly more than 10% of its assets in immovable property4 in Hong Kong and shares in other private companies with direct or indirect holding of immovable property in Hong Kong.
Once the above immovable property test is satisfied, the fund or SPE must also satisfy one of the following two tests:
- Holding period test: the investment in the private company has been held by the fund or SPE for at least two years, whether or not the fund or SPE has control over the private company.
- Short-term assets test: (i) the fund or SPE does not have a controlling interest in the private company; or (ii) the fund or SPE has a controlling interest in the private company, but the latter does not hold (directly or indirectly) short-term asset value in the aggregate exceeding 50% of the value of the total assets of the private company.
Removing tainting features
Under the existing exemption regime, a single non-specified transaction would cause income derived from specified transactions of a nonresident person to be taxable in Hong Kong when such income would otherwise be exempt (the “tainting” provision).
The proposed unified exemption regime does not include the “tainting” provision; accordingly, the tax-exempt profits of a fund or a SPE will not be tainted by disqualifying transactions.
No change to non-fund entities’ qualification to tax exempt status
Under the proposed exemption regime, only the entity qualifying as a “fund” could be exempt from tax whereas under the current exemption regime, nonresident persons that satisfy the exemption conditions would be eligible for tax exemption, regardless of whether they are established as “funds.”
To avoid impacting those non-fund entities, the Bill proposes to retain the current tax exemption regime for the non-fund entities.
