Date
19 November 2017
Hong Kong cannot take its position for granted in Asian private-equity industry as Singapore is going all out to woo new players. Credit: HKEJ
Hong Kong cannot take its position for granted in Asian private-equity industry as Singapore is going all out to woo new players. Credit: HKEJ

HK moves closer to profits tax exemption for offshore PE funds

Hong Kong has taken a step forward in strengthening its position as a key private-equity (PE) hub in the region.

On Friday, the government gazetted the Inland Revenue (Amendment) Bill 2015 that seeks to extend to PE funds the profits tax exemption that is granted for offshore funds.

John Levack, chairman of the technical committee at Hong Kong Venture Capital and Private Equity Association (HKVCA), welcomed the move, saying that the administration is on the right track in promoting the PE industry.

“Hong Kong is adjusting its treatment of investment funds, as other fund hubs have done, to remain competitive in an attractive part of fund management sector,” Levack told EJ Insight.

Hong Kong has become a major hub for PE players in Asia, with the city’s efficient capital markets, deep professional talent and proximity to mainland China driving the growth in recent years.

But the city’s position has come under threat recently as rival Singapore is pulling out all stops to become the preferred base in the region, Levack earlier told EJ Insight in an exclusive interview.

“If we don’t get it right, our friends in Singapore will eat our lunch” he said.

That said, the government is trying to improve the situation and trying to resolve some weaknesses, he said.

The new rules, to be introduced into the Legislative Council on March 25, are expected to attract more PE managers to set up or expand their business in Hong Kong and drive demand, creating jobs for relevant professional services.

Challenges

For many years, offshore PE firms had enjoyed Hong Kong’s friendly tax arrangements and its double taxation avoidance treaties with other countries.

But now, as several Asian countries are tightening the Double Taxation Agreement (DTA) rules, there is new uncertainty over taxation issues, which could threaten Hong Kong’s position as the regional PE hub.

Levack said that any PE firm setting up a new fund now has to study the potential benefits of establishing a legal vehicle in Singapore.

But any churn will be gradual, he said, noting that PE players normally establish new funds every 3 to 5 years.

As of the end of 2014, total capital under management in PE funds in Hong Kong reached US$114.6 billion, a 16 percent increase from the US$99 billion recorded by the end of 2013, and accounting for 21 percent of the figure for Asia, according to official Hong Kong data.

Meanwhile, the industry in Singapore has been growing rapidly after its government unveiled a series of tax benefits, among other preferential policies, about four years ago.

Data from the Monetary Authority of Singapore show a 33.6 percent year-on-year growth in overall assets under management in PE funds in the city as of the end of 2013, amounting to S$74.7 billion (US$53.7billion).

Delicate balance

Levack noted that, typically an offshore PE fund gets itself registered in places such as Cayman Islands to consolidate a number of fund investors into one vehicle, and then make investments in companies in third countries through special purpose vehicles (SPV) based in Hong Kong or elsewhere.

At the operational level, most of the actual fund managers, who are also based in Hong Kong, can only “advise” a nominal fund manager, ultimately controlled by the fund, in other countries to make investments.

Such structures allow the typical PE fund to benefit from direct access to Hong Kong’s first-rate professional services network; be eligible for Hong Kong’s profit tax exemption for offshore funds (the SPV is recognized as an intermediary, thus the fund keeps the offshore identity); and to enjoy tax benefits in destination countries which have DTA agreements with Hong Kong, Levack explained.

With a growing number of Asian countries now saying that tax treaty benefits will be applied only to investors that have “substance” in the jurisdiction from which they are investing, “it has been an extremely delicate balance to determine what is the right amount of activity or people… to put in an SPV,” he said.

Too much “substance” may put the SPVs at risk of being taxed by Hong Kong authorities, while too little may weaken their claims to DTA benefits.

Opportunities

The significance of the new rules is that it will allow managers of PE funds to be based in the city without jeopardizing the funds’ offshore status. This will help boost development of the local PE industry further.

Putting Hong Kong’s PE industry in a wider perspective, the assets under management (AUM) of US$99 billion in PE funds by the end of 2013 represented only a very small part of the total HK$16 trillion (US$2.06 trillion) combined fund management business in Hong Kong at the time.

Levack says the next step — a view which he believes is shared by the government — will be to lure funds (encompassing mutual and hedge funds, as well as private-equity) into establishing onshore legal entities in Hong Kong.

Given the fast-growing outbound investment by Chinese companies, Levack said it’s reasonable to expect that mainland PE firms, many of which are state-backed, would prefer to establish funds in Hong Kong, instead of places like Cayman Islands.

But for this to happen, we do need to upgrade our structures, such as Limited Partnership laws, obtain tax clarity and tailor the regulatory oversight for PE, he said.

Overall, Hong Kong’s PE industry is still in a good position in terms of scale, professional services networks and favorable geographic location, Levack said.

However, the city needs to put in more efforts to consolidate its position and ward off the challenge from Singapore, he said.

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MY/JP/RC

EJ Insight reporter

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