Hong Kong’s OFC regime to commence on July 30 2018

On March 29 2018, the Hong Kong government published the Inland Revenue (Amendment) (No 2) Ordinance 2018 (Ordinance) in the Gazette to extend the profits tax exemption to privately offered Hong Kong open-ended fund companies (OFCs).

The introduction of the OFC regime is a key initiative to help diversify Hong Kong's fund domiciliation platform and will be effective on July 30 2018. The key qualifying conditions for a privately offered OFC to enjoy the profits tax exemption include:

• The OFC must be a Hong Kong resident where the central management and control must be exercised in Hong Kong;

• The OFC must be non-closely held;

• The OFC must carry out transactions in asset classes permissible for privately offered OFCs as specified in the OFC code;

• The OFC's relevant transactions must be carried out through or arranged by a qualified person in Hong Kong; and

• The OFC's trading receipts from incidental transactions to the relevant transactions are subject to a 5% threshold.

There are also complex conditions in meeting the 'non-closely held' definition which includes the number of investors, the minimum investment and the participation interest of each investor. While this is a welcome incentive, its application may be limited due to several key restrictions. The key tax issues associated with the OFC regime include:

• The ordinance is silent on the stamp duty implications associated with an OFC. Under prevailing Hong Kong stamp duty law, the allotment and cancellation of Hong Kong stocks (e.g., shares of an OFC) are not subject to stamp duty. However, the transfer of stocks of an OFC would be subject to stamp duty;

• The OFC must continue to pass the non-closely held test for 24 months after the first 24-month grace period beginning from foundation of the company. If not, the OFC will be taxable retrospectively from its start-up date;

• The OFC can seek exemption from the Commission of Inland Revenue from meeting the non-closely held condition. However, there is no objective test for the Hong Kong tax authority to exercise its discretion;

• For carried interest distributions, there is a provision that deems dividends from a non-exempt OFC to be taxable to the extent they are in relation to services rendered in Hong Kong. It does not take into account any circumstances giving rise to a carry distribution in connection with an investment in the OFC; and

• The exemption does not apply to transactions in certain tainted assets, including gains on shares in companies where the underlying value includes Hong Kong real estate or significant 'short-term assets'.

The Hong Kong government recognises that the asset management industry is a fast-growing sector within the financial services industry. While this is another potentially welcome tax incentive that could promote Hong Kong as a potential fund domiciliation platform, the potentially onerous conditions that need to be satisfied in order to qualify for the tax exemption may limit its real world application.