Open-Ended Fund Companies: IRD Confirms Availability of Offshore Funds Exemption
Contrary to the belief of some tax practitioners, the Inland Revenue Department has confirmed that the offshore funds exemption is available to open-ended fund companies. There are no features inherent in open-ended fund companies which would make it impossible to relocate central management and control outside of Hong Kong. Given the lower costs, greater administrative convenience and lower legal risks associated with open-ended fund companies for asset managers based in Hong Kong, clarity as to the tax neutrality of open-ended fund companies re-affirms that open-ended fund companies are a compelling option for fund structures.
In our article “Tax Exemption for Open-Ended Fund Companies” in September, 2018, we wrote about the possibility of using the so-called “offshore funds exemption” (“Offshore Investment Vehicles Exemption”) under the Inland Revenue Ordinance (“IRO”), s. 20AC to exempt open-ended fund companies (“OFCs”) incorporated under the Securities and Futures Ordinance (“SFO”) from profits tax. Since that article, there has been ongoing debate as to whether or not this is the case. A number of tax practitioners have taken the view that this exemption is never available because the exemption requires that the “central management and control” of an OFC must be situated outside of Hong Kong and an OFC cannot so situate its “central management and control”.
Following a legal interpretation which we provided to the Inland Revenue Department (“IRD”) on the subject, the IRD have now confirmed that it is indeed possible for OFCs to qualify for the Offshore Investment Vehicles Exemption. The IRD stated:
“For privately offered OFCs, profits tax exemption can be available under section 20AC if the OFCs are offshore funds with their central management and control (CMC) located outside Hong Kong…”
Though our legal interpretation reviewed all the inherent features of OFCs which result in a Hong Kong nexus, there was no indication from the IRD that any feature inherent in OFCs which would disqualify OFCs from locating their “central management and control” outside Hong Kong.
The result is that it is possible today for OFCs to qualify for tax exemption on the same basis as Cayman and other offshore funds (i.e. under the Offshore Investment Vehicles Exemption).
Given that the Hong Kong government tabled legislation on December 7, 2018 to revamp the Offshore Investment Vehicles Exemption (see our article “Private Funds Tax Exemption: New Legislation to Re-Center Hong Kong as an Asset Management Center”) so as to re-affirm that OFCs and Cayman and other offshore funds will be exempted from profits tax on the same basis and without the need for non-residency, it is clear that there should be no concerns as to the tax neutrality of OFCs, whether now or in the future.
With OFCs offering Hong Kong based asset managers a single unified legal regime under Hong Kong law, a more robust framework for segregation of assets and liabilities than that available in offshore structures and lower overall legal, compliance and administration costs, confirmation as to tax neutrality provides a compelling case for the adoption of OFCs.