Hong Kong Taxation FUNDS AND FUND MANAGEMENT Taxation of funds. Exemption for authorized or regulated funds. The first exemption applies to:

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1 Hong Kong Taxation FUNDS AND FUND MANAGEMENT Taxation of funds Funds, like other entities, are prima facie subject to Hong Kong tax (currently at the rate of 16.5 percent for the 2009/2010 year of assessment) on Hong Kong sourced profits attributable to a business carried on in Hong Kong. If any part of a fund s investment activities is in substance managed in Hong Kong, it could have a technical exposure to tax on its Hong Kong sourced profits from that activity unless it qualifies for one of the statutory exemptions. There are two specific exemptions available to funds which, subject to the relevant conditions being satisfied, operate to exempt certain or all of the fund s profits from tax in Hong Kong. Exemption for authorized or regulated funds The first exemption applies to: a mutual fund or unit trust authorized under the Securities and Futures Ordinance; or a mutual fund, unit trust, or similar collective investment vehicle which the Commissioner of Inland Revenue is satisfied is bona fide, widely held, and complies with the requirements of a supervisory authority within an acceptable regulatory regime. If the exemption applies, all profits of the fund will be exempt from profits tax to the extent that the profits arise from investment activities which are in accordance with the fund s constituent documents and the requirements of the regulatory regime under which it operates. Exemption for offshore funds The second exemption applies to a broader category of offshore funds and the legislation giving effect to the exemption was only enacted in March The legislation introduced two new provisions into the Inland Revenue Ordinance: an exemption provision and a deeming provision.

2 2 Hong Kong Taxation Broadly, the exemption provision operates to exempt an offshore fund from Hong Kong profits tax where the fund is a non-resident person (a company, individual, partnership, or trust) and derives its profits from certain qualifying transactions carried out through or arranged by specified persons. However, the exemption will not apply where a non-resident fund carried on any business in Hong Kong that involves any transaction other than the qualifying transactions and transactions incidental to these qualifying transactions. The definition of resident is central to the application of the exemption provision, as only a non-resident will qualify for the exemption. In the case of a corporation, partnership, or trust estate, the definition depends on where the relevant entity exercises its central management and control. The Inland Revenue Department has indicated that the central management and control requirement refers to the highest level of control of the entity concerned rather than day-to-day management of the entity. To prevent resident investors abusing the offshore funds exemption by disguising themselves as non-resident persons, the new legislation contains anti-avoidance provisions to counteract potential abuse. These provisions can operate to deem a resident investor to be taxable on the Hong Kong sourced profits of an exempt non-resident fund. These provisions will apply to a Hong Kong-resident investor having a beneficial interest of 30 percent or more (on an associate inclusive basis) in the non-resident fund or any beneficial interest (that is, no minimum threshold) in an associated non-resident fund. Where the deeming provision applies, it effectively looks through the fund structure to deem a resident investor in the exempt fund to be taxable on his share of the Hong Kong sourced trading profits derived by the exempt fund. The nonresident fund s tax position is unaffected. The exemption provision applies with retrospective effect to the year of assessment 1996/97. On the other hand, the deeming provision applies to the 2006/07 year of assessment onwards. Funds not specifically exempt For those funds that are not exempt and fall within the ambit of Hong Kong tax, such funds enjoy the general exemption from Hong Kong tax in respect of dividends, capital gains (but not speculative gains), certain interest income, and offshore sourced profits. The Hong Kong tax position of a fund is unaffected by whether or not the income of the fund is distributed. 3.2 Taxation of real estates investment trusts (REITs) The REITs Code offers retail investors an alternative investment choice to gain exposure to the Hong Kong property sector.

3 3 Hong Kong Taxation REITs must be structured in the form of a trust and must be listed in Hong Kong. The REITs Code sets out the following broad guidelines for establishing REITs in Hong Kong: The REIT must pay out at least 90 percent of the net income after tax. The REIT is required to hold investment properties for a period of no less than two years unless unitholders approve otherwise. The REIT cannot have debt funding in excess of 45 percent of the total gross value of its assets. The Code allows a REIT to hold real estate through special purpose vehicles (SPVs). Where the REIT utilizes SPVs to acquire properties, the SPVs would be subject to the profits tax provisions of the Inland Revenue Ordinance on the same basis as listed property companies. Under such structures, the dividends received by the REIT will be exempt from profits tax, and any distributions made by the REIT to unitholders will not be taxable in the hands of the unitholders. 3.3 Taxation of resident unitholders/investors in a resident fund There is no comprehensive income tax system in Hong Kong. Rather, taxation is imposed under three separate heads, being salaries tax on income from employment and pensions, profits tax on profits of a trade, business, or profession, and property tax on rental income. Any income falling outside the above heads of charge is not taxable. In addition, tax in Hong Kong is generally imposed only on Hong Kong sourced income. Individuals who invest in collective investment funds established in Hong Kong are not subject to tax on dividends or other distributions of either an income or capital nature as such receipts would generally not fall into any of the heads of charge to tax, unless considered to arise from a business carried on in Hong Kong. Even in such circumstances, the exemption from profits tax of dividends operates to ensure that no liability to tax arises to individuals. Non-distributed income or capital gains of a fund do not give rise to any tax liabilities for individual investors. Gains realized by an individual upon the disposal of units in a fund are taxable where they are considered to arise from a business of securities trading carried on in Hong Kong and are Hong Kong sourced. In this regard, if the units are bought and sold through a broker or other agent outside of Hong Kong, the profits therefore may be considered to be non-hong Kong sourced and therefore not taxable.

4 4 Hong Kong Taxation 3.4 Taxation of resident unitholders/investors in a non-resident fund As in the case of a resident fund, individuals who invest in collective investment funds established outside of Hong Kong are not subject to tax on dividends or other distributions of either income or capital as such receipts would generally not fall into any of the heads of charge to tax, unless considered to arise from a business carried on in Hong Kong. Even in such circumstances, as a matter of practice, the exemption from profits tax of dividend/territoriality principle operates to ensure that no liability to tax arises to the individuals. A credit for foreign taxes is generally not available in Hong Kong since income which suffers foreign tax is typically non-hong Kong sourced and is therefore not subject to Hong Kong tax. In the rare case where income subject to foreign tax is also taxable in Hong Kong, the foreign tax should qualify for deduction in limited circumstances. Non-distributed income or capital gains of a fund should not give rise to any tax liabilities for individual investors. However, one possible exception to this general rule is where the deeming provision in the offshore funds legislation operates to deem a resident individual investor having a certain level of beneficial interest in, or control over, an exempt fund to be taxable on a share of the fund s Hong Kong sourced trading profits. Gains realized by an individual upon the disposal of units in a fund are taxable only where they are considered to arise from a business of securities trading carried on in Hong Kong and are Hong Kong sourced. In this regard, if the units are bought and sold through a broker or other agent outside of Hong Kong, the profits therefore may be considered to be non-hong Kong sourced and therefore not taxable. 3.5 Taxation of non-resident unitholders/investors in a resident fund Non-resident unitholders are not liable to Hong Kong tax on distributions from Hong Kong unit trusts or mutual funds. Similarly, profits earned on the disposal of units or shares in a Hong Kong unit trust or mutual fund would not be subject to Hong Kong tax unless the regularity and mode of the transactions causes the investor to be treated as carrying on a business in Hong Kong (either directly or through an agent) of trading in securities. Even in such cases, an exemption may apply to certain non-resident investors whose funds are managed through an approved Hong Kong investment adviser or fund manager. Units in a Hong Kong unit trust or shares in a mutual fund, the share register of which is maintained in Hong Kong, will form part of the estate of a deceased unit holder/investor. Estate duty has been abolished in Hong Kong with effect from 11 February 2006.

5 5 Hong Kong Taxation 3.6 Taxation of fund management/custodian companies Fund management companies carrying on business in Hong Kong and in receipt of Hong Kong sourced income are liable to tax on such income at the rate of 16.5 percent. 3.7 Entitlement to income Distributions from unit trusts are not taxable in the hands of unitholders. 3.8 Double tax agreements Hong Kong has a comprehensive double tax agreement with Belgium, Thailand, Mainland China, Vietnam, and Luxembourg. The Hong Kong government is presently in the process of negotiating comprehensive double tax agreements with approximately 15 other countries. Further, Hong Kong has tax treaties which principally relate to shipping and airline income. 3.9 Other tax-favored vehicles There are no other significant tax favored vehicles Transfer taxes, stamp duty, and capital duty No Hong Kong stamp duty is payable by a fund when it executes transfers of overseas securities owned by it. To the extent that a fund undertakes the transfer of Hong Kong stock, stamp duty at the rate of HKD 1 per HKD 1,000 of the value of the stock is payable by both the vendor and purchaser, together with a fixed duty of HKD 5 on the instrument of transfer. No stamp duty is payable by an investor in respect of the issue or redemption of units. However, where the transfer of the units is not effected by the manager of the trust, stamp duty at the rate of HKD 1 per HKD 1,000 is payable by both the vendor and the purchaser in respect of sales and purchases of units in a Hong Kong unit trust or shares in a mutual fund (the share register of which is maintained in Hong Kong), together with a fixed duty of HKD 5 on the instrument of transfer. A fund organized as a Hong Kong incorporated company is liable to capital duty at a rate of HKD 1 per HKD 1,000 on the authorized capital of a mutual fund incorporated in Hong Kong, and on any increases therein, subject to a maximum of HKD 30,000 per transaction.

6 6 Hong Kong Taxation 3.11 Miscellaneous None KPMG in Hong Kong Darren Bowdern KPMG Tax Limited 8th Floor, Prince's Building 10 Chater Road Central Hong Kong Hong Kong Tel Fax The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

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