In this Focusing on Funds, we look at Hong Kong as a Super Connector for China, facilitating the flow of capital between China and the rest of the world with a particular emphasis on how Hong Kong has developed its local fund offering through a series of legal, regulatory and tax changes.
CMS welcomes the authors of this briefing: Paul Moloney is a new partner and Gigi Ma is a new senior associate who have joined CMS in Hong Kong earlier this year. They bolster our funds and regulatory capability in Asia and complement our strong European funds practice. They are a well-established team advising on private fund formation, public fund registration, regulatory issues and also digital assets. They are happy to help and advise our funds clients and contacts.
Hong Kong has long been recognised as the gateway between China and the global economy due to its strategic geographic location and business-friendly policies.
In the funds arena, however, the Cayman Islands has historically been the dominant choice of fund domicile for asset managers seeking to invest into Hong Kong and China and from Hong Kong and China into the rest of the world.
When an asset manager is evaluating a fund domicile, it will evaluate Hong Kong in the same way it would any of Hong Kong’s competitor fund domiciles and will consider the range of fund structures available, the tax, legal and regulatory environment, its investors requirements and the strength and experience of local service providers.
The Hong Kong funds landscape has however evolved considerably in recent years with the emergence of new onshore structures (see below) available to managers based in Hong Kong as part of the Hong Kong government’s determined efforts in the recent years to reinforce the city’s standing as a premier asset management hub.
This briefing focuses on the private funds arena. However, China has also gradually opened up its broader financial market to greater foreign participation and continuously encourages two-way flow of capital through the development of a number of schemes allowing access to capital markets, trading and certain financial products. Notable schemes include the QFII regime and the Connect Programmes.
Aligning the fund domicile with the manager’s economic substance
As the legal, regulatory and tax environments globally have evolved in recent years, we have seen a renewed focus by governments on clamping down on structuring which seeks to artificially route profits to low tax jurisdictions where companies traditionally had very little economic substance. As the offshore jurisdictions have steadily implemented economic substance requirements in the face of global pressure, we have seen asset managers in Hong Kong choose to align the domicile of their fund structure with where they have the bulk of their economic substance, typically Hong Kong. The benefits include:
- one regulatory regime - operating under a single regulatory framework simplifies compliance requirements and reporting, thereby eliminating the complexities of navigating multiple regulatory environments;
- one tax system - remaining within a unified tax system avoids the complications of cross-border tax implications, streamlining tax planning and filing;
- one time zone - operating in the same time zone facilitates seamless communication and coordination between the fund and manager, better alignment of business hours, thereby improving overall operational efficiency; and
- significant cost savings - avoiding the need for multiple service providers, thereby resulting in significant cost savings.
Onshore Hong Kong fund structures
In the private funds arena in Hong Kong, the emergence of the Hong Kong limited partnership fund (“LPF”) and the open-ended fund company (“OFC”) structures have been game changers for the industry.
LPF
The LPF regime was introduced in 2020. Given that the LPF legislation was closely modelled on the legislation governing Cayman Islands exempted limited partnerships, it quickly gained traction with private equity and venture capital managers. As of May 2024, the total number of LPFs in Hong Kong was 825.
These structures are well placed as vehicles to raise funds from Hong Kong and Chinese investors to invest globally or for overseas investors to invest in China and Asia due to their versatility and Hong Kong’s very business friendly environment. The LPF legislation also has not imposed any investment restrictions and LPFs are free to invest in real asset classes (real estate, debt, private equity and venture capital).
OFC
The OFC regime was first introduced in 2018 and despite its name, can also be closed-ended. After having undergone a series of revisions and enhancements over the years, the OFC has grown to become a fund structure which can very much hold its own against the segregated portfolio company, its counterpart in the Cayman Islands. The OFC continues to gain popularity, especially with hedge fund managers, as evidenced by the recent surge in number of OFCs being incorporated in recent years. As at 31 March 2024, total number of registered OFC was 302.
Key features and requirements of LPFs and OFCs
| LPF | OFC | |
|---|---|---|
| Key Features |
|
|
| In effect since | August 2020 | July 2018 |
| Level of regulation from regulator | The LPF regime is an opt-in registration scheme which does not require SFC authorisation or approval unless the LPF is targeted to the retail public. There is no requirement for SFC approval of offering document. | SFC’s approval required for change of name, appointment of key operators, creation of sub-funds and termination of OFC or sub-fund only. There is no requirement for SFC approval of offering document for private funds. |
| Government subsidy | None. | The Hong Kong Government first launched the grant scheme for subsidising the establishment of OFCs in May 2021. The initial grant scheme was for a period of three years until 9 May 2024. The OFC grant scheme has been extended for period of three years from 10 May 2024 to 9 May 2027. Under the extended scheme, an OFC can recover 70% of the eligible expenses paid to Hong Kong based service providers, subject to a cap of HK$500,000 (~GBP50,000) per private OFC and a maximum of three OFCs per investment manager. |
| Offering document | No requirement to file the offering document with the SFC or the Companies Registry. | Must be filed with the SFC as soon as practicable after issuance at the launch of the fund. In the case of changes (which includes changes to effect the creation of a new sub-fund), revised offering documents must be filed with the SFC within seven days from date of issuance. |
| Investment Manager (IM) | An LPF must appoint an IM (who may be the general partner or another person). No legal requirement for the IM to be licensed by the SFC but to the extent that the IM will conduct regulated business in Hong Kong, it will need to be SFC licensed. | An OFC must appoint an IM, which must be licensed by SFC for Type 9 (asset management) regulated activity. |
| Directors/GP | The LPF must appoint a GP, who may be a natural person who is at least 18 years old, a private Hong Kong company limited by shares, a registered non-Hong Kong company, a limited partnership registered under the Limited Partnerships Ordinance, a limited partnership fund or a non-Hong Kong limited partnership with or without legal personality. | At least 2 individual directors, at least 1 of whom must be an independent director (i.e. who must not be a director or employee of the custodian). A director who is not resident in Hong Kong must appoint a process agent in Hong Kong. |
| Custodian | No mandatory requirement to appoint a custodian but usually a fund will appoint a custodian to hold its assets. | An OFC must appoint a separate legal entity to act as a custodian and all scheme property must be entrusted to a custodian for safekeeping. The custodian must be a licensed corporation or registered institution licensed or registered for Type 1 regulated activity which meets eligibility criteria under 7.1(b)(ii) of the OFC Code. |
| Auditor | The OFC/LPF must appoint an auditor. The OFC/LPF must prepare an audited annual report for each financial year. | |
| Minimum investment | None. However, the offering documents of an LPF may not be issued generally and must avail of an exemption from authorisation under the SFO, such as the offering documents are or are intended to be disposed of only to professional investors. | None. However, a private OFC cannot be offered to the public generally and must avail of an exemption from authorisation under CWUMPO. The usual exemptions that apply are:
|
| Confidentiality | Companies Registry maintains an index of the identity and particulars of the LPF, current and former GP(s), Authorised Representative(s) (if applicable) and IM(s). Identity of the limited partners will not be available for public inspection. The register of partners will be kept by the LPF itself at its registered office or any other place Hong Kong made known to the Registrar. | Companies Registry maintains a public register of OFCs including: (i) name of OFC; (ii) certificate(s) of incorporation for each OFC, and (iii) corporate filings for each OFC. Register of shareholders is not public information but may be inspected by (i) a shareholder as to his/her own shareholding, (ii) custodian or the investment manager, or (iii) the SFC and other public bodies. Register of directors may be inspected by any person. |
| Investment restrictions | None. | |
| AML/CTF obligations | The fund will need to appoint a responsible person to carry out AML/CTF functions. The responsible person must be an authorised institution, a licensed corporation, an accounting professional or a legal professional. | |
Hong Kong’s Tax Competitiveness?
With the rise of the Common Reporting Standards (CRS) to combat tax evasion, businesses are no longer looking to pay no tax, but are looking to pay low tax. Against this background, over the years, there has been a significant drop in the use of offshore managers and a surge of Hong Kong-based managers. There is no capital gain tax nor GST/VAT in Hong Kong and Hong Kong has a low corporate tax rate of 16.5%. Furthermore, transfers of Hong Kong stocks are subject to relatively low stamp duty of 0.1% from each of the buyer and seller.
To make Hong Kong even more fiscally attractive, the government has in recent years introduced a number of tax concession regimes to attract fund managers.
1. Unified Funds Tax Exemption
The Unified Funds Tax Exemption was introduced in 2019 and aims to exempt funds from Hong Kong profits tax. The exemption applies regardless of the fund structure, location of the fund’s central management and control, fund size or fund purpose so long as certain prescribed conditions are satisfied. To be eligible, the following key eligibility requirements must be met:
- The entity must qualify as a “fund”.
- The assessable profits must be derived from transactions in specified assets (which includes most common investments such as securities, shares, stocks, bonds and funds but does not include direct real estate) and “incidental transactions” subject to a 5% threshold. Specified assets do not need to be located in Hong Kong.
- The qualifying transactions are carried out or arranged in Hong Kong by a “specified person”; alternatively, the fund must be a qualified investment fund.
2. Carried Interest Tax Concession
After much deliberation with market participants, the Tax Concession for Carried Interest was introduced in 2021. This concessional tax treatment applies a tax rate of 0% to eligible carried interest arising from in-scope transactions distributed by a fund to a qualifying person (i.e. an investment manager).
Carried interest accrued to a qualifying employee who is employed by the qualifying person and provides investment management services in Hong Kong on behalf of the qualifying person for a fund would also be excluded from assessable employment income for the calculation of salaries tax.
The qualifying person would need to meet the substantial activities requirements, including hiring an adequate number of full time qualified employees and incurring an adequate amount of operating expenditure for carrying out the core income generating activities.
The tax treatment of a recipient outside Hong Kong will still need to be considered according to that person’s tax position elsewhere for the above concessions.
3. Profits Tax Concessions for Single Family Offices (“SFOs”)
More recently, to further grow the wealth and asset management industry, the government introduced another profits tax concession for family wealth. This will be of particular relevance to local Hong Kong and Chinese family wealth. It applies to a structure which has an SFO and a family-owned investment holding vehicle (“FIHV”) under which assessable profits of FIHVs arising from transactions in qualifying assets (which covers most common investments such as securities, bonds and funds but does not include direct real estate) and transactions incidental to the carrying out of qualifying transactions (incidental transactions), subject to a 5% threshold, would be eligible for profits tax concessions, so long as certain conditions are met (see table 2).
Table 2: Tax Concessions for SFO structures. Eligibility requirements:
| Table 3: Key features of the Tax Concession for SFOs
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How we can help
As Hong Kong’s popularity as an asset management hub continues to grow, we are well-positioned to help investors and fund managers to take advantage of the emerging business opportunities arising from further strengthening of the linkage between China and Hong Kong. Our understanding of the regulatory environment allows us to advise fund managers to set up their regulated business in Hong Kong, at the same time, our expertise in the funds space allows us to support investors and fund managers to structure and establish their fund vehicles.
Please do not hesitate to reach out to us to discuss how we may assist you.
The information in this briefing is for general purposes and does not purport to constitute legal or professional advice.
