HK targets China funds as domicile

Industry groups have submitted to CY Leung a tax exemption proposal for fund domiciles, something that could pull in China's GPs.

Implementation plans on how private equity firms can manage funds from Hong Kong and still benefit from tax exemptions — just as hedge funds and mutual funds currently do — have been sent to chief executive CY Leung and the Financial Services and Treasury Bureau, according to a statement from the Hong Kong Private Equity and Venture Capital Association. 

The proposal was announced in February, but the HKVCA and Hong Kong’s Financial Services Development Council  refined it to include recommendations on how it would work in practice.

The proposal is important because it would bring fund managers more clarity over how they will be taxed in Hong Kong, which has been trying to compete with Singapore as a private equity fund domicile.

If the tax exemption proposal was implemented, Hong Kong could target a growing number of Chinese investors keen to do outbound deals, John Levack, vice chairman of HKVCA, told Private Equity International.

“Many funds based in China that have been successful in a mainland role [are] now becoming more international. So many RMB fund managers have established dollar funds and are raising money from the international community. They are looking to be backing their Chinese [portfolio] companies in expanding outside China.”

Levack believes a number of institutions in China, such as banks and state-owned enterprises, want to set up international private equity funds to invest overseas and feel more confident doing so from Hong Kong than somewhere similar to the Cayman Islands.

“Actually where you would see immediate traction from a domiciled fund in Hong Kong is from China funds,” he said.

While the industry is watching developments closely, some believe it is too early to tell whether the implementation proposal is a significant development.

“I think it is significant if it is adopted, but the question will be whether it is adopted,” one Hong Kong-based lawyer told PEI, declining to comment further as it is too premature. He notes that other industry sources have also held off on commenting publicly on the legislation, taking a “wait-and-see” approach. 

The SAR is falling behind Singapore as an attractive fund domicile. In addition to lack of tax clarity, Hong Kong still does not have a number of key double tax treaties with countries such as Australia and India. 

Singapore, by comparison, has inked many key double tax treaties. It is also being used as a domicile through creative structures, something that Hong Kong should look into, sources said. 

“What is happening is that a quite a few firms are now creating Cayman [limited partnerships] and underneath that they have a ‘dropdown limited partnership’ so that their LPs invest into a limited partnership in Cayman, but that limited partnership puts an awful lot of its assets into a fund entity based in Singapore, which then makes the investments,” Levack added.

“There is no push from GPs to change the real domicile of the fund because their LPs are happy with Cayman at the moment. But they are having to do some more complicated structuring under the Cayman entity to get the benefit of the tax treaties.”