How will the amendments on OFC tax exemption address industry concerns?

It remains vague on issues other than ring-fencing and tax leakage.

The Financial Services and the Treasury Bureau’s (FSTB) recently proposed amendments to a bill which offers tax exemption to privately offered open-ended fund companies (OFC) is lauded as a move which will resolve ring-fencing and tax leakage concerns but still leaves a lot of room for improvement, according to accounting and professional services firm PwC.

The FSTB proposed to amend Inland Revenue No. 4 so that OFCs can conditionally enjoy tax exemption on its investment in private companies. 

Amongst the conditions include a provision stating that if an OFC or its sub-funds have controlling interest in an investee private company, 50% or more of the private company’s should be held for a minimum holding period of more than three years.

The rationale behind this is that the holding period may reduce the risk of tax abuse by onshore entities who engage in speculative activities. 

However, PwC notes in its tax news flash noted that the three-year minimum period is quite problematic and vague. 

“The newly imposed three-year minimum period is quite onerous since it is common for the assets of an operating company to turn around frequently even though it does not engage in speculative activities,” the firm said. 

The FSTB was also not clear on how the 50% and three-year tests apply in practice to start-up investee private companies whose balance sheets usually have fluctuating current assets. 

The FTSB’s also proposed to remove the 10% de minimis rule from the bill which would mean that OFCs transacting in permissible asset classes will not be taxed on profits arising from such
transactions. 

If it carries out “non-qualifying” transactions, the profits arising in or derived from a trade or business carried in Hong Kong will be subject to profits tax so that the tax exempted profits of the OFC will not be tainted.

However, PwC also observes that the removal of the 10% de minimis rule does not resolve the problem altogether. 

“Despite the removal of the 10% de minimis rule from the Bill, we consider the tainting effect remains since the same rule will be included in the OFC Code, and if violating the 10% rule would render the investment fund not being an OFC, the fund would still be subject to profits tax on all its investments unless the income / gain is offshore sourced and/or capital in nature,” the firm noted. 

Overall, the firm commends the amendments to address technical loopholes which give rise to ring-fencing and tax leakages but believes that the bill still needs further precision to better address industry concerns.

“Such conditions would render the regime less attractive and competitive and might not as enthusiastically embraced by the industry as it ought to be,” PwC concludes.