Hong Kong Tax Concessions Succeed in Drawing Family Offices

Hong Kong Tax Concessions Succeed in Drawing Family Offices

The Hong Kong government’s FamilyOfficeHK team revealed in an August interview with the AsianInvestor that the newly introduced tax concessions for family offices had driven interest in the set up of family offices in Hong Kong, with 30 family offices setting up in Hong Kong this year amid the team receiving 100 enquiries to do so.

Originally announced in February, 2022 as part of the Hong Kong government’s initiative to strengthen Hong Kong as an asset management hub, the Hong Kong Proposed Tax Concession for Family Offices have a retroactive effect beginning from April 1, 2022 (i.e. from the 2022-23 tax year), even though legislation to bring the concessions into law was only passed in May, 2023.

FAMILY OFFICE SET UP

As contemplated by the Inland Revenue (Amendment) (Tax Concessions for Family-owned Investment Holdings Vehicles) Ordinance, a family wishing to take advantage of the tax concession will establish a single family office that meets certain criteria, known as an eligible single family office (“ESF Office”), to manage family assets and will hold family assets through one or more qualifying investment vehicles, known as family-owned investment holding vehicles (“FIHVs”). Similar to the tax exemption for investment funds (“Unified Funds Exemption”) and the carried interest tax concession, the final legislation provides that profits tax will be charged at a zero percent concessionary rate on the assessable profits earned by an FIHV from qualifying transactions and transactions incidental thereto if 2 conditions are satisfied:

• Hong Kong Presence - The FIHV is “normally managed or controlled in Hong Kong” during the basis period; and

• Execution via ESF Office - The qualifying transactions are “carried out” or “arranged” in Hong Kong by or through an ESF Office.

ELIGIBLE TRANSACTIONS

Transactions eligible for taxation at the zero concessionary rate are the same as those eligible for exemption under the Unified Funds Exemption, meaning that to be regarded as “qualifying transactions”, transactions must be in prescribed classes of assets (“Schedule 16C Assets”), namely securities, futures contracts, foreign exchange contracts, foreign currencies, deposits, exchange-traded commodities and OTC derivative products. Securities includes shares and bonds issued by a private company.

Profits from transactions which are not “qualifying transactions” may still be eligible for the zero concessionary rate if they are incidental to the carrying out of qualifying transactions. However, if the FIHV’s trading receipts from such incidental transactions exceed 5% of the total of its trading receipts from both qualifying transactions and incidental transactions in the basis period, the FIHV ceases entirely to be eligible for the zero concessionary rate during the basis period.

ELIGIBLE SINGLE FAMILY OFFICE

An FIHV is only eligible for the zero concessionary rate on qualifying transaction which are carried out or arranged in Hong Kong by an ESF Office, thereby encouraging wealth management activities in Hong Kong. In broad terms, the team a family uses to manage its assets will qualify as an ESF Office only if the team is housed in a private company which is owned by the family and which predominantly focuses on managing the family’s own assets from Hong Kong.

FAMILY OWNERSHIP FOCUS

At least 95% of the beneficial interest of an ESF Office must be (directly or indirectly) held by members of the same family (unless a charitable entity holds a beneficial interest in the ESF Office).

HONG KONG FOCUS

An ESF Office must provide services to specified persons of a family. An FIHV is eligible only for the zero tax concessionary rate if an ESF Office manages the FIHV, meaning that it provides the following types of investment services:

• Conducting research and advising on any potential investments to be made by the FIHV; 

• Acquiring, holding, managing or disposing of property for the FIHV; and

• Establishing or administering a family-owned special purpose entity (“FSPE”) for holding and administering one or more underlying investments of the FIHV.

An ESF Office must be normally managed or controlled in Hong Kong. The ESF Office must carry out its investment activities in Hong Kong. It must maintain at least 2 qualified full-time employees and incur not less than HK$2 million operating expenditures per year in Hong Kong when carrying out these activities.

Separate questions may arise as to whether ESF Offices will need to be licensed with the SFC.

The fees charged by an ESF Office for its investment services must be chargeable to profits tax. The aggregate management profits of the ESF Office derived from services to specified persons (including a related FIHV and FSPE) of the family should be more than or equal to 75% of the ESF Office’s profits from all sources in Hong Kong. The 75% test can be met in a single year or as an average across 2 or 3 years. The measure is consistent with the Hong Kong government’s approach to encouraging asset management and wealth management activities, namely to exempt investment vehicles managed from Hong Kong from profits tax but to subject the management activities themselves to profits tax.

Minimum Net Asset Value Under Management

An ESF Office must manage Schedule 16C assets of an aggregate net asset value of not less than HK$240 million (or the equivalent in foreign currency).

Assets which do not qualify as Schedule 16C assets (e.g. real estate) do not count towards the minimum net asset value requirement. Both assets and liabilities must be taken into account to ascertain a net asset value position and the Commissioner of Inland Revenue may specify how the net asset value will be calculated. In calculating the aggregate value, the net asset values of all FIHVs which are managed by the ESF Office and which have elected to be eligible for the zero concessionary tax rate are combined.

Schedule 16C assets held through holding companies count towards the net asset value calculation but only to the extent such holding companies are beneficially owned by the FIHV.

The minimum net asset value test can be met at the end of the current basis period or the end of each of the 2 basis periods immediately before the current basis period so long as the ESF office was established during those periods.

Maximum Number of FIHVs

Each ESF Office of a family can only manage up to 50 FIHVs which have made an election to be eligible for the zero rate tax concession.

ELIGIBLE FAMILY INVESTMENT HOLDING VEHICLE

Family Office Investing Structure

The FIHV must be any entity, including a partnership, corporation or trust. It may be established in or outside of Hong Kong.

The inclusion of a trust as a type of entity is unusual. The law does not regard a trust as a legal person. Instead, the law regards the trustee rather than the trust as the owner of trust assets and the trust is merely an arrangement in respect of the holding of those assets.

Existing family trusts in Hong Kong may wish to consider whether the new zero rate tax concession may offer substantial tax savings.

Business Activity

To be eligible for the zero tax concessionary rate, an FIHV must not be a business engaging in general commercial or industrial activities.

Ownership

To be eligible for the zero tax concessionary rate, at least 95% of the beneficial interest of an FIHV must be held by members of a single family. The 95% threshold is relaxed if a charitable entity holds an interest in the FIHV.

Election

An FIHV is eligible for the zero rate tax concession only if it has made an election to be eligible for the concession. The election is irrevocable. Once the election is made, it will apply to all subsequent years of assessment.

INVESTMENT PORTFOLIO RESTRICTIONS

De Minimis Real Estate

If, during a basis period, an FIHV transacts in shares and bonds of a private company which holds immovable property and:

• the aggregate value of the immovable property and the company’s share capital exceeds 10% of the value of the company’s assets, the zero tax concessionary rate is inapplicable to assessable profits from those transactions; or

• the aggregate value of the immovable property and the company’s share capital is 10% or less of the value of the company’s assets, the zero tax concessionary rate will apply to assessable profits on those transactions only available if: (i) the FIHV held the shares or bonds of the private company for at least 2 years or, (ii) failing that, the FIHV does NOT have control over the private company or, (iii) failing that, the short-term assets of the company account for less than 50% of the company’s assets.

• “Short-term assets” means assets that are neither immovable property nor Schedule 16C assets and that are held for less than 3 years.

No Real Estate

If, during a basis period, an FIHV transacts in shares and bonds of a private company which holds neither immovable property nor shares of another private company which holds immovable property, whether directly or indirectly, the zero tax concessionary rate will apply to the assessable profits from those transactions only if:

• the FIHV held the shares or bonds of the private company for at least 2 years or,

• failing that, the FIHV does NOT have control over the private company or,

• failing that, the short-term assets of the company account for less than 50% of the company’s assets.

TAX CONCESSION FOR HOLDING COMPANIES

The zero tax concessionary rate applies not only to assessable profits FIHVs but also to that proportion of assessable profits of an eligible FPSE which are earned from specified transactions and which are commensurate with an FIHV’s beneficial interest in the FPSE in that year of assessment.

Eligible Specified Transactions

FPSE transactions which are eligible for tax relief include transactions in shares and bonds issued by an investee private company or an interposed FPSE (“IFPSE”), transactions in rights, options or interests in such shares and bonds and transactions in Schedule 16C assets. An “investee private company” is a private company whose shares are held by an FSPE or IFSPE for an FIHV. An IFSPE is an FPSE which is interposed between an FPSE and an investee private company.

Where an FPSE transacts in shares and bonds of a private company which holds (i) immovable property in Hong Kong, or (ii) share capital of another private company which holds immovable property, the assessable profits from such transactions are ineligible for the zero tax concessionary rate if:

• the aggregate value of the immovable property and share capital held by the company exceeds 10% of the value of the company’s assets; and

• even though the aggregate value of the immovable property and share capital held by the company is 10% or less of the value of the company’s assets, the company has not held such shares or bonds for at least 2 years and either (i) the FPSE does not have control over the company, or (ii) if the FPSE has control over the company, the company holds short-term assets which do not exceed 50% of the company’s assets.

Where an FPSE transacts in shares and bonds of a private company which holds neither immovable property in Hong Kong nor share capital of another private company which holds immovable property in Hong Kong, whether directly or indirectly, the assessable profits from such transactions are ineligible for the zero tax concessionary rate unless the FPSE has held the shares or bonds for at least 2 years; or failing that, the FPSE has no control over the company, or failing that, the company holds short-term assets the aggregate value of which does not exceed 50% of the company’s assets.

Eligible FPSEs

An FPSE is eligible for the zero tax concessionary rate if it is an entity in which an FIHV has a beneficial interest which is established solely to hold investee private companies or to hold Schedule 16C assets.

ANTI-ROUND TRIPPING

Anti-round tripping provisions aim to ensure that only individual family members and their FIHVs and FPSEs benefit from the zero rate tax concession.

FIHVs

Under the anti-round tripping provisions, unless exempted, a Hong Kong tax resident who is not an individual and who benefits from the zero rate tax concession on assessable profits earned by an FIHV will be subject to profits tax on those assessable profits to the extent of its interest in the FIHV if:

• the resident has, either alone or jointly with his associates, a beneficial interest in the FIHV of 30% or more; or

• the FIHV is an associate of the resident.

FPSEs

Similarly, where a Hong Kong tax resident has a not less than 30% beneficial interest in an FIHV, the FIHV has a beneficial interest in an FPSE and the FPSE benefits from the zero rate tax concession, the assessable profits of the FPSE which benefit from the zero rate tax concession are to be taxable as assessable profits of the Hong Kong tax resident if either:

• The FIHV itself benefits from the zero rate tax concession; or

• The FIHV is an associate of the resident person.

Tax Resident

For the purpose of the round tripping provisions, there are 3 types of tax residents which may be subject to profits tax on the assessable profits which otherwise benefit from the tax concession, namely corporations who are not trustees, partnerships who are not trustees and trustees. In each case, the person will be resident in Hong Kong for tax purposes if the central management and control of the person is exercised in Hong Kong.

Exempt Hong Kong Tax Residents

The following 3 types of non-individual Hong Kong tax residents are exempt from the anti-round tripping provisions:

• Holding vehicles, known as specified entities, by which a family holds a beneficial interest in an FIHV;

• Trustee of a trust that is a specified entity; and

• An ESF Office that manages the FIHV.

For these purposes, a “specified entity” in relation to the family to which an FIHV is related is an entity that falls into either of the below categories:

• The entity must be an entity, whether by itself or through a series of entities, by which a member of the family holds an indirect beneficial interest in the FIHV.

• The entity holds a 100% direct or indirect beneficial interest in the FIHV and members of the family have at least a 95% direct or indirect beneficial indirect in the entity.

A specified entity must be a special purpose holding entity. It cannot be a business undertaking for general commercial or industrial purposes and cannot carry on any trade or business.

Family members themselves are not subject to the anti-round-tripping provisions.

Associate

For this purpose, in broad terms, an “associate” includes:

• In the case of a Hong Kong tax resident which is a corporation (but which is not a trustee of. a trust), a person who controls the corporation and a director of the corporation and relatives of that person or director.

• In the case of a Hong Kong tax resident which is a trustee of a trust, a settlor, a protector, an enforcer or a beneficiary of the trust.

ANTI-TAX AVOIDANCE

The Commissioner of Inland Revenue has the discretion to determine certain types of arrangements as being abusive and to deny tax benefits which otherwise might arise from the zero tax concessionary rate. These anti-avoidance of provisions are unusual in that they give the Commissioner of Inland Revenue broad discretion to make an avoidance determination.

Arrangements Main Purpose of Which to Obtain Tax Benefit

The Commissioner of Inland Revenue has the discretion to determine whether a main purpose of any arrangement in which an FIHV or FPSE enters is to obtain a tax benefit, whether for the FIHV or FPSE, as the case may be, or another person. On such a determination, the zero tax concessionary rate will not apply to assessable profits arising from such an arrangement. For this purpose, a “tax benefit” means an avoidance, postponement or reduction of liability to pay tax.

Non-Arm’s Length Property Transfers

Where assets are transferred from a person carrying on a business in Hong Kong to an FIHV and the income of that person in relation to the transferred assets would have been subject to profits tax, then assessable profits of the FIHV arising from the transfer may be ineligible for the zero rate tax concession unless the transfer is carried out on an arm’s length basis and assessable profits from the transfer are chargeable to profits tax.