Hong Kong Hedge Funds Threaten Government

by Mary Swire, Tax-News.com, Hong Kong

10 April 2002

The row over taxation of Hong Kong offshore funds, including hedge funds, is stepping up, with the Inland Revenue Department continuing to demand income returns from the funds while fund managers threaten to decamp to other jurisdictions if the action doesn't stop.

There isn't much doubt that funds which don't comply with Hong Kong's regulatory investor protection regime are taxable on their Hong Kong-sourced income. This isn't a question of residence: profit from transactions which take place in Hong Kong, which would include stock market or futures transactions, is taxable in the SAR, unless the fund in question is regulated. Some of the funds now being attacked are registered in Hong Kong and others are not.

It is estimated there are about 200 such funds in Hong Kong, and about 100 of them have received letters from the Inland Revenue.

The Government has not previously attempted to impose the tax on fund transactions, no doubt realising that the fund management offices are very mobile, and could easily go to Singapore or elsewhere. Once the fund is managed outside Hong Kong, it would be practically impossible to collect any tax that was due. But with growing pressure on the SAR's budget, the Inland Revenue now doubtless feels obliged to seek tax collection whereever it can find it.

Investec Asset Management Asia managing director Stewart Aldcroft urged the Government to hold back: "Most advanced markets do not require offshore funds to pay tax. If Hong Kong does, it will definitely lose its competitiveness to its overseas counterparts," he said. "If the Inland Revenue [Department] does not suspend its action, it will force fund managers to leave Hong Kong, and it would ruin all the government efforts to make Hong Kong an international fund management centre."

The spat is taking place alongside the Government's consultation exercise aimed at permitting retail access to hedge funds, which would presumably imply that they are outside the tax net like their mutual fund peers.

Mr Aldcroft said in the longer term, the fund managers wanted the Government to change the law to allow offshore funds to be exempt from tax, as retail funds were. 2,314 funds authorised by the Securities and Futures Commission are exempt from profits tax.

A group of fund houses recently sent a letter to the Government to express their concern. It said: "The Inland Revenue Department now appears to be trying to subject offshore funds to Hong Kong profits tax by issuing profits tax returns and query letters to a number of offshore funds. Unquestionably, if these enforcement actions continue, large portions of the fund management industry will move out of Hong Kong.

"If large integrated financial groups' offshore hedge funds are subjected to Hong Kong profits tax, then it is unlikely they would view Hong Kong as a favourable place to do business for their entire fund management operation."

An Inland Revenue Department spokeswoman said the Government had never changed its policy, saying: "It should be stressed that the issue of tax returns by the department is to ascertain the profits tax position . . . is in accordance with the prevailing practice and tax policy." She added that the Government was considering submissions from interested parties lobbying for an extension of the exemption to cover non-qualified offshore funds.

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