Hong Kong 2023-24 Budget insights

With a view to strengthening Hong Kong’s asset management sector and Hong Kong’s profile as an international financial center, the Financial Secretary noted today that a legislative bill providing tax concessions for family-owned investment holding vehicles (FIHVs), managed by an eligible single-family office (ESFO), has already been introduced into the Legislative Council. The bill is currently being scrutinized by a Bills Committee of the Legislative Council.
 

Under the existing Unified Fund Exemption (UFE) regime contained in the Inland Revenue Ordinance (IRO), Hong Kong is already competitive as a preferred location for fund operations in the region.
 

Generally, under the UFE regime, the investment income (including incidental income subject to a 5% threshold) of a fund as a collective investment scheme, regardless of its residence, is tax exempt in Hong Kong provided that certain specified conditions are satisfied. This exemption would also extend to special purpose entities (SPEs) employed by such funds in their investment holding structures, e.g., an investment in an investee private company.
 

However, funds owned by a family may not be eligible for the tax exemption under the UFE regime as they may not qualify as a collective investment scheme. Furthermore, even if they are eligible for the UFE regime, Hong Kong resident beneficiaries of such family-owned funds would potentially be subject to tax in Hong Kong under the deeming provisions of the UFE regime in respect of the tax-exempt profits of such family-owned funds.
 

It is for the above reasons that a dedicated tax concession regime for FIHVs managed by an ESFO is proposed to be introduced into Hong Kong by the bill.
 

Under the bill, similar to the concessionary tax treatment granted to funds under the UFE regime, investment income (including incidental income subject to a 5% threshold) earned from qualifying transactions by FIHVs and their SPEs will be taxed at a 0% concessionary tax rate.
 

The FIHVs and the EFSOs must be at least 95%, in aggregate, beneficially owned by one or more than one member of a family. Members of a family are widely defined to include a person’s spouse, lineal ancestors, lineal descendants and siblings of the person and the person’s spouse. FIHVs and ESFOs could be held by a discretionary trust for a family under certain conditions.
 

To be eligible for the proposed dedicated tax concession regime, the net asset value of assets specified in Schedule 16C to the IRO of all the FIHVs (including their SPEs) owned by a family that are managed by an ESFO to which the family is related, must be at least HK$240 million for a year of assessment.
 

However, two qualifying conditions for the proposed dedicated tax concession regime for FIHVs are more stringent than those for the UFE regime.
 

First, unlike the UFE regime which applies to both resident and non-resident funds, the central management and control or the tax residence of the FIHVs and ESFOs must be exercised in Hong Kong. FIHVs and ESFOs which are managed and controlled by non-resident individuals may therefore potentially be unable to demonstrate that their tax residence is in Hong Kong.
 

Second, while the UFE regime does not include any substantial activities requirement in terms of the fund or the fund manager (i) employing any number of full-time qualified employees in Hong Kong; and (ii) incurring any amount of annual operating expenditure in Hong Kong, the proposed dedicated tax concession regime for FIHVs requires each of the FIHVs concerned to employ at least two persons under (i) and incur at least HK$2 million under (ii). Furthermore, in addition to the above minimum threshold figures, the bill also imposes an overarching requirement that the number of persons employed, and the amount of annual operating expenditure incurred, are in the opinion of the Commissioner of Inland Revenue “adequate”.
 

In contrast, in terms of substantial activities requirement, generally speaking the UFE regime only requires that the qualifying transactions of a fund be carried out in Hong Kong by or through a specified person; or arranged in Hong Kong by a specified person, i.e., without imposing any minimum threshold in terms of either (i) and (ii) nor an overarching “adequate” requirement referred to above.  
 

Furthermore, where the investment activities of a number of FIHVs owned by a family are undertaken by a single ESFO, it is unclear how the Commissioner of Inland Revenue will attribute the number of persons employed by the ESFO, and the amount of annual operating expenditure incurred, to each FIHV in determining whether the substantial activities requirement is satisfied for each FIHV. This may create some uncertainties about the application of the dedicated tax concession regime for FIHVs.
 

Given the above, the government may need to consider whether further refinements to the bill can be made, or if the above issues could be addressed by way of administrative guidance issued by the IRD.

In October 2021, in order to tackle so-called base erosion and profit shifting (BEPS) risks arising from the digitalization of the economy, the Organization for Economic Co-operation and Development (OECD)/Group of Twenty (G20) announced a landmark international agreement for a two-pillar solution to reform international taxation rules starting from 2023, (commonly referred to as “BEPS 2.0”). Agreed by Hong Kong as well as over 135 other jurisdictions, the BEPS 2.0 framework represents one of the most ambitious international tax reform projects ever developed.
 

As part of BEPS 2.0, Pillar Two proposes global minimum tax mechanisms with the objective of subjecting multinational enterprise (MNE) groups whose annual revenues exceed €750 million to a minimum effective tax rate (ETR) of 15% on their profits in every jurisdiction where they operate. The Global Anti-Base Erosion (GloBE) rules – which comprise the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR) – are the primary mechanisms through which Pillar Two seeks to achieve this objective and consist of defensive tax measures that jurisdictions can adopt to collect additional tax (called “top-up tax”) on MNE groups doing business in low-tax jurisdictions.
 

Last August however, the Hong Kong Secretary for Financial Services and the Treasury (SFST) announced that, in line with the delay of the implementation of BEPS 2.0 – Pillar Two in other jurisdictions, Hong Kong would delay the implementation of the IIR from the original OECD timeline of 2023 to 2024 at the earliest. With respect to the UTPR and the possible adoption of a domestic minimum top-up tax (DMTT) in Hong Kong, the SFST stated that the Government would continue to monitor the implementation targets of other jurisdictions as regards those measures without providing any specific timeline.
 

Today, with the benefit of the additional documents issued by the OECD on safe harbor and penalty relief, the GloBE Information Return, and the OECD’s most recent publication addressing tax certainty and technical guidance under the Implementation Framework for the GloBE rules, the Financial Secretary announced that a public consultation will soon be launched on the intended implementation of BEPS 2.0 in Hong Kong in 2025.