Proposed amendments to enhance the attractiveness of the family office tax concession
The Inland Revenue (Amendment) (Tax Concessions for Family-owned Investment Holding Vehicles) Bill 2022 (Bill)1, which was gazetted on 9 December 2022, seeks to introduce a 0% concessionary profits tax rate on assessable profits earned from qualifying and incidental transactions for an eligible family-owned investment holding vehicle (FIHV) managed by an eligible single family office (ESF Office) in Hong Kong (the latter subject to a 5% threshold). After taking into account the views and comments raised by the members of the Bills Committee and various deputations, the Hong Kong SAR government (the Government) has recently come up with a number of proposed Committee Stage Amendments (CSAs)2 to the Bill with a view to enhancing the attractiveness of the family office tax concession.
At the same time, the Government has also prepared a written response to the various issues raised by the professional deputations in their submissions.
This news flash summarises the proposed CSAs, the salient points of the Government’s responses and our observations.
In detail - The CSAs proposed by the government
Since the gazettal of the Bill on 9 December 2022, three Bills Committee meetings have been held to discuss the provisions in detail and written submissions have been made by various professional deputations, including PwC, to provide comments and suggestions on the Bill. After due consideration, the Government has recently proposed a number of CSAs to the Bill which centre on the following four issues:
(1) Centralmanagementandcontrol(CMC)ofESFOfficesandFIHVs The Government proposes to replace the CMC requirement with provisions that ESF Offices and FIHVs are required to be normally managed or controlled in Hong Kong (NMC requirement)3. The NMC requirement will provide more flexibility for families to exercise either the management or control of their ESF Offices / FIHVs in Hong Kong having regard to their operations.
(2) OwnershipofESFOfficesandFIHVs The Government proposes that a charitable institution or trust of a public character that is exempt from tax under section 88 of the Inland Revenue Ordinance (IRO) may have up to 25% of the beneficial interest (whether direct or indirect) in an ESF Office and / or an FIHV, subject to the conditions that:
(i) at least 75% of the beneficial interest in the ESF Office and / or FIHV must be held by family members; and
(ii) the total percentage of beneficial interest in the ESF Office and / or FIHV held by any unrelated person(s) (excluding the charitable institution or trust) does not exceed 5%.
Such proposed amendment aims to cater for families’ culture of philanthropy that ESF Offices and / or FIHVs may be held not only by family members but also charitable organisations (whether or not associated with the family members) having more than 5% of the beneficial interest in the ESF Offices and / or FIHVs.
(3) Specified trusts
The Government proposes to provide flexibility for considering holding structures of the ESF Office and / or FIHV involving specified trusts. Specifically, under section 8 of the Bill where one or more than one family member has an indirect beneficial interest through a specified trust in the ESF Office and / or FIHV which is not a specified trust (e.g. a corporation or a partnership), the specified trust is required to have 100% beneficial interest (whether direct or indirect) in the ESF Office and / or FIHV. It is now proposed that where the holding structures of the ESF Office and / or FIHV involve one or more than one specified trust that does not have 100% beneficial interest in the ESF Office and / or FIHV, a family member(s) will be taken to have fulfilled the 95% beneficial interest requirement for the ESF Office / FIHV concerned provided that the Commissioner of Inland Revenue is satisfied, after having regard to all the circumstances of the case particularly the relationship between the entities in the structure, that it is highly probable that one or more than one family member will have at least 95%, in aggregate, of the beneficial interest in the ESF Office / FIHV.
(4) Transactions in private companies by FIHVs and family-owned special purpose entities (FSPE)
The Government clarifies that the FIHV’s / FSPE’s qualifying transactions in (among other assets provided for in schedule 16C to the IRO) shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a private company will not be affected by any transactions in a private company failing to meet the relevant requirements (i.e. non-qualifying transactions that are ineligible for the proposed tax concession5). To provide certainty, the Government proposes to draft amendments to remove any misunderstanding of there being a tainting effect.
The Government's responses to the issues raised by the professional deputations
To address the issues raised by various professional deputations, in their submissions made to the Bills Committee, the Government has prepared a written response. The salient points, apart from those addressed through CSAs as discussed above, are summarised below:
‘Spouse’ is not specifically defined in the Bill and will be interpreted in accordance with its definition under the existing section 2(1) of the IRO, which does not include ‘common law spouse’.
‘Entity’ is defined in the Bill to mean a body of persons (corporate or unincorporate) or a legal arrangement, and includes a corporation, a partnership and a trust. It is clarified that ‘foundation’ is a legal arrangement and hence included in this definition.
The Bill provides that an FIHV is ‘not a business undertaking for general commercial or industrial purposes’ mentioned in section 20AM(6) of the IRO. It is clarified that an entity engaging in investment holding as managed by an ESF Office and meeting the relevant conditions specified in the Bill will be regarded as an FIHV eligible for the proposed tax concession.
An FIHV is permitted to outsource its core income generating activities that must be carried out in Hong Kong to an ESF Office, provided that the use of outsourcing is not for circumventing the ‘substantial activities requirement’.
The assessable profits of an ESF Office arising from the provision of services to an FIHV have to be computed based on the arm’s length principle pursuant to the transfer pricing rules under section 50AAF of the IRO.
Given that an ESF Office is required to carry out qualifying transactions or arrange to carry out such transactions for an FIHV in Hong Kong, and also to provide investment services to the FIHV in Hong Kong, the Government considers that it would be very unlikely that the fees derived by an ESF Office from the provision of services to an FIHV are sourced outside Hong Kong. The profits tax concession for FIHVs does not extend to cover ESF Offices.
‘Full-time employee’ under the Bill is to be construed in accordance with its ordinary meaning.
It is clarified that the anti-avoidance provisions in relation to a non-taxable transfer of assets or businesses would not apply if the income from such transfer is not chargeable to profits tax in the first instance (e.g. capital in nature), irrespective of where the transfer takes place.
Generally, the timing of an FIHV / FSPE earning assessable profits from a qualifying transaction will be determined by reference to the FIHV’s / FSPE’s accounts on condition that the booking of the transaction is made in accordance with the prevailing accounting standards.
While no changes will be made to the classes of specified assets in schedule 16C, the Government has undertaken to explore room for adjustment as part of the larger exercise to review the unified tax exemption regime for funds.
Departmental Interpretation and Practice Notes (DIPN) will be issued to provide operational details in relation to the proposed tax concession upon passage of the Bill and the CSAs.
We are pleased that the Government has taken up the comments and suggestions made by stakeholders to provide more flexibility for family offices with different background and holding structures to benefit from the proposed tax concession. In particular, the change from the CMC requirement to the NMC requirement will certainly enhance the attractiveness of the concession, especially to non-Hong Kong resident families considering establishing their family offices in Hong Kong. Meanwhile, we look forward to the expansion of the classes of specified assets in schedule 16C when the Government undertakes the enhancement exercise for the unified tax exemption regime for funds, such that more investments made by family offices can benefit from the concessionary regime.
Echoing the Government’s recent Policy Statement on Developing Family Office Businesses in Hong Kong7, we believe that the introduction of the tax concession with the proposed amendments, together with the Government’s committed efforts, supported by the allocation of HK$100 million budget, in attracting more family offices to Hong Kong, will significantly help build a vibrant ecosystem for global family offices and asset owners in Hong Kong.