Hong Kong: Draft legislation implementing family office tax exemption regime

The Hong Kong government on 9 December 2022 published draft legislation implementing the profits tax exemption regime for family-owned investment holding vehicles (FIHVs) managed by a single-family office (SFO) in Hong Kong. The government previously consulted on the proposed FIHV regime in March 2022. Read TaxNewsFlash

The new regime would provide—effective from year of assessment (YOA) 2022/2023—a 0% tax rate for assessable profits derived by FIHVs owned by ultra-high-net-worth individuals and their family members from qualifying transactions and incidental transactions (subject to a 5% threshold), subject to fulfillment of the specified conditions.

• Must be an entity with its central management and control exercised in Hong Kong
• At least 95% of its beneficial interest must be held (directly or indirectly) by one or more members of a family, which is defined broadly and covers multiple generations
• Must not be a business undertaking for general commercial or industrial purposes

The exemption also extends to special purpose vehicles held by an FIHV that are set up solely for holding and administering specified assets (i.e., Schedule 16C assets) and/or investee private companies (i.e., a family-owned special purpose entity or an FSPE). 

As an enhancement of the March proposal, an FIHV can now take the form of any body of persons or legal arrangement as opposed to a corporation, partnership or trust only. In addition, an FIHV does not need to be exclusively and beneficially owned by the members of a family. For example, an FIHV may be owned by a discretionary trust with the trustee as the legal owner and charities as one class of beneficiaries or a residual beneficiary. In addition, the manner in which family members’ beneficial interests in an FIHV are determined addresses situations in which family members may only have a mere expectation of receiving distributions from the trust at the discretion of the trustee and therefore may not beneficially own the FIHV in the strict legal sense.  

• Must be a private company with its central management and control exercised in Hong Kong
• Must provide services to an FIHV (and its FSPEs) and/or member(s) of the family (specified persons) and the related service fees must be chargeable to Hong Kong profits tax
• At least 95% of its beneficial interest is held (directly or indirectly) by one or more members of the relevant family
• Must satisfy the safe harbor rules (i.e., at least 75% of the SFO’s assessable profits is derived from services provided to specified persons in the current YOA or in the current YOA and up to two preceding YOAs on average)

The major enhancement from the March proposal is that an SFO can provide services to entities outside the family provided it can satisfy the 75% safe harbor rules. Thus, an SFO may provide services to non-specified persons who co-invest with the family or when there is a change of family member status. 

An FIHV may enjoy a tax exemption for profits derived from:

• Transactions in Schedule 16C assets (e.g., shares, stocks, debentures, bonds, future contracts, and foreign exchange contracts) (qualifying transactions)
• Transactions incidental to the carrying out of qualifying transactions (incidental transactions), subject to a 5% threshold

The qualifying transactions must be carried out or arranged in Hong Kong by or through an ESF office.

The tax exemption for an FSPE also covers profits from transactions in (1) specified securities (e.g., shares, debentures, bonds and notes) of, or issued by, an investee private company or an IFSPE, (2) rights, options or interests in respect of the specified securities, and (3) certificates of interest or warrants to subscribe for or purchase of the specified securities). 

If an FIHV or an FSPE has derived assessable profits from both (1) transactions eligible for a tax exemption and (2) non-qualifying transactions during a YOA, only those assessable profits derived from non-qualifying transactions would be subject to profits tax (i.e., there is no tainting effect). 

Transactions in assets such as loans, artwork, and cryptoassets would not qualify for a tax exemption under the regime. In addition, similar to the existing unified fund exemption (UFE) regime, dividend and interest income would be regarded as income from incidental transactions and therefore would not be tax-exempt under the regime if the 5% threshold is exceeded. Such income may be tax-exempt under the other existing provisions of the tax law. 

The aggregate net asset value (NAV) of Schedule 16C assets held by one or multiple relevant FIVHs managed by the ESF office, as at the end of the basis period of a YOA, must be not less than HK$240 million.

• In computing the above aggregate NAV, the NAV of Schedule 16C assets4 of the FSPEs held by the relevant FIHVs would also be included.
• For each ESF office, a maximum of 50 relevant FIHVs that are managed by that office can be included in the aggregate NAV computation upon an irrecoverable election made by the relevant FIHVs.

Although stakeholders have recommended that all assets held by the FIHVs/FSPEs be taken into account in determining whether the minimum asset threshold is met, the rule in the draft legislation only allows the inclusion of Schedule 16C assets for such purpose.

Each FIHV must meet the following requirements during the basis period of a YOA:

• The minimum economic substance requirements
• The adequacy test (i.e., not less than on average two full-time qualified employees in Hong Kong and not less than HK$2 million of total operating expenditure in Hong Kong for carrying out investment activities)

The draft legislation specifies that the qualifying transactions of an FIHV have to be carried out or arranged by or through an ESF office. Given this, it is not necessary for each FIHV to have two full-time employees in Hong Kong to carry out the investment activities. It is expected that further guidance on the outsourcing arrangement and the practical administration of the above substantial activity requirements will be issued by the Inland Revenue Department. The guidance is expected to be similar to that applicable to other concessionary tax regimes that specify a minimum substance requirement. 

There are circumstances in which the tax exemption would not apply to an FIHV or an FSPE. The four tests below would be used to determine the exceptions to tax exemption for an FIHV or an FSPE (they are the same as the existing tests under the UFE regime):

• The immovable property test
• The holding period test
• The control test
• The short-term assets test

The modified anti-round tripping / deeming provisions under the regime are modelled on the existing ones under the UFE regime, with two carve-outs for (1) Hong Kong resident individuals, and (2) Hong Kong resident entities (i.e., an ESF office and a specified entity as defined).

Under the deeming provisions, the tax-exempt profits of the FIHV or FSPE are deemed as assessable profits of the resident person if the resident person: (1) has, either alone or jointly with its associate(s), not less than 30% beneficial interest in the FIHV, or (2) has any beneficial interest in the FIHV and the FIHV is an associate of the resident person.  

The carve-out in (2) above is to cater for situations where a family holds FIHVs directly or indirectly through resident companies. To qualify as a specified entity, an entity must be a passive investment holding vehicle interposed between the family members and the FIHV and at least one family member must have a direct or indirect beneficial interest in the entity.  

The draft legislation also contains the following anti-avoidance provisions under which the tax exemption for an FIHV or an FSPE would not apply:

• One of the main purposes of an FIHV or an FSPE in entering into an arrangement is to obtain a tax benefit
• One of the main purposes of transferring any assets or business to an FIHV or FSPE is to obtain a tax benefit, unless the transfer is carried out at arm’s length and the transferor’s assessable profits arising from the transfer is chargeable to Hong Kong profits tax

An FIHV and the ESF office must keep sufficient records to ensure the identity and particulars of the beneficial owner(s) of the FIHV and the ESF office to be readily ascertainable.

Although the draft legislation includes numerous refinements to the FIHV tax regime based on feedback received during the consultation exercise, there are still issues that have not been addressed that may impact the attractiveness of the regime. 

It is expected that the FIHV tax regime would be regarded as a preferential tax regime in Hong Kong for the purpose of the specified income exclusion under the revised foreign-sourced income exemption (FSIE) regime. Therefore, foreign-sourced dividends, equity disposal gains, and interest income derived by an FIHV or FSPE that may not be tax-exempt under the FIHV tax regime may nevertheless be excluded from the FSIE regime and thus continue to be non-taxable.

For more information contact a KPMG tax professional:

David Ling | +1 609 874 4381 | davidxling@kpmg.com