Hong Kong mulls role as PE fund domicile

Private equity funds should be allowed to set up in Hong Kong as limited partnerships, a move that would open the door for Hong Kong-domiciled funds, according to a recent recommendation from the Financial Services Development Council, an advisory body to the Hong Kong government.

The government proposal was one of several this month from the FSDC, which is trying to promote Hong Kong as a regional financial hub in the face of competition from Singapore.

Mark Shipman, partner at Clifford Chance, said onshore funds in Hong Kong would attract fund managers from China as well as provide specific benefits for private equity.

“There’s a lot of demand from GPs coming out of China who want to domicile their funds in Hong Kong or in Asia rather than thousands of miles away.”

It would also help the dozens of private equity firms who have their offices in Hong Kong but are using funds domiciled in the Cayman Islands.

These firms could consolidate service providers – legal, accounting and administration – into Hong Kong rather than using services in both jurisdictions, Shipman added.

A Hong Kong-domiciled fund would also ease specific tax concerns when investing in China.

A number of Cayman funds route their investments into China through Hong Kong companies to get tax treaty benefits, said Andrew Ostrognai, partner at Debevoise.

However, there have been concerns that such a structure could be challenged by Chinese tax authorities because the Hong Kong company may be seen as not having enough of a substantive presence in Hong Kong to qualify for tax treaty benefits, Ostrognai explained.

A limited partnership fund domiciled in Hong Kong would eliminate the issue of substance – and bring Hong Kong in line with what Singapore already offers.

However, Shipman adds, “in order for it to work, Hong Kong has to accept that vehicle is tax neutral”.

He believes the work being done through the FSDC on several fronts will go a long way in making onshore funds possible.

The limited partnership proposal is separate from another FSDC initiative that asks the government to clarify the tax position of private equity firms using offshore funds.

Dozens of private equity firms have their offices in Hong Kong, but their funds are typically domiciled in the Cayman Islands. The offshore funds have not been subject to tax, but Hong Kong law does not state that they are tax exempt.

“We are asking the government to legislate what people are already doing by making it clear that private equity funds won’t be taxed,” says Darren Bowdern, partner at KPMG Hong Kong.

Adds Ostrognai: “Singapore has provided certainty to private equity funds that it won’t drag your fund onshore and tax it. Hong Kong hasn’t provided that certainty.”

The lack of a tax exemption also makes private equity firms go through “onerous operational procedures” Browdern adds. “Their deal guys must go offshore to make investment decisions. What we’re saying is that’s not encouraging for promoting the fund industry in Hong Kong.”

The FSDC proposals are part of a broader initiative to improve Hong Kong’s competitiveness in the financial services industry. Hong Kong is particularly concerned that it is falling behind Singapore, which has signed double tax treaties and clarified rules to make itself more attractive for private equity.

However, Ostrognai thinks permitting onshore funds would not necessarily be a transformative move.

“Where the fund is formed doesn’t matter much at all. It’s where your employees are based that brings the benefits.”