Hong Kong a Friendlier Place for Hedge Funds

HONG KONG (HedgeWorld.com)--Hong Kong's recently adopted ordinance to exempt from taxation offshore funds drew more a sigh of relief from the hedge fund industry than a joyous celebration. For years, hedge fund managers that could stomach the uncertainty of where they stood with the Inland Revenue Department carried out activities in Hong Kong, while those that required certainty stood on the sidelines or went elsewhere in the region.

While it's still early to judge the impact of the legislation, the move is seen as necessary in maintaining Hong Kong's competitiveness as a regional financial center. Passed in March after originally being announced in the 2003?? 1/2 2004 budget, the Revenue Ordinance 2006, effective retrospectively from April 1, 2006, exempts non-resident funds (individuals, partnership, trustee or corporation) from profits tax on certain transactions.

Exempt transactions are defined broadly, intending to cover most types of transactions carried out by investment funds, including transactions in securities, futures, currency contracts, options and exchange-traded commodities.

Hedge funds and traditional long-only funds are going to benefit from the rule, with most hedge fund trading strategies exempt under the new legislation, according to Deloitte's senior manager of the International Tax Services Group, Jesse Kavanagh.

There are some exceptions, though, such as strategies that involve direct lending and hedge funds branching out into private equity-like investment. "These give rise to concern whether they will be covered or not by the rule, as the rule has not been tested yet," Mr. Kavanagh said.

Generally, his hedge fund clients are happy because the ordinance provides a lot more certainty for them in about 95% types of trades they do.

A few other items barred by the Hong Kong government are insurance products, Hong Kong private companies and real estate, which is mentioned but not written in the law, according to Florence Yip, a partner at PricewaterhouseCoopers.

In the new legislation the government also has completely redefined the term "securities" for exemption purposes. Whereas the government originally wanted to borrow the definition of securities as defined in the Securities and Futures Ordinance, it heeded to industry protests that this definition was for regulatory purposes, and the scope too narrowly defined.

Since the enactment of the rule, both Mr. Kavanagh and Ms. Yip have seen more fund managers include Hong Kong in their research for locations in which to set up, but there are still no hard figures as to fund flows, since it is still early.

The excitement over Hong Kong's ordinance may be taken down a notch as Singapore, Hong Kong's Asian financial center rival to the west, has trumped its recent initiative with a proposal that was announced in the Singapore government's budget for 2006.

Singapore will introduce over the next few months a new incentive scheme to exempt from tax resident funds with substantial foreign ownership. The legislation, which will likely be applicable from Feb. 17, 2006, to Feb. 16, 2011, aims to encourage fund managers to register funds set up in the form of companies in Singapore that invest in all securities.

"Not only does it [Singapore] want to compete with Hong Kong, it wants to see if it can compete with Cayman Islands as well," said Florence Chan, tax partner at Ernst & Young. "It may not be that easy, but at least Singapore is taking the steps towards it."

Is the move realistic? "It will take time because Singapore needs to build critical mass and build up its reputation. Having said that, apart from tax, people will look at the infrastructure as well to determine if it's an ideal location," noted Ms. Chan.

In comparison, Hong Kong's recent legislation may not be that favorable to small fund managers, she added, because at the moment it only exempts offshore funds, meaning the funds have to be centrally managed and controlled outside Hong Kong. Funds that are wholly managed by managers based in Hong Kong may not be able to quality for the exemption. In these cases, Singapore may be regarded as an alternative.

In the end it may simply come down to where your operational concerns lie. If your investment playing field is Southeast Asia then you are more likely to go to Singapore; if you're looking at eastern or northern Asia you'll consider Hong Kong. It's no longer tax that is driving it to one side; cost considerations, of course, also play a huge part in the decision-making process.

APasceri@HedgeWorld.com

Contact Bob Keane with questions or comments at bkeane@investmentadvisor.com.

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