The Hong Kong government has announced a series of policy measures to attract the establishment of family offices with a view to bringing investment management and related activities to Hong Kong and enhancing the city’s position as a prime wealth management hub. The tax concession regime for family offices came into operation on 19 May 2023 is one of the policy measures which provides tax incentive intended to attract high-net-worth private families to set up family offices in Hong Kong and operate family-owned investment holding vehicles from Hong Kong.
Hong Kong mainly adopts a territorial basis of taxation and an entity which holds investments is generally subject to Profits Tax only if it derives profits from carrying on trade or business in Hong Kong (as opposed to income that is capital in nature). With the introduction of Specified Foreign Sourced Income Exemption regime in 2022 (as explained in our article published on 23 December 2022), entities may face a risk of profits tax if they received foreign source investment income in Hong Kong, subject to certain exemption requirements. The tax concession regime for family offices offers certainty such that income derived by a family-owned investment holding vehicle shall be charged at a concessionary tax rate (0%) provided that certain conditions are met.
Structure of a typical single family office
A typical single family office structure is illustrated in the diagram below:
Family members include a natural person and all of the persons related to such person. The definition of family members under the tax concession regime is very broad and covers most lineal descendants and ancestors. A lineal descendent also includes adopted and step children of the person’s spouse (including a deceased spouse) or former spouse. However, note that Hong Kong law do not recognize common-law partner, same-sex marriage or civil unions.
A single family office (SFO) provides a variety of functions and services to the family members and their investment holding entitles. Usually, portfolio investment and asset management services are the main function of the family office, accompanied by personal, administrative and financial advisory services, etc.
The function of a family-owned investment holding vehicle (FIHV) is to hold assets for the family. Investment income usually arise at the FIHV. FIHVs may hold and manage assets indirectly through special purpose entities (SPEs).
What income is tax-exempt under the tax concession regime?
Only the profits of FIHVs and SPEs arising from transactions in specified assets can be exempted from profits tax. Income that arises incidental to the holding of specified asset is also tax-exempt, subject to a 5% threshold. Common incidental income includes interest income.
Specified assets include:
- Securities;
- Shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a private company;
- Futures contracts;
- Foreign exchange contracts under which the parties to the contracts agree to exchange different currencies on a particular date;
- Deposits other than those made by way of a money-lending business;
- Deposits made with a bank;
- Certificates of deposit;
- Exchange-traded commodities;
- Foreign currencies;
- Over-the-counter derivative products.
It is quite common for an FIHV to establish SPEs for holding and administering the FIHV’s assets. Therefore, profits tax concessions will be extended to the SPE level to the extent of the percentage of beneficial interest of the FIHV in the SPE. For example, if the FIHV owns 50% shares of an SPE, 50% of the profits from transactions in specified assets derived by that SPE is also tax-exempt.
Note that income arise from trading or provision of other services will not be exempted.
Requirements for the FIHV and the SFO
Structure requirement
- The FIHV must be an entity (established or created in or outside Hong Kong) that is not a business undertaking for general commercial or industrial purposes. Entity means a body of persons, corporate or incorporated, or a legal arrangement, including a corporation, partnership and trust (including a discretionary trust).
- The SFO must be a private company (incorporated in or outside Hong Kong) and is not required to obtain a license if it only serves the family (so registering with the Securities and Future Commission of Hong Kong (“SFC”) is not required).
- Members of the family must have at least 95%, in aggregate, of the beneficiary interest in the FIHV and the SFO respectively. This can be reduced to 75% if at least 20% of the remaining is held by charitable institutions. No matter whether a charitable entity is involved, the percentage of beneficiary interest held by unrelated parties (other than a charitable entity) cannot exceed 5%.
Management requirement
- The FIHV and the SFO must be normally managed or controlled in Hong Kong.
- The FIHV must be managed by the SFO and the aggregate value of specified assets managed by the SFO for the FIHV (or multiple FIHVs) must be at least HK$240 million (or roughly US$ 30 million). Not less than 75% of the SFO’s profits must come from services to the FIHVs (and their SPEs) and the family members. These could include investment management fees from the FIHV or service fees from the family members which are chargeable to Hong Kong profits tax.
- Not more than 50 FIHVs managed by the same SFO may benefit from the profits tax concession.
Substantial activities requirement
- There is no local investment requirement, the FIHV is free to investment worldwide. However, for compliance with the latest international tax standards of economic substance, an FIHV must carry out its core income-generating activities in Hong Kong. Outsourcing of the activities to the SFO is permitted.
- The minimum requirements for employee and operating expenditure are:
- at least two full-time employees in Hong Kong who carry out the core income-generating activities and have the qualifications necessary for doing do; and
- at least HK$2 million annual operating expenditure incurred in Hong Kong for carrying out the core income-generating activities.
Election Mechanism
There is no separate application or pre-approval requirement. An FIHV can elect for the profits tax concession through an election in its annual tax filing. The election, once made, will apply to all subsequent years of assessment and is irrevocable.
To obtain tax certainty, FIHVs may apply to the Commissioner of Inland Revenue Department (IRD) of Hong Kong for advance rulings on their eligibility for the profits tax concessions.
Anti-avoidance Measures
To reduce the risk of tax evasion by FIHVs and SPEs through their investment in private companies, the profits tax concession is applicable to the profits from investment in a private company when the immovable property test and either of the following tests are met:
- Holding period test; or
- Control and short-term asset test
Immovable property test: The private company holds, whether directly or indirectly, not more than 10% of its assets in immovable property (excluding infrastructure) in Hong Kong.
Holding period test: The FIHV or SPE holds the investment in the private company for at least two years.
Control and short-term asset test: The FIHV or SPE does not have control over the private company and the private company holds not more than 50% of value of its assets in short-term assets. Short term assets are assets (excluding specified assets and immovable property in Hong Kong) held by the private company for less than three years before the date of disposal.
If the investment in a private company fails to meet the requirements above, only the profits from such investment is not tax-exempt and the profits from other qualifying investment will not be affected.
Our observations
The Hong Kong tax concession for single family offices will encourage more family offices to establish a physical presence and manage their global investments in Hong Kong. We anticipate a range of policy measures will be further introduced to enhance the city’s attractiveness and competitiveness for family offices and to develop Hong Kong into a leading hub for global family offices in Asia.
Singapore also provide tax exemption scheme for family offices. A fund company in a single family office in Singapore can apply for a tax incentive under Section 13O or Section 13U of the Income Tax Act 1947. Compared with Singapore, the tax concession for family offices in Hong Kong appears to be more flexible and has less stringent requirements.
The main differences between the tax concession in Hong Kong and tax exemption scheme in Singapore for family offices are:
Family offices can seek professional advice and assess if they can take advantage of the tax concession. They may also apply to the IRD for advance rulings on whether their structure and income form investment activities are eligible for the tax concession.
Hope you find this helpful in understanding more about the tax concession for single family offices. If you have any questions about this topic, feel free to contact us.