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On being questioned in the Legislative Council on the regulatory and tax arrangements for the new open-ended fund company (OFC) structure in Hong Kong, the Secretary for Financial Services and the Treasury, Professor K C Chan, confirmed that the structure will be aimed at providing fund managers with more flexibility in their choice of tax-efficient legal structures.

The Financial Services and the Treasury Bureau (FSTB) issued the Open-Ended Fund Companies Consultation Paper on March 20, which proposed to introduce a new OFC structure to complement the existing unit trust structure. It followed the Financial Secretary’s announcement in the Budget that Hong Kong would provide the additional legal and regulatory structures necessary to strengthen its position as a premier international asset-management center.

Currently, an open-ended investment fund may be established under Hong Kong law in the form of a unit trust, but not in corporate form, due to restrictions on capital reduction under the Companies Ordinance. As the more popular fund structure from an international perspective is the corporate structure, it is hoped that an OFC provision will attract more funds to domicile in Hong Kong.

It is proposed that OFCs will be structured in corporate form with limited liability and variable share capital. Given the nature of an OFC, the day-to-day management and investment functions of the OFC must be delegated to an investment manager licensed by or registered with Securities and Futures Commission (SFC).

On being asked why the Government would not extend an OFC’s permitted range of investments, Chan reiterated that the investment scope of an OFC should be aligned with a traditional investment fund, i.e. those types of investment activities that are subject to licensing and regulation by SFC under the Securities and Futures Ordinance (SFO), namely, securities, futures and over-the-counter derivatives.

He confirmed that, as the primary purpose of an OFC is to operate as an investment fund, it is not designed to operate as a corporate entity for the purposes of general commercial business, trade or other uses.

“The scope of securities and futures currently defined under Schedule 1 to the SFO is fairly broad,” Chan added. “It covers, among other things, debentures, loan stocks, bonds or notes of, or issued by, a body, whether incorporated or unincorporated, or a government or municipal government authority, unless such instruments fall within any of the specific exclusions set out in the definition.”

The Government has also confirmed that the existing profits tax exemption for public funds will apply to publicly offered OFCs. For privately offered OFCs, profits tax exemption will be available under the existing regime for offshore funds with their central management and control (CMC) located outside Hong Kong. Careful consideration will also be given to the provision of an exemption, or to the extent of exemption that should be applied, to privately offered OFCs with CMC located in Hong Kong, having regard to possible read-across implications.

On being questioned as to why there could, as presently proposed, be no ad valorem stamp duty exemption on transfers of shares in OFCs, Chan stated that, as stamp duty is charged on transfers of Hong Kong stocks and that shares in OFCs by definition are Hong Kong stocks, it has been suggested that their transfer should, prima facie, also be subject to stamp duty.

However, it is also recognized that stamp duty is currently exempted if the sale or purchase of a unit in a unit trust scheme involves a redemption by way of extinguishing the unit; or if the manager of a unit trust scheme sells to a new unit-holder a unit which arises from a transfer of a unit to the manager within the preceding two months or the unit sold is a new unit. Transfer instruments of units are also exempted from payment of the fixed stamp duty of HKD5 (USD0.65), under specific situations.

As contained in the terms of the public consultation paper on OFC, Chan pointed out that there is a proposal to treat allotments, transfers and surrenders of shares in OFCs or of units in unit trusts in the same way, and the consultation has requested views in that respect.