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21 April 2010
Revised DIPN 43 clarifies the location of offshore funds for Hong Kong profits tax purposes
By Debby Davidson, AFP Group Director, Business and Strategic Development
During the Hong Kong budget speech delivered on March 24, 2010, Mr John Tsang announced that the Inland Revenue Department (“IRD”) has been instructed to further clarify the meaning of “central management and control”, as it applies in the context of the exemption for offshore funds.
The current exemption is for non-resident funds only. Funds established in the form of either a corporation, a partnership or a trust whose “central management and control” is exercised in Hong Kong are Hong Kong tax residents and the profits of such fund vehicles are assessable to Hong Kong tax, to the extent that any such profits are Hong Kong-sourced income.
The IRD has previously stated that the location of “central management and control” is wholly a question of fact. In general, if the “central management and control” of a company is exercised by directors in board meetings, the relevant locality is where those meetings are held. However, it remained uncertain as to what role, if any, the residence of individual directors played in determining the location of a company’s “central management and control”.
In the revised DIPN 43, it is now clear that the residence of individual directors of a fund vehicle is not a determinative factor in the location of “central management and control”. Paragraph 15 of the IRD’s revised practice note (DIPN 43), issued on the day of the Budget, includes the following statement:
It should be noted that the residence of individual directors is generally not relevant in determining the locality of a company’s central management and control (see, however, the comments in paragraph 16 below). Therefore, the mere fact that the majority of the directors of the management board of a company are resident in Hong Kong does not of itself mean that the company is centrally managed and controlled in Hong Kong, and hence would not adversely affect the application of the tax exemption.Notwithstanding paragraph 15 however, it cannot be assumed that an individual director’s residence is completely irrelevant in the determination of the location of a company’s “central management and control”. In our view, if all or most of the individual directors are Hong Kong-resident and there are no genuine commercial reasons for holding board meetings overseas, it may difficult to argue that the “central management and control” of the company is exercised outside of Hong Kong, particularly if the operations and day-to-day management of the fund are exercised within Hong Kong. In this case, the board meetings held outside of Hong Kong may be deemed to be mere formalities.
Whilst the revised DIPN 43 is not a departure from well known case law principle in the determination of central management and location, funds that have a majority of Hong Kong-resident individual directors should bear the new guidance in mind, particularly as the burden of proof is on the offshore fund to substantiate the fact that the “central management and control” of the fund is exercised outside of Hong Kong.