China Cross-Border Investments and Offshore Funds in Hong Kong
Foreign Investment Environment is changing rapidly around China and the country has released a number of remedial measures to promote investment activities, enable easier cross-border financing and pave way to foreign fund and equity investment activities in order to assist overseas and domestic investors engaging in cross- border investment financing, funds and trading operations.
Hong Kong which has played a key role in attracting foreign capital to China, has so far been largely unaffected by local demonstrations and punitive tariffs imposed by the USA in its trade war with China. However, Hong Kong has introduced new Legal Compliance, qualification and reporting requirements such as Economic Substance rules for offshore business operation in the territory.
The following explains new Chinese investment regulations as well as Legal compliance to be followed in Hong Kong in due course of such gross-border investment activities:
Cross-Border Investment Financing, Equity Investment and Safe Measures
China’s State Administration of Foreign Exchange (SAFE) has released measures to ease the cross- border investment financing reporting requirements which went to effect on January 1st 2020. Measures aim to provide a better business environment for foreign invested enterprises, domestic enterprises and overseas investors.
Restrictions on cross-border investment financing are being removed and foreign invested enterprises are allowed to widely engage in investment activities. Enterprises are allowed to engage in investment equity activities with their own capital reserves and funds which earlier was only possible with their own retained profits and cash.
Moreover, enterprises are allowed to use capital funds, foreign debt and funds raised by overseas listing more freely making the processing time of transactions much shorter assisting start-up enterprises in their China market entry in speeding up equity transactions thus reducing the capital occupation of foreign investors.
In addition, using foreign debt financing will be easier for non-financial enterprises where enterprises are now allowed to have foreign debts up to twice their net assets.
Cross-Border Trade Financing and Flexibility
In addition to investment activities, the new rules aim to facilitate foreign financing of trading business and services by giving banks flexibility in payment of formalities.
However, all such deals are subject to compliance requirements and authentication of transaction checks before a trusted relationship is built between the bank and the enterprises in question.
Hong Kong Fund Structuring, Economic Substance Rules and Exemptions
The government has identified a number of sectors including Offshore financing and funding as key roles for Hong Kong development, however, lately government has been taking numerous steps to address global tax avoidance and implemented various measures to bring the territory in bar with OECD harmful tax practices regulations. New regulations include new economic substance requirements in offshore jurisdictions which will most likely impact funds with management and advisory teams in Hong Kong.
Hong Kong tax regulations applicable to asset management industry and private equity funds have led to fund managers to adopt complex management structures and protocols in order to avoid a taxable presence for these funds in Territory due to anti-avoidance legislation.
The government has tried to improve the situation by introducing offshore fund tax exemptions to non-resident private equity funds as well as providing special tax-free treatment for special purpose holding companies from restrictions imposed by the Inland Revenue Department.
However, in response to OECD BEPS 2.0 initiatives, Hong Kong has introduced Economic Substance Laws (ESL) targeting offshore jurisdictions such as British Virgin Islands and the Cayman Islands. ESL regulations require conduct of business and profit-generating activities related to profits to be located in the same jurisdiction where profits are booked. In the event of profits are being booked in an offshore company which is registered there as a tax resident, minimum core income generating activities (CIGA) are required to be undertaken in the jurisdiction of incorporation.
BVI and the Cayman Islands have long been tax neutral jurisdictions where fund structuring allows investment returns to be distributed to investors who in-turn can report investment returns in their own jurisdictions.
Cayman Island Exemption, Registration Requirements and Managers beware
Hong Kong EPL regulations exclude Cayman Islands investment funds, investment special purpose vehicles (SPVs), their general partners and limited partnership funds from ESL scope but such fund management activities remain in scope, which means that Cayman fund managers will be required to meet the CIGA requirements.
In Hong Kong, fund management is defined as “the business of managing securities carried on by a relevant entity licensed or otherwise authorized to conduct business as an investment fund” and such persons are from January 15th 2020 onwards required to register for a license as a licensed investment advisor based in Hong Kong. Fund managers should note that such entities have annual reporting obligations to the Cayman Island and BVI authorities in respect of their compliance with the new rules.
Foreign Fund Managers and Foreign Invested Companies should take note that due to push for global tax environment towards transparency economic substance requirements and similar regulations will effect issues such as
offshore disposals of equity interests, cross-border M&A transactions, calculation of the tax cost base and qualification for safe harbour rules and, therefore, proper tax due diligence (TDD) is required before any investment in China, Hong Kong and, especially, at Offshore jurisdiction and using of Special Purpose Vehicles.