Advance Ruling Case No. 73

RULING

The provisions of the Ordinance

The ruling applies in respect of sections 9(2), 16(2), 22, 23, 26 and 27 of Schedule 16E to the Inland Revenue Ordinance (“IRO”) and sections 15H(1), 15K, 61 and 61A of the IRO.

Background

The Family

(a)

Person A and family members of Person A (including Person A’s spouse and lineal descendants) together constitute a family (“the Family”) within the meaning of section 4 of Schedule 16E to the IRO.

Family investment management before restructuring

(b)

In the past, the assets of the Family were mainly held by Company A and Company B within Group A. Group A is a multinational enterprise (“MNE”) group having its headquarters and part of its business operations in Hong Kong.

(c)

Company A is a company incorporated in Hong Kong. At all times during the basis period for the year of assessment 2023/24, at least 95% of the beneficial interest in Company A was held directly, and indirectly through a specified trust and a foundation, by members of the Family.

(d)

Company B is a private company incorporated in Hong Kong and a wholly owned subsidiary of Company A.

(Please refer to Supplementary Information for details about the ownership of the companies within Group A.)

The arrangement

Transfer of assets of the Family to Group B

(a)

In a restructuring exercise, certain assets of the Family held within Group A were transferred to Company X and Company Y (i.e. the applicants) within Group B during 2022 and 2023.

(b)

The considerations of the transfers were agreed on an arm’s length basis. Any assessable profits of the transferors arising from the transfers will be chargeable to profits tax in Hong Kong.

Holding structure of Group B

(c)

Group B is an MNE group specialising in family investment management. The ultimate parent company of Group B is Company W. Company W is a company incorporated in Hong Kong. Similar to Company A, at all times during the basis period for the year of assessment 2023/24, at least 95% of the beneficial interest in Company W was held directly, and indirectly through a specified trust and a foundation, by members of the Family.

(d)

Company W is not a business undertaking for general commercial or industrial purposes and does not carry on any trade or business. It is merely a passive investment holding company interposed between the Family and a group of companies which include:

(i)

Company X, which is a company incorporated in Hong Kong and a wholly owned subsidiary of Company W. Company X is engaged in investment holding principally holding assets that fall within the classes specified in Schedule 16C to the IRO (“Schedule 16C assets”) and is not a business undertaking for general commercial or industrial purposes.

(ii)

Company Y, which is a company incorporated in Hong Kong and had previously been wholly owned by Company B. Company Y has become a wholly-owned subsidiary of Company X since August 2023. Company Y is engaged in investment holding principally holding Schedule 16C assets and does not carry on any other trade or activity.

(iii)

Company Z, which is a private company incorporated in Hong Kong and a wholly owned subsidiary of Company W.

(Please refer to Supplementary Information for details about the ownership of the companies within Group B.)

Family investment management after restructuring

(e)

After the restructuring, the assets of the Family have been mainly held by Company X and Company Y. Company X and Company Y have been managed in Hong Kong by a family office as follows:

1 January 2023 to 30 June 2023 (“the Transitional Period”) – Company B

(i)

Company B temporarily served as a family office of the Family.

(ii)

The place of business of Company B was in Hong Kong.

(iii)

Company B had three full-time employees managing the assets of Company X in Hong Kong. All of them have the necessary qualifications for carrying out the investment activities of Company X. Those employees were transferred to Company Z in July 2023.

(iv)

Company B received a service fee for the provision of services to Company X. The fee was determined on an arm’s length basis and chargeable to profits tax under section 14 of the IRO.

(v)

At least 75% of the assessable profits of Company B were derived from the services provided to Company X.

(vi)

Company B incurred operating expenditure of at least HK$3 million in Hong Kong for carrying out the investment activities in respect of Company X.

Since 1 July 2023 (“Ongoing Period”) – Company Z

(i)

Company Z has served as a family office of the Family.

(ii)

The place of business of Company Z has been in Hong Kong.

(iii)

Company Z has had four full-time employees managing the assets of Company X in Hong Kong. All of them have possessed the necessary qualifications for carrying out the investment activities of Company X and Company Y.

(iv)

Company Z has received a service fee for the provision of services to Company X and Company Y. The fee is determined on an arm’s length basis and chargeable to profits tax under section 14 of the IRO.

(v)

At least 75% of the assessable profits of Company Z have been derived from the services provided to Company X and Company Y.

(vi)

Company Z has incurred operating expenditure of at least HK$10 million in Hong Kong annually on its employees and running expenses for carrying out the investment activities in respect of Company X and Company Y.

(Please refer to Supplementary Information for an overview of the arrangement during the Transitional Period and the On-going Period.)

(f)

The investment activities carried out by Company B and Company Z in Hong Kong during the Transitional Period and the Ongoing Period include:

(i)

conducting research and advising on any potential investments to be made by Company X;

(ii)

acquiring, holding, managing or disposing of property for Company X; and

(iii)

establishing or administering Company Y for holding and administering one or more underlying investments of Company X.

(g)

Company B, Company X and Company Z are normally managed or controlled in Hong Kong.

(h)

As at 30 September 2023, the aggregate of the amount of net asset value (“NAV”) of the Schedule 16C assets of Company X and Company Y managed by Company Z amounted to a few billion Hong Kong dollars. While the NAV may vary from time to time due to acquisition and disposal of assets, the aggregate amount of the NAV will not, at any time, be less than the minimum asset threshold of HK$240 million.

Foreign-sourced income derived by Company X and Company Y

(i)

Company X and Company Y derive income from transactions in the Schedule 16C assets (“qualifying transactions”) and transactions incidental to the carrying out of the qualifying transactions (“incidental transactions”). The income may include foreign-sourced interests, dividends or disposal gains.

(j)

The specified economic activities of Company X and Company Y are making necessary strategic decisions in respect of assets they acquire, hold or dispose of and managing and bearing principal risks of the relevant assets.

(k)

The specified economic activities of Company X and Company Y are carried out by Company B or Company Z. Company X and Company Y undertake adequate monitoring of the outsourced activities and the outsourced activities are carried out in Hong Kong.

Election as a family-owned investment holding vehicle (“FIHV”)

(l)

Company X will elect in writing that section 9 of Schedule 16E to the IRO applies to it.

How the IRO applies in relation to the arrangement

(a)

Company X is an FIHV within the meaning of section 5 of Schedule 16E to the IRO and is managed by an eligible single family office (“ESF Office”). As Company X satisfies the conditions specified in section 9(4) of Schedule 16E, profits tax is to be charged, at the rate specified in section 24(2) of Schedule 16E, on Company X’s assessable profits earned from qualifying transactions, and incidental transactions that are subject to the 5% threshold, pursuant to section 9(2) of Schedule 16E to the IRO.

(b)

Company Y is a family-owned special purpose entity (“FSPE”) within the meaning of section 6 of Schedule 16E to the IRO. As the profits tax concession under section 9 of Schedule 16E applies to Company X, profits tax is to be charged, at the rate specified in section 25(2) of Schedule 16E, on Company Y’s assessable profits earned from qualifying transactions, and incidental transactions that are subject to the 5% threshold, pursuant to section 16(2) of Schedule 16E to the IRO.

(c)

Sections 22 and 23 of Schedule 16E to the IRO will not operate to regard the assessable profits of Company X and Company Y as assessable profits of Company W.

(d)

Sections 26 and 27 of Schedule 16E to the IRO as well as sections 61 and 61A of the IRO will have no application to the arrangement.

(e)

As the profits tax concessions under sections 9(2) and 16(2) of Schedule 16E apply to Company X and Company Y respectively, any foreign-sourced interest, dividend or disposal gain derived by Company X as an FIHV or Company Y as an FSPE from their respective qualifying transactions and incidental transactions to which the profits tax concessions apply will not be regarded as a specified foreign-sourced income as defined in section 15H(1) of the IRO.

(f)

In case where Company X derives any foreign-sourced interest, dividend or disposal gain that falls within the scope of specified foreign-sourced income as defined in section 15H(1) of the IRO, section 15I(1) will not operate to bring such income into the charge of profits tax as Company X meets the economic substance requirement under section 15K of the IRO. Similarly, foreign-sourced interest, dividend or disposal gain derived by Company Y that falls within the scope of specified foreign-sourced income as defined in section 15H(1) will not be chargeable to profits tax as Company Y meets the economic substance requirement.

The period for which the ruling applies

(a)

The ruling concerning the tax treatments of Company X under Schedule 16E to the IRO will apply for the year of assessment 2023/24 and subsequent years of assessment.

(b)

The ruling concerning the tax treatments of Company Y under Schedule 16E to the IRO will apply for the year of assessment 2023/24 (i.e. the period from the date when Company X acquired a beneficial interest in Company Y in August 2023 to the end of the basis period of Company Y for the year of assessment 2023/24) and subsequent years of assessment.

(c)

The ruling concerning the tax treatments of the specified foreign-sourced income derived by Company X and Company Y will apply for the years of assessment 2023/24 to 2027/28.

The material assumptions in respect of a future event or any other matter made by the Commissioner

(a)

If Company X carries out transactions in shares, stocks, debentures, loan stocks, funds, bonds or notes (“specified securities”) of, or issued by, a private company (“the relevant company”), Company X will not fall into the circumstances where the exceptions specified in section 12 or 13 of Schedule 16E to the IRO will apply.

(b)

If Company Y carries out transactions in the specified securities of, or issued by, the relevant company, Company Y will not fall into the circumstances where the exceptions specified in section 17 or 18 of Schedule 16E to the IRO will apply.

Date of ruling issued

17 January 2024

SUPPLEMENTARY INFORMATION

(The supplementary information does not form part of the Ruling.)

Ownership of the companies within Group A and Group B

(a)

The beneficial interest in Company X, Company B and Company Z is as follows:

(i)

The immediate parent company of Company X and Company Z is Company W.

(ii)

The immediate parent company of Company B is Company A.

(b)

At all times during the basis period for the year of assessment 2023/24, the beneficial interest in Company A and Company W has, respectively, been held by members of the Family, a trust (“Trust F”) and a foundation (“Foundation G”).

Trust F

(c)

Trust F has the following features:

(i)

Trust F is created by Person A under a settlement instrument.

(ii)

Under the settlement instrument, the specified beneficiaries of the Trust F are members of the Family.

Foundation G

(d)

Foundation G has the following features:

(i)

Foundation G is a family foundation established by Person A in Jurisdiction H. It is a legal entity that does not have any shareholder but only beneficiaries.

(ii)

According to the relevant regulatory law in Jurisdiction H, beneficiaries would have a beneficial interest in the foundation and would be entitled to the benefits from the foundation assets or foundation income.

(iii)

Pursuant to the statutes of Foundation G, the foundation assets include capital and assets contributed by the founder or third parties to the foundation.

(iv)

Foundation G is managed and controlled by the Board of Trustee. The Board of Trustee manages the foundation assets and has the discretionary power to determine the amount, extent, and manner of grants to a beneficiary.

(v)

Both Person A and the Board of Trustee declared that the beneficiaries of Foundation G are members of the Family and they are entitled to the capital and profits of Foundation G.

Overview of the arrangement

An overview of the arrangement, which is separated into two periods: (a) period from 1 January 2023 to 30 June 2023 (i.e. the Transitional Period) and (b) period from 1 July 2023 and onwards (i.e. the Ongoing Period), is illustrated in the diagrams below:

Arrangement during the Transitional Period

Note:

(a)

Please refer to Commentary for analysis of the extent of beneficial interest the Family has in Trust F and Foundation G.

(b)

During the Transitional Period, Company B served as a family office of the Family and carried out the investment activities for Company X.

(c)

Company Y was a subsidiary of Company B during the Transitional Period. In view that Company X (i.e. an FIHV) had no beneficial interest in Company Y during the Transitional Period, Company Y was not an FSPE during this period.

Arrangement during the Ongoing Period

Note:

(d)

Please refer to Commentary for analysis of the extent of beneficial interest the Family has in Trust F and Foundation G.

(e)

During the Ongoing Period, Company Z serves as a family office of the Family and carries out the investment activities for Company X and its subsidiary (if any).

(f)

Company X acquired 100% of the beneficial interest in Company Y in August 2023 and since then, Company Y has operated as an FSPE.

COMMENTARY

(This commentary is not a legally binding statement and it does not form part of the Ruling.)

Whether the Family holds at least 95% of the beneficial interests in Company X and its ESF Office

(a)

In this case, the beneficial interest in Company A and Company W (i.e. the ultimate parent company of Company X and its ESF Office) is held by members of the Family, Trust F and Foundation G.

(b)

Trust F is a specified trust within the meaning of section 8(22) of Schedule 16E to the IRO. Members of the family are the specified beneficiaries of Trust F who are entitled to benefit from the entire trust estate. Thus, they can be taken to have an entire beneficial interest in Trust F with reference to section 8(9) of Schedule 16E to the IRO.

(c)

A foundation resembles something of a hybrid between a company and a trust and is commonly used as a holding entity to manage assets transferred by the founder for family or charitable purposes in the civil law jurisdictions. In the present case, in determining the extent of beneficial interest that a member of the Family has in Foundation G under section 8 of Schedule 16E to the IRO, it is necessary to ascertain the legal form of Foundation G. In view that Foundation G is a legal entity that does not have any shareholder but only beneficiaries, it should be regarded as an entity that is not a corporation, a partnership or a trust and thus, section 2(d) of Schedule 16F to the IRO applies to this case accordingly. As members of the Family are the only beneficiaries under Foundation G and they are entitled to the foundation assets (i.e. capital of the entity) and the foundation income (i.e. profits of the entity), they can be regarded as having an entire beneficial interest in Foundation G according to section 2(d)(i) or (iii) of Schedule 16F to the IRO.

(d)

Based on the information set out in section 1 of Part B above, it is highly probable that at all times during the basis period for the year of assessment 2023/24, members of the Family have at least 95%, in aggregate, of the beneficial interest in Company A and Company W, which in turn have at least 95%, in aggregate, of the beneficial interest in Company X (i.e. the FIHV), Company B (i.e. the ESF Office for the Transitional Period) and Company Z (i.e. the ESF Office for the Ongoing Period) respectively.

Whether Company X and its ESF Office are normally managed or controlled in Hong Kong

(a)

The concept of “normally managed or controlled in Hong Kong” does not require that both management and control be exercised in Hong Kong. “Management” refers to management of daily business operations, or implementation of the decisions made by top management, etc. “Control” refers to control of the whole business at the top level, including formulating the central policy of the business, making strategic policies of the company, choosing business financing, evaluating business performance, etc. The “management” or “control” of an FIHV and ESF Office may be conducted in more than one place. However, provided that the FIHV and ESF Office are normally managed or controlled in Hong Kong, the conditions regarding the normal management or control requirement will be considered as being satisfied.

(b)

In this case, Company X and its ESF Offices are considered to be normally managed or controlled in Hong Kong having regard to the following information:

(i)

Company X and the respective ESF Offices share the same business address in Hong Kong and have common directors.

(ii)

Company X was managed by Company B during the Transitional Period and is managed by Company Z during the Ongoing Period. The investment activities as defined in section 1(1) of Schedule 16E to the IRO were/have been carried out by the employees of Company B and Company Z in Hong Kong.

Whether the substantial activities requirement is met in relation to Company X

(a)

In determining whether an adequate number of full-time qualified employees has been employed, and an adequate amount of operating expenditures has been incurred, for carrying out the investment activities for Company X under section 10(1)(b) and (c) of Schedule 16E to the IRO, the following issues have been considered:

(i)

the number of FIHVs managed by the ESF Office;

(ii)

the investment strategies of Company X and Company Y;

(iii)

asset types held by Company X and Company Y;

(iv)

investment activities undertaken by the ESF Office;

(v)

details of employees employed in Hong Kong (e.g. experience, qualifications, position held and duties performed);

(vi)

amount and types of the operating expenditure (e.g. fixed or variable cost) incurred in Hong Kong.

(b)

Having regard to the totality of facts and circumstances of this case, it is considered that the actual number of qualified employees of the respective ESF Offices and the amount of operating expenditure incurred in Hong Kong for carrying out the investment activities can adequately and reasonably demonstrate the fulfilment of the substantial activities requirement.

Whether the ESF Office has met the safe harbour rule

(a)

An ESF Office is required to satisfy the safe harbour rule under section 3 of Schedule 16E whereby at least 75% of the ESF Office’s assessable profits should be derived from the services provided to specified persons of the family. To provide for flexibility, an ESF Office may choose to apply either the 1-year or multiple-year (subject to a cap of 3 years) safe harbour rule. An ESF Office falls within: (i) the 1-year safe harbour rule if the Family Office Management Profits (“FOMP”) percentage of the ESF Office for the subject year is more than or equal to 75%; or (ii) the multiple-year safe harbour rule if the average FOMP percentage of the ESF Office is more than or equal to 75%. FOMP refers to the aggregate amount of the management profits of the ESF Office in the basis period for the year of assessment that are derived from services provided to any one or more specified persons of the family. The services concerned are not limited to investment services.

(b)

In this case, Company B provided services to Company X and other group companies during the year of assessment 2023/24 and received service fees in return. Those group companies are not specified persons within the meaning in section 2(8) of Schedule 16E to the IRO. A proforma profit and loss account of Company B in respect of the basis period for the year of assessment 2023/24 was provided to substantiate that the safe harbour rule would be met whereby at least 75% of the assessable profits of Company B were derived from the services provided to Company X during the year of assessment 2023/24.

(c)

Company Z is a dedicated family office solely providing services to Company X and Company Y. It is expected that Company Z will meet the safe harbour rule during the year of assessment 2023/24 and subsequent years of assessment.

Whether the anti-round tripping provisions apply to the arrangement

(a)

Sections 22 and 23 of Schedule 16E to the IRO provide that the assessable profits of an FIHV or an FSPE are deemed as assessable profits of the resident person if the resident person: (1) has (either alone or jointly with its associate) not less than 30% of the beneficial interest in the FIHV or (2) has any beneficial interest in the FIHV and the FIHV is an associate of the resident person. The anti-round tripping provision does not apply to a resident person which is a resident individual, an ESF Office or a specified entity within the meaning of section 20(3) of Schedule 16E to the IRO.

(b)

In the present case, Company W is a resident person having 100% of the beneficial interest in Company X. Nevertheless, Company W is a passive investment holding vehicle and does not carry on any trade or business. Also, members of the Family have a direct and indirect beneficial interest in Company W which in turn has a 100% direct beneficial interest in Company X. Thus, Company W can be regarded as a specified entity under section 20(3) of Schedule 16E to the IRO. The anti-round tripping provisions will not operate to regard the assessable profits of Company X and Company Y as assessable profits of Company W.

Whether the anti-avoidance provisions apply to the arrangement

(a)

Sections 26 and 27 of Schedule 16E provide that if the Commissioner is satisfied that (i) the main purpose, or one of the main purposes of an FIHV or FSPE in entering into an arrangement, or (ii) the main purpose, or one of the main purposes of a person making a transfer of any asset/business to the FIHV or FSPE is to obtain a tax benefit, whether for the FIHV or FSPE or another person/entity, the tax concession will not apply to the FIHV or FSPE concerned. The purpose of the main purpose test is to prevent tax abuse (e.g. taxpayers who seek to take advantage of the tax concessions or treaty benefits without any commercial reasons and business substance established in Hong Kong). It would not operate to deny tax concessions for the vast majority of genuine businesses with core income generating activities carried out in Hong Kong. Whether the main purpose or one of the main purposes of setting up a business in Hong Kong is to obtain a tax benefit is a question of fact. Before reaching a conclusion under the main purpose test, all relevant facts and circumstances have to be considered.

(b)

In this case, a restructuring exercise was conducted under which assets of the Family were transferred from Group A to Group B. The purpose of such transfer is to distinguish the family wealth from the family business of Group A such that the assets of the Family can be well-managed by a family office within Group B. Coupled with the circumstances that the transfers of assets were carried out on an arm’s length basis while the transferors are chargeable to tax in respect of the assessable profits arising from the transfers, it is therefore considered that sections 26 and 27 of Schedule 16E to the IRO, as well as sections 61 and 61A of the IRO, should have no application to the present case.