In the never-ending moves toward full disclosure, two powerhouse financial centres, Hong Kong and the UK, have recently sought to establish further clarification on what is required of onshore managers and advisors of offshore funds to ensure their tax-free status. The UK HM Revenue & Customs issued new draft guidance in July in reference to the determination of a company’s residence, and more specifically, key points to note when determining central management and control.
The guidance follows hot on the heels of Hong Kong’s clarification in reference to central management and control in February this year.
The Hong Kong clarification, which for one addresses the issue of residency of directors, arguably provides investment managers and advisors with a greater perspective on the issues they must address in achieving a successful application for a profits tax exemption for offshore vehicles. The Hong Kong Internal Revenue Department (IRD) clarification that came into play on 24 February 2010 was announced in March during the Budget Speech by Financial Secretary John Tsang. Since the offer of exemption was introduced in 2006 there has been some confusion over what role, if any, the residence of individual directors played in determining a company’s central management and control. The IRD clarification now maintains that residency is not generally a criterion in assessing the locus of ‘central management and control’.
In other words, you should not simply rely on the residency of the fund directors to secure the desired tax status exemption. The central management and control test is a well-established common law principle adopted in many jurisdictions in determining the residency of a company and other non-individual entities and ultimately their offshore status. With a likely aim of creating a more appealing and consistent environment for investment advisors, the clarification is part of Hong Kong’s efforts to retain and grow its foothold in the offshore fund arena, while further enhancing its other related financial services sectors.
In general, if the central management and control of a company is exercised by the directors in board meetings, the relevant locality is where those meetings are held. However, the location of board meetings is not entirely conclusive in determining central management and control. It is significant only in so far as those meetings constitute the medium through which central management and control is exercised. In cases where central management and control of a company is in fact exercised by an individual, the relevant locality is the place where the controlling individual exercises his power. Furthermore, the clarification recognises that the residence of the person who manages the asset portfolios on behalf of a fund is not the sole conclusive factor in determining the residence of the fund.
So what does this clarification mean in practical terms for the exercise of central management and control? Having the majority of the board reside in Hong Kong would appear only to raise the burden that an offshore fund would have in achieving the desired tax status. In adhering to these well-established principles, the location of central management and control is “wholly a question of fact”. The popular practice of travelling out of the jurisdiction simply to hold board meetings may not be viewed as an acceptable genuine commercial reason in successfully navigating the control offshore. Nonetheless, investment funds often delegate a level of control to an investment manager or an advisor. Once again, the issue of the locality of where this management is being exercised may be a corollary factor in determining the central management and control issue. Any retrenchment in this field is most welcome.
On a similar note, the HMRC draft guidance offers a number of examples of situations where HMRC would not usually seek to establish that a given offshore company is a UK resident for the purpose of determining the scope of the charge, if any, to corporation tax. The given examples focus largely on issues such as the number of UK directors versus foreign directors, their normal base location, location of meetings held and their frequency.
Six circumstances are assumed:
- the company is wholly owned by a UK headed group or a UK headed sub-group with a non-UK resident ultimate parent;
- the company is incorporated outside of the UK in a territory where it is considered to be resident for tax purposes by virtue of its incorporation there;
- the country of incorporation and residence has a double taxation agreement with the UK which contains a residence tie-breaker;
- the company is genuinely established in its territory of residence;
- the company does not (except in the particular circumstances of examples 6 to 8 of the draft guidance) have investment business as its main business; and,
- the central management and control of the business of the company is at least in part exercised at meetings of its board of directors.
This new guidance is unlikely to have a direct or immediate impact on offshore jurisdictions. Each particular circumstance would be looked at on a case-by-case basis, if HMRC were to decide to seek confirmation regarding UK residency. The guidance is primarily focused on defining the issues that HMRC would take into consideration when making that decision.
Cayman – the jurisdiction of choice for many hedge and private equity funds with a global investor base – has proven to be an ideal jurisdiction from which Hong Kong and UK managers alike can set up their offshore vehicles. The appointment of a Cayman service provider can provide a total solution and help to ensure that Hong Kong and UK managers and their offshore funds maintain their tax exempt status by offering the highest level of control.
Cayman service providers confront these complex issues on a daily basis across multiple jurisdictions and are able to offer a cost-effective solution. The principals can act as directors who are able to make business decisions and confer meaningful value-added leadership; service providers further assists with trading activities of the fund, offer accounting and administrative support, global communications, serviced office facilities, directly contracted employees and bank account services.
Where a Cayman-incorporated investment manager is established, physical services and leadership to that entity can be delivered as well, helping to maintain central management and control offshore.