Jay Krause and Philip Munro, Withers, examine how Asian IFCs are beginning to justifiably rival their western counterparts, assessing what specifically gives the East the current edge over the West.
Given the dynamic nature of Asia’s economies during the last quarter of the 20th century, and their continued growth notwithstanding the global financial crisis, it is no surprise that the impact of international finance centres (‘IFCs’) has been significant in Asia.
The three jurisdictions that have consistently been the leading investors into the People’s Republic of China (‘PRC’) have, for example, been Hong Kong, the British Virgin Islands (the ‘BVI’) and the Cayman Islands.
The PRC is not unique in the use of IFCs for inbound investment with, for example, much investment in India being undertaken through companies formed in Cyprus, Mauritius and Singapore. The rise of Asia’s economies has led to a shift in investment trends, with there now being a significant focus on strategies for outbound investment from Asia and also for preserving the wealth generated in Asia now increasingly, comprising liquid investments rather than interests in family-owned trading businesses. As IFCs continue to be used in Asian planning, there is scope for Asian IFCs to begin to rival some of those found in Europe and the Caribbean.
Hong Kong’s position as a major investor into the PRC is, perhaps, not unsurprising given its geographical location. It is understood that, in 2009 alone, US$54billion of investment was channelled into the PRC from Hong Kong. Hong Kong does, however, have a role beyond investment into the PRC. Central in Hong Kong’s success as a finance centre has been its continued political and social stability and its favourable tax regime. Control of Hong Kong was returned by the United Kingdom to China on 1 July 1997, with Hong Kong becoming a special administrative region (‘SAR’) of the People’s Republic: as an SAR, Hong Kong has a constitution set out in the Basic Law which is intended (for a period of 50 years) to give it a separate legal and administrative system.
Hong Kong’s tax regime can be very favourable. Hong Kong has abolished the estate duty it previously levied on Hong Kong assets on death (with effect on deaths on or after 11 February 2006), has always been a ‘free port’ and levies no gift or sales taxes. In terms of direct taxation, Hong Kong does not tax by reference to residency on a worldwide basis, having, instead, a ‘territorial’ system. Hong Kong’s territorial system means that certain income types are taxed if, and to the extent that, they have a Hong Kong source. Trading profits can be taxable if there is trading in Hong Kong (subject to an exemption for certain offshore funds), but not the proceeds of investment as Hong Kong does not tax capital gains, and interest paid by regulated financial institutions is generally exempt from tax. Where companies are subject to tax on Hong Kong source trading income, the rate is 16.5 per cent.
A traditional weakness of Hong Kong as a jurisdiction for establishing holding companies and for non-residency planning for individuals has been its lack of double tax treaties (until 2001, Hong Kong had no tax treaties at all). Hong Kong was not, however, able to enter into full OECD model treaties because it lacked a statutory basis on which to collect information in relation to non-Hong Kong tax reporting matters. This position changed on 12 March 2010 when the Inland Revenue (Amendment) Ordinance 2010 ('IRAO') and Inland Revenue (Disclosure of Information) Rules were enacted. The amendments set out in the IRAO will extend the power of the Inland Revenue Department to obtain information from a person with relevant information in relation to any person’s liability, responsibility or obligations under the laws of a jurisdiction with which Hong Kong has a tax treaty. With these powers in force, Hong Kong has a statutory basis for entering into double tax treaties. Hong Kong now has 23 full double tax treaties either in force, or agreed but pending implementation.
Hong Kong is not alone in Asia in having a territorial system of tax; Singapore also taxes on this basis. Persons carrying on a trade, profession or business in Singapore are chargeable to tax on all profits (excluding profits arising from the sale of capital assets) arising, in or derived from, Singapore and certain foreign-sourced income from such trade, profession or business. Where Singapore does tax, its corporate tax rate is capped at 17 per cent and its personal rate at 20 per cent (15 per cent for non-residents). Like Hong Kong, Singapore does not tax capital gains and has moved (with effect from 15 February 2008) to abolish estate duty. It too has the potential for treaty benefits to be obtained: Singapore has now concluded more than 50 comprehensive double tax treaties.
In addition to its abolition of estate duty, Singapore has sought to attract private wealth through the introduction of a modern trust law. Singapore's trust law is broadly based upon English trust law principles, but has been revised to provide for a 100-year perpetuity period, the abolition of the rule against excessive accumulations of income and foreign elements provisions to provide protection against forced heirship claims, making Singapore law trusts attractive for international settlors. Singapore has also introduced a specific exemption from its trust licensing requirements to facilitate the creation of Singapore private trust companies. Singapore can specifically exempt from tax Singapore trusts of which none of the settlor or the beneficiaries are citizens or residents of Singapore.
Both Hong Kong and Singapore are attractive as jurisdictions for holding investments, not levying capital taxes nor, generally, taxing investment returns; as jurisdictions for holding company operations they have a regime for taxing profits that is limited to taxing locally sourced profits at a relatively low rate. That Hong Kong and Singapore do have some local tax considerations will, for some families, be seen as an attractive feature given the negative connotations that some now ascribe to traditional ‘offshore’ jurisdictions.
Other Asian IFCs
Asia does have tax neutral jurisdictions with modern company laws in the form of Labuan and Brunei. Labuan is part of Malaysia but, recognising its geographical advantages close to major shipping routes and offshore oil and gas fields, the Government of Malaysia has designated it as an ‘International Offshore Financial Centre’. Labuan has a comprehensive deck of trust and company laws and a tax regime that does not tax investments held by Labuan entities. Although Labuan may tax certain trading operations, Labuan entities can, in some instances, take advantage of Malaysia’s double tax treaty network. Nearby Brunei also has a modern company law regime which specifically exempts locally formed ‘international business companies’ from any tax. While internationally the use of Labuan and Brunei entities is not yet widespread, they are being used in some sectors. There are a number of publicly marketed investment funds, for example, that are domiciled in Labuan and it is a jurisdiction that is increasingly being used in Islamic finance transactions.
Asia is, accordingly, not only using IFCs from other parts of the globe but, also, is offering its own. The territorial tax regimes applying in Hong Kong and Singapore make them appealing from both a personal and a corporate tax perspective while, at the same time, they might be seen as attractive in that they are not traditional ‘zero-tax’ jurisdictions having substance and wider infrastructure. Labuan and Brunei are tax neutral and may, in the future, be increasingly used.
Philip Munro has practiced as a tax and trusts lawyer in Withers’ London, Hong Kong and Singapore offices.
Jay Krause heads Withers’ wealth planning practice in Asia from the firm’s Singapore office. Jay's personal practice focuses on cross-border tax efficient wealth, business and inheritance structuring. Typical clients include family businesses, fund managers, high net worth families, single and multi-family offices, trustees, insurers and financial institutions. Jay has been heavily involved in advising individuals on the IRS voluntary disclosure programs and both individuals and institutions on the implications of the new US Foreign Account Tax Compliance (FATCA) legislation.