If you want to provide offshore services to China, go to Hong Kong. This statement is not new, but it seems to become more significant with each passing year. A combination of regulatory policy, strong local capital markets and geographical proximity are allowing the region to consolidate its position as the location of choice for China inbound and outbound corporate structures.
An offshore environment that revolves around the use of double tax treaties (DTTs) to achieve tax efficiency – and the substance requirements that arise from that – inevitably works hugely in Hong Kong’s favour. According to a survey of industry participants as part of OIL’s latest Offshore 2020 White Paper[i], DTTs and tax information exchange agreements (TIEAs) are increasingly seen as important factors in investment decision-making. Zero-tax considerations, by contrast are becoming less important.
On a basic level, the advantages of Hong Kong’s DTT with China are clear: Placing a Hong Kong entity in between a China-based wholly foreign owned enterprise and a Cayman Islands or similar parent vehicle can at a stroke eliminate double taxation and offer reduced withholding taxes on certain passive income streams.
But that’s not all. With a growing number of nations ruling that DTT benefits are only available to an entity able to prove a certain level of business activity in the relevant jurisdiction, the onus is on companies to open offices and hire staff. This is much easier to do in a developed international business centre like Hong Kong where it makes commercial sense to maintain an operational base.
More than three quarters of respondents in OIL’s survey said that they are seeing increased demand from clients to incorporate elements of onshore into offshore structures, citing more stringent regulation on information exchange and DTTs as the key driving factors. In this context it is no surprise that Hong Kong and Singapore are expected to become the industry’s most “mid-shore” jurisdictions in Asia.
Asked to rank jurisdictions by importance now and in five to 10 years’ time, survey respondents said the British Virgin Islands (BVI) is the market leader at present, closely followed by the Cayman Islands and Hong Kong, with Singapore in fourth place. However, the situation is expected to turn on its head over the next five to 10 years, with Hong Kong and Singapore assuming the top two places.
Many of the characteristics of Hong Kong that appeal to investors seeking to build substance – a well-established and high performing onshore financial sector, a strong legal system, high levels of service, relatively painless bureaucracy and extensive international trade links – also allow the jurisdiction to flourish in areas that complement offshore structures.
The OIL survey found that Hong Kong is the most popular option for initial public offerings, corporate trading and investment holding companies. Roughly 22 per cent of respondents cited investment holding purposes as their primary motivation and 11 per cent cited special purpose vehicles (SPV). By 2020, the holding, trading and SPV shares are expected to rise to 25 per cent and 15 per cent, respectively.
The investment holding numbers in particular reflect Hong Kong’s enduring appeal as a platform for corporate M&A and also investment fund activity, whether it is private equity and venture capital vehicles or hedge funds. Increasingly, this activity will focus on Chinese outbound capital flows as well as money entering the country.
Hong Kong's emergence as a popular jurisdiction in cross-border structures doesn't spell the end for traditional jurisdictions such BVI and Cayman; in fact, they can benefit from it to a certain extent. Although Caribbean offshore financial centers and European strongholds like Jersey, Guernsey and the Isle of Man are expected to cede ground to Hong Kong, this is more a reflection of evolving offshore structures than a death knell.
Without question these jurisdictions will retain their appeal for “pure” offshore demand as Cayman Islands holds its status as the preeminent home for fund structures and BVI continues to be favoured as a location for SPVs and individual tax planning and asset protection. Indeed, BVI remains by some distance the most commonly used jurisdiction in Asia. However, these functions form part of a chain in which Hong Kong also features. For example, of the last 100 IPOs in Hong Kong to November 2011, 62 were Cayman-incorporated entities. And BVI is commonly used as a domicile for the SPVs set up by company owners to hold investments in these newly-listed entities.
Singapore too appears to be following a path that minimises direct competition with Hong Kong. While the latter draws in fund managers with its proximity to China and developed capital markets, the former has identified space around the Hong Kong footprint, notably private banking where its firm line on information exchange and proactive wealth management policies pay dividends.
[i] Copies of OIL's Offshore 2020 White Paper can be obtained free of charge by emailing email@example.com.
Martin Crawford, Chief Executive Officer, Offshore Incorporations Limited (OIL)