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Eurekahedge
Eurekahedge Hedge Fund Indices
Hedge Fund Monthly
Hedge Fund Structures and Regulatory Positions in Hong Kong, Singapore and Japan
Eiichi Kanda & Tatsuhiko Kamiyama, Clifford Chance (Tokyo) LLP
Mark Shipman, Clifford Chance, Hong Kong
Choo Wai Hong, Clifford Chance Wong, Singapore

September 2004

Hong Kong Singapore Japan
The Hedge Fund
(offshore)

The preferred hedge fund structure for Hong Kong based managers/advisers tends to be an offshore limited liability company. The main factors determining this preference is investor familiarity and that such a vehicle is relatively low risk to the hedge fund manager i.e. it has a separate legal identity distinct from the management functions, and is easy to operate with respect to day to day subscription and redemption of shares. Furthermore, offshore jurisdictions used such as Cayman Islands, British Virgin Islands and Bermuda, are tax neutral. The preferred
hedge fund
structure for Singapore
investors tends,
as in Hong Kong
and for the same reasons, to be an offshore limited liability company
Different from Hong Kong and Singapore, the preferred hedge fund structure for Japanese investors is not an offshore limited liability company, but an offshore limited partnership, which is typically located in Cayman Islands. Some Japanese investors also favour an offshore unit trust structure.
The Fund Manager
(offshore)

For tax (and regulatory)1 reasons, the fund manager tends to be located, and operates from, offshore and often in the same jurisdiction as the hedge fund itself. In this way it is not subject to the licensing or regulatory requirements of Hong Kong. The fund manager will have day to day investment discretion for the hedge fund2. It may appoint an investment adviser to provide it with (non-discretionary) investment advice.

Typically, the fund manager will be paid a management fee and a performance fee.

There are
incentives
provided by the Singapore government
for funds to
use fund mangers
/investment
advisers based
in Singapore. Consequently
the fund
manager tends
to be located,
and operate from, offshore (for financial reasons) and may delegate its management functions to a sub-manager in Singapore.M


Typically, the
offshore fund manager will
be paid a management
fee and a performance fee,
and it will pay
a sub-management fee to the sub-manager, if any,
on a cost
plus basis.
For tax and regulatory reasons, the fund manager tends to be located, and operates from, offshore. In this way it is not subject to licensing or regulatory requirements in Japan.

The fund manager will have day-to-day investment discretion for the hedge fund and may appoint an investment advisor to provide it with (non-discretionary) investment advice.

Typically, the fund manager will be paid a management fee and a performance fee.
The Investment Adviser
(onshore)

The fund manager will appoint the investment adviser in Hong Kong (which is generally part of the same group of companies as the fund manager and often a wholly-owned company of such or vice versa) to carry out the investment advisory function on a non-discretionary basis. The Hong Kong based traders would be employed by this investment adviser, and would give "advice" to the offshore fund manager. Depending on the precise activities of the investment adviser and any available exemptions 1, the investment advisers may be required to be licensed by the Securities and Futures Commission ("SFC") pursuant to the Securities and Futures Ordinance ("SFO") for Type 4 (advising on securities) and perhaps Type 5 (advising on futures contracts) and Type 93 (asset management) regulated activities in relation to the business it carries on in such regulated activities in Hong Kong.

The Hong Kong based investment adviser would not normally be granted investment discretion.

Typically, the fund manager will pay the investment advisory fee to the investment adviser on a cost plus 5 or 10% basis.
The fund manager
will appoint
the investment
adviser in
Singapore to
carry out the investment
advisory function
on a non-
discretionary
basis or a sub-manager to
whom the fund manager delegates the discretionary
fund management activities.

Prima facie the investment adviser (and/or sub-manager) would need a Capital Markets Service Licence ("CMS Licence") however
it may be exempt
from holding a CMS Licence under the Securities and
Futures Act 2002 ("SFA") on the basis that a person
resident in
Singapore who undertakes fund management on behalf of not more than 30 "qualified investors" (as
defined in the SFA) are exempt from licensing. A "
qualified investor" includes a fund
(e.g. the hedge
fund) which is not offered to the
public
in Singapore,
or if offered in Singapore, is
offered only to accredited
investors,
meaning an
individual with
net assets
exceeding S$5
million or a corporation with
net assets
exceeding S$10 million. A
qualifying hedge
fund would
therefore count
as "one"
qualified investor.
This is an option adopted by hedge fund
sub-managers/
investment
advisers in
Singapore.

Typically, the
fund manager
will pay an
investment
advisory fee
to the
investment
adviser on a
cost plus basis.
The fund manager will usually appoint an investment advisor in Japan to carry out the investment advisory function on a non-discretionary basis. In order to provide those investment advisory services, the investment advisor in Japan is required to register with the Regional Financial Bureau under the Investment Advisory Business Law. If a foreign investment advisor wants to establish a liaison office in Japan solely for the purpose of collecting and distributing market information without recommendation or advice, it is only required to give prior notification under that law. Neither an investment advisor nor a liason office may deal in securities without additional approvals. The Japan based investment advisor would not normally be granted the discretion to make investments.

Typically, the fund manager will pay an investment advisory fee to the investment advisor on a cost plus basis.
Tax A limited liability hedge fund company established offshore Hong Kong and not carrying on any trade or business in Hong Kong will generally enable investors to roll up income and gains tax-free and so to choose when to pay tax on the sale of their investment. However, incorporation of a company in a jurisdiction that imposes minimal or no taxation does not guarantee that the hedge fund will not be regarded by the Hong Kong Inland Revenue ("HKIR") as carrying on a business in Hong Kong for tax purposes and therefore subject to Hong Kong's taxation regime on its profits which are sourced in Hong Kong. This is because the recent practice of HKIR (of issuing profits tax returns to offshore hedge funds) has raised uncertainties as to whether non-residents (including offshore hedge funds) may fall within the Hong Kong tax net through their continued use of Hong Kong brokers and the appointment of Hong Kong-based fund managers. Although the Hong Kong government has recently unveiled a consultation paper providing for a proposed tax exemption of offshore funds and although the general industry response is that the proposed exemption regime is not extensive enough, the Hong Kong government's Financial Secretary has announced its intention not to impose Hong Kong profits tax on offshore hedge funds merely because they use the services of Hong Kong brokers and fund managers and does not provide certain Hong Kong tax treatment to offshore funds.

Hong Kong profits tax is not charged on profits arising from the sale of capital assets. Based on decided cases, investment gains accruing to an investor which is an insurance company, a securities dealer or a financial institution are prima facie of a trading nature and therefore will be subject to profits tax. Depending on its trading pattern, investment gains made on subscriptions to securities in a hedge fund structured as a corporate entity may be regarded as gains of a trading nature and subject to profits tax if the two criteria listed above are satisfied.

A Hong Kong-based fund manager or adviser will be subject to Hong Kong profits tax on the fee income it receives.
A limited liability hedge fund
company
established
offshore
Singapore will
not be subject to Singapore income
tax unless the activities of the manager/sub-manager would
cause the profits or income of the
fund to be
considered sourced
in Singapore and hence liable to Singapore income
tax. This will depend on the activities
of the manager
/sub-manager. However under the Income Tax
(Income from
Funds Managed
for Foreign
Investors) Regulations there is an exemption for where "specific income" derived
from "foreign investors" in
respect of "designated investments" from funds is managed by any Singapore manager/sub-manager or as a result of investment advisory services provided by any Singapore manager. The definition of "foreign investor" includes in relation to a company not resident in
Singapore where no more than 20% (excluding total percentage owned directly by
designated
persons such
as the
Government of Singapore
Investment Corporation
Plc and any
statutory board or company owned by the Minister of Finance) of its
issued share
capital is
beneficially
owned, directly
or indirectly, by persons who are citizens of
Singapore or
resident in
Singapore. Most offshore hedge
funds managed in Singapore tend
to fall within this exemption and therefore enjoy
the tax exemption
so long as other
required conditions are satisfied (which are beyond the
scope of this summary).

There is available
to a qualifying
fund manager in Singapore an "approved fund manager" ("AFM") status according
a 10%
concessionary
tax (as opposed
to the normal corporate tax
rate of 20%) on
fees and
commission
s earned by it from managing funds of foreign investors for the purposes of designated investments as discussed above.
The qualifying
criteria for an
AFM includes
the fund manager having at least 2 investment professionals, managing at least S$100 million of assets in
Singapore and a commitment by
it to a 5-year
growth plan
in terms of
assets under management,
number of
investment professionals
and/or additional capacities.
Traditionally, the prevailing view is that an offshore limited partnership is a pass-through entity for the purposes of Japanese taxation. In other words, an investor in a limited partnership (i.e., a holder of a limited partnership interest) is treated for Japanese taxation purposes as if the investor, not the limited partnership itself, directly holds part of underlying investments of the limited partnership. Based on this view, the profits/losses incurred by the limited partnership are treated as incurred by the investor and the investor may utilise losses (if any) incurred by the limited partnership to set against other taxable income.

However, recently the Japanese National Tax Administration (the "NTA") has challenged this view. In 2001 the NTA ruled that a limited liability company formed under New York law should be treated as a "foreign corporation", rather than a pass-through entity, for Japanese taxation purposes and it has recently been reported that a regional NTA office has taken the view that a limited partnership formed under Delaware law should be treated as a "foreign corporation", rather than a pass-through entity.

It is uncertain whether a limited partnership formed under Cayman Inlands law (a "Cayman LP") will be treated as a "foreign corporation" by the NTA and how the taxation position will be affected if it is treated as a "foreign corporation". If a Cayman LP is treated as a "foreign corporation" by the NTA, it is possible that the returns from the limited partnership in the form of distributions, redemption premiums or capital gains would be treated in the same manner as the return on stock of a corporation and a Cayman LP may be subject to Japanese income tax if the activities of the fund manager cause the profits or income of the fund to be considered as sourced in Japan and hence liable to Japanese income tax, though this also would depend on the activities of the fund manager.

A Japan-based investment advisor will be subject to Japanese income tax on the fee income it receives.

1Under the SFO there is an exemption from licensing where an entity provides advice solely to its parent who owns all its issued share capital and other wholly-owned companies of the same parent. The SFC's current view is that this applies only to the parent's own assets but not those of its clients. However, we do not entirely agree with this view. If it is necessary to establish a quick start up, this exemption may be used as a short term measure but a SFC licence should be sought in due course.

2There are some obvious practical considerations/tensions here.

3It is worth noting that currently a Type 9 licence does not permit a person (without a separate relevant licence) to advise on securities or futures contracts even where such activities are wholly incidental to the asset management activity.


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