Hong Kong Hedge Funds Caught in Tax Haven Clampdown

The new Cayman Islands Economic Substance Law, which aims to prevent multinational companies using subsidiaries in tax havens to lower liabilities, is affecting Hong Kong hedge funds there.

Hong Kong hedge funds are being impacted by new laws introduced in the Cayman Islands to target large tech and pharma firms that shift their intellectual property to subsidiaries in low or zero-tax jurisdictions where royalties will be paid.

The Economic Substance Law, effective 1 January 2019, requires firms involved in a range of activities including funds management, banking, finance and leasing, to maintain a level of operational substance that is effectively commensurate with their income-generating activities. Similar laws were also introduced in other offshore jurisdictions like the British Virgin Islands and Bermuda.

Hong Kong hedge funds are particularly affected because they use Cayman investment managers, while offshore management companies have been less popular among European managers in recent years.

To comply with the requirements, they either have to set up an office there or outsourcing their income-generating activities covered by the rules to service providers in the Cayman Islands.

Entities will have annual reporting obligations to the Cayman tax information authority in respect of their compliance to the new rules from 2020. According to KPMG, there are heavy penalties for failing to satisfy economic substance requirements – the fine starts at $10,000 in the first year, and goes up to $100,000 in subsequent years. Entities may also be struck off the Register of Companies.