Written by: Mankiw Blockchain Legal Services
When considering where to set up an investment vehicle to invest in virtual assets, whether it is a fund or a single family office investment vehicle, tax issues should be the first consideration. Hong Kong is known for its favorable tax policies. For example, it adopts the territorial principle, which means that companies are only taxed on profits generated in Hong Kong. This creates a favorable environment for international companies because foreign income is not taxed.
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Now, when we talk about Profits Tax in Hong Kong, there are some important tax exemptions. However, until recently, virtual assets have not been included in the list of tax-exempt assets in Hong Kong.
However, this situation is about to change...
Proposed changes regarding the tax treatment of virtual assets in (i) private fundraising funds and (ii) single family office investment vehicles
Currently, Hong Kong is publicly soliciting opinions on introducing a new profits tax exemption policy for virtual assets. The Hong Kong Financial Services and the Treasury Bureau suggests expanding the existing profits tax exemption scope to cover (i) private fundraising funds and (ii) single family office investment vehicles, specifically including but not limited to:
Overseas real estate
Carbon credits and emission derivatives or quotas
Private credit investments and loans
Virtual assets
(i) Private fundraising funds
In Hong Kong, there is a unified tax exemption system that provides profits tax exemptions for qualifying private funds, including those established in the form of limited partnership funds and open-ended fund companies. Under this system, private funds can enjoy exemptions from profits tax on income generated from their investments (such as capital gains, interest, and dividends), provided these funds meet specific criteria. These criteria include being managed by investment managers licensed under the Securities and Futures Ordinance, and the fund's activities must primarily relate to investments, rather than commercial or trading activities.
However, until now, there has been controversy over whether virtual assets can be included in Hong Kong private funds and whether this would affect the applicability of Hong Kong's unified tax exemption system. Therefore, the new proposals bring much-needed clarity to this issue, indicating that virtual assets can indeed qualify as 'eligible investments' and thus enjoy profits tax exemptions.
It is worth noting whether the government will further clarify the tax treatment of other cryptocurrency-related income or derivatives in the consultation paper. For example, it is currently unclear how cryptocurrency-related income such as staking rewards will be classified for tax purposes in Hong Kong.
(ii) Single family office investment vehicles
Currently, Hong Kong has a law ensuring that qualifying single family office investment vehicles can enjoy profits tax benefits, offering a 0% preferential tax rate on taxable profits from qualifying transactions and related transactions. However, virtual assets are currently not included in this scope. Therefore, if the new proposals in the consultation paper come into effect, the scope of designated assets will be expanded to include virtual assets. Virtual assets will encompass common crypto assets such as Bitcoin, Ethereum, as well as certain utility tokens, security tokens, and stablecoins.
Potential implications of Hong Kong as a virtual asset center
Hong Kong's introduction of a profits tax exemption policy for virtual assets will have a profound impact on the entire crypto industry. Here are some specific potential impacts:
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1. Attract global investors
The new tax policies will attract investment managers and high-net-worth individuals globally, making Hong Kong their preferred virtual asset investment center. In particular, hedge funds and family offices seeking to maximize after-tax returns may be more inclined to establish investment vehicles in Hong Kong. Additionally, this policy may attract international virtual asset exchanges, custodial service providers, and other ecosystem participants to expand their operations in Hong Kong, further solidifying Hong Kong's position in the global crypto industry.
2. Promote local economic growth
As more investment managers and family offices set up in Hong Kong, the local legal, accounting, tax, banking, and other professional services industries will also benefit from the additional demand. This will not only help drive growth in related industries but also increase job opportunities. Meanwhile, the Hong Kong government, through such policy direction, demonstrates its supportive stance towards crypto technology and virtual assets, providing confidence to attract more technology-oriented companies.
3. Incentivize innovation and ecosystem development
Hong Kong's inclusive attitude towards virtual assets and clear tax policies will inspire more startups, developers, and investors to enter the virtual asset space. This may accelerate innovation in areas such as decentralized finance (DeFi), blockchain infrastructure, and tokenized assets. The rapid development of these emerging fields will make Hong Kong not only a center for capital accumulation but also a laboratory for global crypto innovation.
4. Enhance international competitiveness
Currently, Hong Kong and Singapore are in fierce competition for the status of Asia's virtual asset center. By offering competitive tax policies, Hong Kong can gain an advantage in this competition, especially in attracting virtual asset funds and family offices. The Goods and Services Tax (GST) imposed on virtual asset transactions in Singapore may make Hong Kong more attractive in this regard. Furthermore, Hong Kong's close ties with mainland China also provide international investors looking to enter the vast mainland market with a unique strategic advantage.
Issues to focus on next
The consultation period for the consultation paper will end on January 3, 2025. We will closely monitor this consultation paper and its conclusions to share with everyone the impact of these new changes on the industry.