Hong Kong Limited Partnership Funds and Open-Ended Fund Companies

This note sets out the key differences between the Hong Kong private open-ended fund company (the “OFC”) and the Hong Kong limited partnership fund (the “LPF”). The choice of using an OFC or a LPF may not solely be determined by legal or regulatory considerations but may also be influenced by “soft” issues, such as the preference of the founders and/or the investment manager, where for example an investment manager or a founder with a US background may be more familiar and hence prefer LPF structures. Equally, the choice of fund structure may be determined by investor preference, for example, US investors may be more familiar and comfortable with a LPF structure whereas Asian-based investors have in the past favoured a corporate fund structures (although in recent years have been making increasing use of LPF structures).

The Hong Kong OFC

An OFC is an open-ended fund in corporate form domiciled in Hong Kong. Unlike a limited partnership, an OFC is a separate legal entity with a board of directors; each director owes fiduciary duties and statutory duties of care, skill and diligence to the OFC.

An OFC must register with and be approved by the Securities and Futures Commission (the “SFC”). Once the OFC is approved by the SFC, it is incorporated under Part IVA of the Securities and Futures Ordinance (Cap. 571) (the “SFO”) and registered with the Companies Registry. The regulatory regime governing OFCs comprises:

• Part IVA of the SFO which sets out the legal framework for establishing an open-ended fund company;
• the Securities and Futures (Open-ended Fund Companies) Rules (OFC Rules) and the Code on Open-ended Fund Companies (OFC Code) which contain the detailed legal and regulatory requirements for OFCs; and
• the Securities and Futures (Open-ended Fund Companies) (Fees) Regulation (Fees Regulation) which provides for the fees chargeable by the SFC and the Companies Registry in respect of OFCs.

The governing document of the OFC is the instrument of incorporation (the “Instrument”) which must be filed with the SFC upon application for registration. Part IVA of the SFO sets out the requirements in relation to what must be included in the Instrument which include:

• the OFC’s name;
• a statement that the OFC’s registered office is situated in Hong Kong;
• the objects of the OFC;
• provision as to the types of property in which the company will invest;
• statements that:
• • the company is an open-ended fund company with variable share capital;
  • the company’s paid-up share capital will always be equal to its net asset value;
  • the company’s shareholders are not liable for the company’s debts;
  • the company’s scheme property is entrusted to a custodian for safe keeping in compliance with the law; and
• any other matters prescribed by the OFC Rules.

The Instrument must provide that “the object of the OFC is the operation of the company as a collective investment scheme.”

The Hong Kong LPF

The LPF regime in Hong Kong is an opt-in regime which means that registration of a limited partnership fund under the Limited Partnership Fund Ordinance (Cap. 637) (the “LPFO”) is not compulsory.

The LPF must be constituted by a partnership agreement and must have a registered office in Hong Kong. The LPFO provides flexibility in respect of contractual freedoms. The LPF generally has the freedom of contract regarding the operation of the LPF. In addition, the LPFO contains a number of safe harbours (the “Safe Harbours”) for those involved in certain activities of the limited partnership fund. A limited partner may conduct certain safe harbour activities, which will not be regarded as ‘management’ of the limited partnership fund and will not therefore compromise its limited liability status in respect of the LPF. Examples of safe harbour activities include:

• serving on a board or committee of the limited partnership fund;
• discussing with, advising or approving the general partner or investment manager of the limited partnership; and/or
• calling, requesting, attending or participating in a partners meeting.

Hong Kong tax – Hong Kong fund ‘unified tax exemption’ (“Exemption”)

Section 20AM of the Inland Revenue Ordinance (Cap. 112) (the “IRO”) provides the key elements for the definition of a fund to which the Exemption applies and specifically provides that “the contributions of the persons participating in the arrangement (participating persons), and the profits or income from which payment is made to them, are pooled under the arrangement.” The definition has been modelled on the definition of a collective investment scheme (CIS) as defined under the SFO.

The IRO defines a “fund” as an arrangement in respect of property where:

• either:
• • the property is managed as a whole by, or on behalf of, the person operating the arrangement; or
  • the contributions of the participating persons, and the profits or income from which payment is made to them, are pooled under the arrangement, or both;
• the participating persons do not have day-to-day control over the management of the property (whether or not they have the right to be consulted on, or to give directions in respect of, the management); and
• the actual or pretended purpose or effect of the arrangement is to enable the participating persons, whether by acquiring any right, interest, title or benefit in the property or any part of the property or otherwise, to participate in or receive profits, income, payments or other returns

Subject to anti-avoidance provisions, a fund is exempt from profits tax on profits earned from the following transactions:

Qualifying transactions

These are transactions in asset classes specified in Schedule 16C to the IRO which include: securities; shares, debentures, bonds, etc. issued by a private company¹; futures contracts; foreign exchange contracts; deposits made with a bank; certificates of deposits; exchange-traded commodities; foreign currencies; OTC derivative products; and an investee company’s shares co-invested under the Innovation and Technology Venture Fund Scheme;

Eligibility for the profits tax exemption for qualifying transactions requires the fund to satisfy one of following conditions:

• the qualifying transactions of the fund are carried out or arranged in Hong Kong by or through a person licensed or registered with the SFC; or
• the fund is a qualified investment fund, i.e. a fund in respect of which:
• • at all times after the final closing of sale of interests: (A) the number of independent investors exceeds 4; and (B) the capital commitments made by investors exceed 90% of the aggregated capital commitments; and
  • the originator of the fund (i.e. the person who originates or sponsors the fund and has the power to make investment decisions on behalf of the fund) and its associates are entitled to no more than 30% of the net proceeds of the fund’s transactions, after deducting the portion attributable to their capital contributions (which is proportionate to that attributable to the investors’ capital contributions).

Incidental transactions

Transactions which qualify as incidental transactions can also enjoy the profits tax exemption for the profits earned from these incidental transactions. However, a fund cannot enjoy the profits tax exemption for the profits earned from an incidental transaction if the trading receipts from the transaction exceed 5% of the total receipts of qualifying transactions and incidental transactions in the relevant period. If the 5% threshold is exceeded, all receipts from incidental transactions will be chargeable to profits tax.

OFC transactions and the Exemption

In addition to the above principles, an OFC may be exempt from profits tax on transactions in assets of a non-schedule 16C class, provided that the OFC meets the definition of a fund (as described above)². However, the profits tax exemption is not available to an OFC which:

• carries on a direct trading or direct business undertaking in Hong Kong in assets that are not specified in Schedule 16C to the IRO (“non-Schedule 16C assets”); or
• holds non-Schedule 16C assets that it utilises to generate income.

Comparisons of the key features of a LPF and OFC

Please see the table below which sets out some of the key differences in respect of the LPF and the OFC. As outlined in the introduction to this note, we must point out that the choice of fund vehicle is dependent on a number of factors, including the regulatory regime, the nature of the proposed fund and the jurisdictions where the investors are based. For example, limited partnerships are popular among US investors due to relevant tax treatment in the US.

		Hong Kong LPF	Private Hong Kong OFC
Key operators	Directors / General Partner	The GP of a LPF may be: a natural person who is at least 18 years old; a private Hong Kong company limited by shares; a registered non-Hong Kong company; a limited partnership registered under the Limited Partnerships Ordinance (Cap. 37); a limited partnership fund; or a non-Hong Kong limited partnership without legal personality.	Two (2) directors who are natural persons and at least 18 years of age or older. The directors of the OFC must be approved by the SFC and must be of good repute, appropriately qualified, experienced and proper for the carrying out of the business of the OFC.
	Investment manager	The LPF is required to appoint a person (who may be the general partner or another person) as an investment manager to carry out the day-to-day investment management functions of the partnership. The investment manager must be either a: Hong Kong resident; Hong Kong company; or registered non-Hong Kong company. Please note that where the investment manager undertakes any regulated activities in Hong Kong, it will be subject to Hong Kong’s licensing regime.	The investment management function must be delegated to an investment manager which is licensed or registered with the SFC for carrying on Type 9 (asset management) regulated activity.
	Custodian	There is no requirement to appoint a custodian. However, the GP is under a duty to ensure the proper custody of the LPF’s assets.	The OFC’s investment property is required to be entrusted to a custodian for safe-keeping by Part IVA of the SFO. Criteria for a custodian meet the same eligibility criteria as set out in the UT Code; or be a licensed or registered institution which is licensed or registered with the SFC for carrying on Type 1 (dealing in securities) regulated activity.
Auditors		The GP must appoint an auditor for each financial year.	An auditor must be appointed for each financial year.
Investment restrictions		There are no investment restrictions.	There are no investment restrictions for private Hong Kong OFCs. The OFC must not be a business undertaking for general commercial or industrial purposes.
Legal personality		The LPF does not have separate legal personality. The GP has unlimited liability for all the debts and obligations of the LPF. The GP may itself have limited liability where for example the GP is a limited liability company.	The OFC does have separate liability.
Liability of limited partners / shareholders		The LPs are not liable for the debts and obligations of the LPF beyond the amount of the LP’s agreed contribution provided that the LP does not participate in the management of the fund outside of the safe harbours provided for in the LPFO.	Shareholders are not responsible for the debts and liabilities of the OFC.
Flexibility of contract		The LPF generally has the freedom of contract regarding the operation of the LPF which included the freedom of contract in respect of: admission and withdrawal and partners; transfer of interests by the LPs’ organisation, management structure and decision making; investment scope and management; powers, rights and obligations of the partners; scope of fiduciary duties; financial arrangement between partner; the life of the LPF; frequency of valuation reporting; custodial arrangement; and dissolution procedures.	The OFC does not provide the same the degree of flexibility. Restrictions include: as mentioned above, there are certain requirements in respect of the custodian and investment manager; the OFC Code, OFC Rules and the SFO prescribe termination and dissolution and cancellation of registration requirements and procedures; and there are specific requirements in relation to corporate administrative matters for example the certain requirements in respect of holding AGMs.
Post establishment changes		In general, the LPF does not need approval for changes made after it is established. However, the Companies Registry must be notified of certain changes, for example, a change of name or when the LPF changes the place where it keeps its records.	The following changes to an OFC require SFC approval: appointment of a director, custodian or investment manager; change of name of an OFC or sub-fund of an OFC; establishment of a new sub-fund under an OFC; and termination of an OFC or a sub-fund and cancellation of registration of an OFC.
Approval regime		Registration of a limited partnership fund under the LPFO is not compulsory.	An OFC must register with and be approved by the SFC. Once the OFC is approved by the SFC, it is incorporated under Part IVA of the SFO.
Timing		Approximately 2 – 3 weeks depending on the provision of documents and information. However, this timeframe may be driven by commercial considerations.	The SFC have indicated that they aim to process an application for the establishment of a private OFC within one (1) month from the date that they take up the application (i.e. from the time that all the required documents are sent to and accepted by the SFC) and based on our experience this is accurate.

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