China Considers Tax Breaks to Draw In Global Funds, Fend Off Tax Havens

(Bloomberg) -- China is considering tax breaks to attract more global funds to register in the country and reverse swelling outflows to international tax havens, people with knowledge of the matter said.

The Ministry of Finance has enlisted a global accounting firm to conduct due diligence ahead of a potential feasibility study on a capital gains tax exemption, the people said, asking not to be identified discussing confidential information. The deliberations are at a preliminary stage, and there are regulatory hurdles that would need to be cleared first.

Attracting international funds is a key part of President Xi Jinping’s push to build a more institutionally driven financial system that’s less prone to the boom-and-bust cycles that have plagued China. International funds registered in China are currently subject to taxes of up to 25 percent on capital gains earned worldwide, marring the nation’s appeal as a base.

The Ministry of Finance didn’t immediately respond to a fax seeking comment.

Offshore Havens

Dropping the levy could also reduce the propensity of local fund managers to use offshore tax havens as a base. The Cayman Islands and British Virgin Islands remain second and third only to Hong Kong as the most-popular destinations for China’s foreign direct investment outflows. Chinese money flows into the British Virgin Islands jumped almost 60 percent in 2017 even as overall outflows fell, according to the latest available official data.

China Considers Tax Breaks to Draw In Global Funds, Fend Off Tax Havens

The other main benefit for international funds of being domiciled locally is having easier access to domestic investors.

“If there’s such a tax break, it would certainly attract funds that invest globally but want to register in China,” said Qi Huaying, a Beijing-based partner at Han Kun Law Offices. “There are regulatory restrictions around issues such as the use of foreign currencies that would need to be eased first.”

Such a move would mirror a similar shift in Hong Kong. The former British colony last year proposed widening tax breaks to include hedge funds and private equity firms that are domiciled in the city. Market watchers said at the time that should encourage more of them to move there, and away from offshore centers such as the Cayman Islands.

Any potential capital gains tax break would only be for funds that invest in foreign currency outside China, the people said. It wouldn’t apply to other levies the fund management companies pay locally, they said. It would also only apply to so-called private funds, or those that cater to institutional clients and wealthy individuals, one of the people said.

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