A Paper on Tax Issues Affecting

Hong Kong to Become a Preferred

Location for Regional and International

Financial Institutions to Originate and

Trade International Financial Products

December 2016

FSDC Paper No.26

Index

Executive Summary ................................................................................................................... 1

1. Introduction and Key Issues ............................................................................................... 3

2. Key Hong Kong Tax Challenges and Possible Improvements ........................................... 5

2.1 Interest Deductibility ............................................................................................... 5

2.2 Regulated Capital Requirements and Total Loss Absorption Capacity .................. 8

2.3 Hong Kong Sourcing Rules and Offshore Claims .................................................. 9

2.4 Base Erosion and Profit Shifting (BEPS) and Transfer Pricing ............................ 11

2.5 Double Tax Treaties with Tax Jurisdictions Where Financial Products are Issued

or Where Clients are Resident ............................................................................... 13

2.6 Other Considerations .............................................................................................. 13

3. Looking Ahead ................................................................................................................. 14

Appendix .................................................................................................................................. 15

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Executive Summary

To strengthen Hong Kong’s role as an international financial centre, Hong Kong should

develop as a potential hub for originating and trading in global financial products. In light of

recent global developments such as Brexit, Hong Kong should seize the opportunity to

promote itself as an alternative centre for the origination and trading of international financial

products.

The report entitled "Enhancing Hong Kong's Role as a Centre for Regional and International

Financial Institution Operations: Booking" issued by the Financial Services Development

Council (FSDC) in September 2015 outlined some of the regulatory and licensing

developments needed to strengthen Hong Kong’s position as a centre for the origination and

trading of international financial products. However, for Hong Kong to promote itself as a

preferred financial origination and trading centre and to take advantage of the expertise and

infrastructure that already exist, some refinements are required to the current taxation rules.

This paper discusses some of these key tax considerations that the Government should review

closely:

To create a level playing field between financial institutions (i.e. banks) and non-

financial institutions such as broker/dealers, the Government should consider amending

the interest deductibility rules so that interest expense paid by a company licensed by the

Securities and Futures Commission (SFC) should also satisfy one of the interest

deduction conditions in the same way that a bank would fulfil the conditions.

In addition to the SFC’s recent Consultation Paper on Proposed Changes to the

Securities and Futures (Financial Resources) Rules to update its financial resource

requirements in the context of the new over-the-counter (OTC) derivative licensing

regime in order to be more internationally competitive, the Government should consider

introducing new rules on the deductibility of payments under a hybrid capital instrument

paid by SFC licensed entities such as broker/dealers when issuing new types of

regulatory capital securities under the SFC regime.

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The Government should give consideration to providing clearer guidance on how to

interpret and apply the sourcing rules to complex global financial products origination

and trading operations, taking into consideration the multiple locations of traders,

salespersons, front and back offices in and outside Hong Kong supporting the same

global trading book. The sourcing of derivative trades connected to or hedging principal

trades should also be clarified. One suggestion to provide certainty and a pragmatic

solution to the complex issue is to adopt a “deemed onshore/offshore split” similar to the

50:50 apportionment basis currently accepted by the Inland Revenue Department (IRD)

to assess Hong Kong Profits Tax payable by Hong Kong enterprises in respect of certain

situations.1

The Government may consider issuing clearer guidance on appropriate transfer pricing

methodologies for complex global book trading operations for taxpayers to follow as

they consider placing their entity to originate and trade international financial products

in Hong Kong. It is crucial that the guidance takes into account that no single method

should apply in all cases, and there may be a list of acceptable alternative methodologies,

having regard to different facts and circumstances of the Authorised Institutions (AIs)

and SFC licensed entities.

Vigorous ongoing efforts by the Government to push forth with treaty negotiations and

conclusions with key jurisdictions like Australia, India, the Philippines, Singapore,

Taiwan and other jurisdictions along the Belt and Road are of utmost strategic

importance.

We believe the recommendations advocated in this paper will help Hong Kong move toward

being the preferred financial product origination and trading location for international and

regional financial institutions, hence we respectfully request that the Government give these

recommendations favourable consideration.

1 Please refer to Departmental Interpretation and Practice Notes No. 21 “Locality of Profits” issued by the

IRD in July 2012 (“DIPN 21”). The 50:50 apportionment basis currently accepted by the IRD includes (i)

profits from sale of products processed by mainland manufacturing units under “contract processing”

regime, and (ii) interest income from offshore loans initiated, etc. by an associated party outside Hong

Kong but funded by the Hong Kong institution or offshore loans initiated, etc. by a Hong Kong institution

but funded by offshore associates. However, the latter only applies to start-up positions where the Hong

Kong institution has yet to establish a market presence.

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1. Introduction and Key Issues

The FSDC in September 2015 released a report entitled "Enhancing Hong Kong's Role as a

Centre for Regional and International Financial Institution Operations: Booking" (the Report).

The Report outlines recommendations for enhancing Hong Kong's position as a preferred

origination and trading centre, where regional and global financial institutions can enter into

contracts for financial products, undertake primary obligations for delivery or payment with

respect to financial products, or open and maintain accounts for their clients or counterparties.

The Report noted that although Hong Kong has been actively introducing changes to its

regulatory environment to align its standards with international benchmarks, there are still

many tax and non-tax areas where the Hong Kong Government can do more to help further

promote Hong Kong’s position and reputation as a preferred origination and trading location

for international financial products. This initiative is particularly timely as many financial

institutions have been considering whether to relocate their origination and trading locations

away from the traditional choices of London and New York amidst vastly changing

regulatory landscapes in these financial centres. The UK’s decision to leave the European

Union has also prompted discussion as to whether financial institutions with operations in the

City of London will look to relocate businesses away from the UK.

Hong Kong is generally well-ranked as a global financial centre, with a highly developed and

sophisticated financial services industry. However, historically it has not been seen as the

world’s leading origination and trading centre for financial products as in the case of

London or New York. There have also been earlier reports of London based banks looking at

relocating their derivatives trades from London to Hong Kong to take advantage of the city’s

favourable funding and regulatory environment.2 Hong Kong has the potential of being the

recipient of some of the relocated operations and the Government should be actively

promoting Hong Kong’s strengths and capabilities as a global financial centre while

balancing its potential to accumulate risk as a result of increased origination and trading.

2 http://www.scmp.com/print/business/banking-finance/article/1872931/hsbc-shifts-derivatives-trades-hong-

kong-decision-move-hq

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To strengthen Hong Kong’s role as an international financial centre, Hong Kong should

develop as a potential origination and trading hub for trading in global financial products. In

light of recent global developments such as Brexit, Hong Kong should respond now to

promote itself as an origination and trading centre for international financial products to seize

the opportunity.

To carry out financial product origination and trading activities in Hong Kong, a

multinational group would typically set up either a branch of a foreign corporation or a

locally incorporated company that was either:

(a) an AI, e.g. a licensed bank or restricted licensed bank, that is subject to banking

capital requirements supervised by the Hong Kong Monetary Authority (HKMA); or

(b) a licensed corporation, e.g. a securities company or brokerage company licensed by

the SFC, that is subject to the capital requirements under the financial resources rules

(FRR) supervised by the SFC.

The Report issued by the FSDC in September 2015 outlined some of the regulatory and

licensing developments needed to strengthen Hong Kong’s position as an origination and

trading centre. However, for Hong Kong to promote itself as a preferred financial origination

and trading centre and to take advantage of the expertise and infrastructure that already exist,

some refinements are required to the current taxation rules in order for Hong Kong to

maximise its full potential as an origination and trading centre.

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2. Key Hong Kong Tax Challenges and Possible Improvements

Hong Kong does have a favourable tax regime that encourages businesses to establish

operations in Hong Kong. For instance, Hong Kong has a source based system of taxation

such that only Hong Kong sourced profits are subject to tax. As well, dividends and capital

gains are exempt from tax. However, there are certain aspects of the Hong Kong tax regime

that may hinder the establishment of international financial product origination and trading

centres in Hong Kong.

We discuss below some key tax considerations that the Government should review closely in

order to promote Hong Kong as a preferred location to establish regional or international

origination and trading activities.

2.1 Interest Deductibility

Reform to the existing interest deduction rules may be required in order to promote Hong

Kong as a preferred international financial products origination and trading centre.

Both banks and broker/dealers are generally subject to stringent regulatory capital

requirements, which are amongst the main considerations for financial institutions looking to

establish regulated trading activities in Hong Kong. As part of their trading operations, banks

and broker/dealers would use a combination of debt and equity to support their trading

activities including the funding of their financial product trading activities. The use of

leverage is a fundamental part of a global trading business, as both banks and broker/dealers

use leverage to enhance the returns they can achieve from their financial product trading

operations. In order to ensure Hong Kong is a preferred location to carry out trading in

financial products, there needs to be symmetry between the tax treatment of interest expense

and the taxation of the related profits – the interest expense should be deductible where the

related profits are subject to tax.

Hong Kong has strictly defined and long standing rules on the deductibility of interest

expense. The interest expense deduction rules under the Inland Revenue Ordinance (IRO)

also differ between “financial institutions” and “non-financial institutions” (i.e. banks versus

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broker/dealers). A financial institution, such as a bank, would satisfy one of the conditions

for an interest deduction simply because it is a bank. However, this is not the case for a

broker/dealer regulated by the SFC. These differences could potentially give rise to concerns

for non-financial institutions such as broker/dealers that carry on similar businesses to that of

banks as broker/dealers may not be entitled to a deduction for interest that banks operating

the same business would be entitled to. As such, a broker/dealer may not consider

establishing financial origination and trading centre activities in Hong Kong if there was a

risk of its funding costs not qualifying for a deduction while the related profits were subject

to tax.

As noted, the problem in Hong Kong arises because of the specific interest deduction rules.

For a bank or deposit-taking company licensed under the Banking Ordinance, interest

expense is generally deductible if it is incurred to generate assessable profits. This rule

applies regardless of the source of funding and whom the interest is paid to. Furthermore, the

rules have been extended for banks to allow them to claim a deduction in respect of certain

funds raised through hybrid instruments under the new Inland Revenue (Amendment) (No. 2)

Ordinance 2016 gazetted on June 3, 2016.

A broker/dealer would not normally fall within the definition of a financial institution for

Hong Kong Profits Tax purposes, and thus would not qualify for the same interest deduction

rules that apply to banks and other financial institutions. As such, the interest expense would

need to satisfy one of several other conditions contained within the interest deduction rules in

order for the expense to be deductible. These other conditions include where the interest was

paid to:

a bank, either in Hong Kong or offshore;

a person that was taxable on that interest in Hong Kong;

in respect of an intra-group financing business, or a person that was taxable in a territory

outside Hong Kong at a rate not lower than the applicable Hong Kong tax rate of 16.5%

or 8.25%, and the payor is a qualifying corporate treasury centre (CTC) under the new

Inland Revenue (Amendment) (No. 2) Ordinance 2016.

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However, if the interest was paid to an offshore lender that was not a bank and that person

was not taxed on the interest income in Hong Kong, the interest expense would be non-

deductible.3

It is therefore conceivable that a broker/dealer could be disadvantaged compared with a bank

if they were to borrow from an offshore lender to finance the capital requirements needed to

engage in financial trading activities in Hong Kong. While a bank would generally be

entitled to a deduction for funding costs if they are subject to profits tax in Hong Kong on the

related profits, the broker/dealer may not qualify for a deduction on the interest paid to the

foreign lender. This is notwithstanding that the funding costs are being used in the same way

i.e. that both the bank and the broker/dealer are using the loan funds to generate profits that

may be taxed in Hong Kong. Such difference in taxation treatment between banks and

brokers/dealers should be appropriately rectified.

To create a level playing field between financial institutions (i.e. banks) and non-financial

institutions such as broker/dealers, the Government should consider amending the interest

deductibility rules so that interest expense paid by a company licensed by the SFC should

also satisfy one of the interest deduction conditions in the same way that a bank would fulfil

the conditions. Amending the interest deductions rules as described would put banks and

SFC licensed entities on equal footing in that regardless of whom the interest was paid to, a

deduction for the interest should be available to the extent that it relates to taxable profits in

Hong Kong.

Section 16(2)(a) of the IRO should be extended to include a person licensed under the Hong

Kong Securities and Futures Ordinance and also stipulated conditions, similar to those as

applicable to CTCs under the new Inland Revenue (Amendment) (No. 2) Ordinance 2016.

The above proposed amendment to the IRO would be a relatively straight forward change to

increase the competitiveness of Hong Kong as an origination and trading centre. Further,

amending the legislation to enable a funding cost deduction for non-banks conducting

financial product origination and trading activities can be achieved without the risk of the

rules being subject to abuse. It is important to note that since the SFC licensed entities are

3 Please also refer to the conditions stipulated in Section 16(2)(f) of the IRO.

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subject to strict SFC regulations and scrutiny on capital and various aspects of business

activities, it would be highly unlikely for them to be able to (or be motivated to) manipulate

their origination and trading location and related trade flows to abuse the interest

deductibility rules. The more borrowing and hence debt that the broker/dealer has on its

balance sheet, the more capital it would be required to hold. The strict and complex capital

rules imposed by the SFC and the current anti-abuse rules in the tax legislation would be

sufficient to address any potential abuse arising from such arrangements or transactions.

2.2 Regulated Capital Requirements and Total Loss Absorption Capacity

Following the financial crisis in 2008, Hong Kong regulators, like many others, are

increasing their capital requirements for banks and broker/dealers. The recent focus on Total

Loss Absorption Capacity (TLAC) is also forcing banks and broker/dealers to issue new

instruments such as contingent capital (loss absorbing instruments) to meet the local

regulatory requirements.

For banks in Hong Kong, we welcome the promulgation of the Inland Revenue (Amendment)

(No. 2) Ordinance 2016 mentioned above to clarify the Hong Kong Profits Tax treatment of

new types of regulatory capital securities issued by banks to meet the requirements imposed

by the Banking (Capital) Rules. In essence, the new rules allow Additional Tier 1 or Tier 2

capital instruments issued by a bank, other than in the form of a share to be treated for their

purposes as if it were a debt security. Thus a payment in respect of such regulatory capital

securities other than a repayment of principal is to be treated as interest payable on the

security and deductible for Hong Kong Profits Tax purposes. This new provision was

introduced to address the need for banks to raise additional regulatory capital that has debt

like characteristics.

The changes to the tax treatment of the regulatory capital rules do not cover non-bank entities

carrying on similar financial product origination and trading activities. As noted in the

Report, broker/dealers are subject to strict capital requirements by the SFC which is a liquid-

asset based regulatory capital regime that gives rise to a much heavier regulated capital

burden than the Basel-based regime adopted by banks in Hong Kong and other international

markets. Nevertheless, if SFC licensed entities were to use hybrid capital instruments, we

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would propose that the tax treatment of such hybrid capital should be the same as those

hybrid capital instruments used by banks.

Thus, in addition to the SFC’s recent Consultation Paper on Proposed Changes to the

Securities and Futures (Financial Resources) Rules to update its financial resource

requirements in the context of the new over-the-counter (OTC) derivative licensing regime in

order to be more internationally competitive, the Government should consider introducing

new rules on the deductibility of payments under a hybrid capital instrument paid by SFC

licensed entities such as broker/dealers needing to issue new types of regulatory capital

securities under the SFC regime.

2.3 Hong Kong Sourcing Rules and Offshore Claims

Hong Kong is a source-based tax jurisdiction whereby only profits derived from business

activities carried out in Hong Kong are subject to Hong Kong Profits Tax. Ascertaining the

source of a profit is largely determined based on the facts and circumstances of the

transaction in question and there is a vast body of precedent case law on the principles of

source, as well as detailed guidance from the IRD.

However, difficulties can still arise in determining the source of profits from complex trading

transactions and this is particularly relevant in the context of a global trading book of

financial products.

For simple financial product trading transactions, the sourcing rules are relatively clear. For

example, the source of trading in listed equities is generally determined by either where the

securities are traded or the location of listing. For example, trading of stocks listed on the

Hong Kong Stock Exchange would be considered Hong Kong sourced gains. Whereas, the

source of gains made on trading in Tokyo listed shares would generally be offshore sourced.

It is inevitably more complicated to apply the sourcing rules to global trading activities. For

example, the trading of a global book may involve people located in different jurisdictions

with traders in different countries trading parts of an overall transaction and all trading off the

one global platform. The global book may involve traders in Hong Kong that have a general

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authority to transact on behalf of the book. Traders in other locations may have a similar

authority to transact. The trading can be complex such as the principal trade executed in one

location, whilst the hedge trade takes place in a different location. Both trades may be

connected and are integral to the overall trading strategy. Likewise, there may be multiple

traders in multiple locations trading amongst themselves and with their respective clients.

These scenarios make the task of assessing whether profits of the global book should be

subject to Hong Kong Profits Tax a potentially very complicated and problematic one.

Examples of the complexity of determining the source of a profit are shown in the Appendix.

To encourage multinational groups to choose Hong Kong as their international financial

products origination and trading location, the Government should give consideration to

providing clearer guidance on how to interpret and apply the sourcing rules to complex global

origination and trading operations. These should take into consideration the multiple

locations of traders, salespersons, front and back offices in and outside Hong Kong

supporting the same global trading book. The sourcing of derivative trades connected to or

hedging principal trades should also be clarified.

In the absence of clearer guidance, the risk is that potentially some trades could give rise to

taxable profits, whilst other trades could give rise to offshore sourced losses (and vice versa).

This potential mismatch of profits and losses would not be a forwarded outcome to Hong

Kong’s effort to be the international financial products origination and trading location of

choice.

One suggestion to provide certainty and a pragmatic solution to the above complex issue is to

adopt a “deemed onshore/offshore split” similar to the 50:50 apportionment basis currently

accepted by the IRD to assess Hong Kong Profits Tax payable by Hong Kong enterprises4

or

variations thereof depending on the specific facts of the financial product origination and

trading entity. Notwithstanding the absence of a specific statutory provision for

apportionment in the IRO, section 14 of the IRO provides the legal authority to apportion

profits if some of the essential profit-generating activities of the taxpayer are performed

outside Hong Kong. This would be a practical approach to dealing with the source of profits

4 See footnote 1.

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from a global trading book, and that would acknowledge that the global trading activities can

give rise to multiple sources. Instead of ascertaining the sources of profits from complex

trading on an actual basis, a simpler approach would be to adopt a 50:50 split. Taxpayers

would then make an election either to adopt the 50:50 apportionment for the total profits or

determining the source and/or apportionment based on a detailed examination of all the

relevant operations on an actual basis.

2.4 Base Erosion and Profit Shifting (BEPS) and Transfer Pricing

BEPS continues to be a topic of considerable focus, with the Organisation for Economic Co-

operation and Development (OECD) recently issuing its final reports on a range of

deliverables to address perceived abusive arrangements. Hong Kong, along with Mainland

China, has stated its support of those initiatives and the global development on tax

transparency and automatic exchange of information. BEPS could have a significant impact

on the choice of origination and trading jurisdiction. One of the principles of the BEPS

initiatives is to ensure that the profits are recorded where the value is created. BEPS would

therefore be especially relevant to Hong Kong based origination and trading entities in

relation to the way they are funded, what these entities do for other members of the group vis-

a-vis clients in other locations and the substance, capital and risks of the origination and

trading entities residing in Hong Kong.

Examples of BEPS actions impacting on an origination and trading location proposal could

include the following:

Action 4: Interest deductions. This action is intended to recommend best practice in the

design of rules to limit deductibility of interest (or financial payments economically

equivalent to interest). Debt ratios are being recommended to limit tax deductibility

going forward. Such rules could have an adverse impact on a highly leveraged financial

product origination and trading platform in Hong Kong and would require further

analysis should the Government implement new tax law changes to limit deductibility.

Action 7: Definition of Permanent Establishment and the expanded definition. This

action has particular relevancy on the role of a dependent agent in concluding contracts,

and hence how the multiple locations of traders, salespersons or other agents in the

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running of a global financial product trading book affect the tax treatments in these

multiple locations (including Hong Kong) when the origination and trading entity is in

Hong Kong. This would have a significant impact on the methodology to allocate profits

amongst the Permanent Establishments.

Actions 8 to 10: Intellectual Property and Transfer Pricing outcomes. These actions are

possibly the most impactful to the international financial products origination and trading

location proposal of Hong Kong especially in the area of determining an arm’s length

allocation of profits relating to risks and capital, based on the principle of aligning

returns with value creation for the complex operation of a global trading book. The

country-by-country reporting will increase the transparency of the transfer pricing

methodologies and resulting profit/loss allocation among all relevant jurisdictions.

We therefore advocate that, if Hong Kong is to promote itself as a preferred international

products origination and trading location, then the BEPS implications need to be recognized

and acted upon to ensure that having an origination and trading location does not give rise to

any adverse consequences. In other words, we should expect the economic substance of the

banks or broker/dealers to increase in Hong Kong to support the change of origination and

trading location to Hong Kong, and a bigger share of the profit or loss be attributable to Hong

Kong.

The Government may therefore need to consider issuing clearer guidance on appropriate

transfer pricing methodologies for complex global book trading operations for taxpayers to

follow as they consider placing their origination and trading entity in Hong Kong. Such can

be the commonly seen “revenue or profit split” methodology utilizing drivers such as

compensation expenses, capital funding costs, overhead costs etc. among the participating tax

jurisdictions, or variations thereof. It is crucial that the guidance takes into account that no

single method should apply in all cases, and there may be a list of acceptable alternative

methodologies, having regard to different facts and circumstances of the AIs and SFC

licensed entities.

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2.5 Double Tax Treaties with Tax Jurisdictions Where Financial Products

are Issued or Where Clients are Resident

In order for Hong Kong to actively promote itself as a preferred international financial

products origination and trading location, it needs to ensure that cross border payments and

product flows (e.g. dividends, interest, fees, derivative settlements) do not represent any

unnecessary costs to a Hong Kong resident origination and trading entity and/or its clients

(such as suboptimal withholding taxes, foreign tax credit availability and profit attribution to

a permanent establishment). Having robust double tax treaties in place between Hong Kong

and as many of the jurisdictions where financial products are issued and where clients are tax

resident as possible is crucial to help eliminate or mitigate these costs.

The fact that Hong Kong has an ever expanding double tax treat network with 35 treaties

concluded to-date is encouraging news. Nonetheless, competing origination and trading

entity location choices like London in the United Kingdom, New York in the United States

and Singapore each has an even wider tax treaty network. Hence, vigorous ongoing efforts

by the Hong Kong Government to push forth with treaty negotiations and conclusions with

key jurisdictions like Australia, India, the Philippines, Singapore, Taiwan and jurisdictions

along the Belt and Road are of utmost strategic importance.

2.6 Other Considerations

We support Hong Kong in becoming a key international financial products origination and

trading centre because we believe it would offer both quantitative and qualitative benefits for

Hong Kong flowing from greater economic activity. For example the increased asset

allocation, liquidity and volume of transactions will not only translate into significant

financial revenues for Hong Kong but will also promote an increased pool of talent, and in

turn, job creation in areas of operations, risk management and compliance. However, that

greater economic activity needs to be commensurate with Hong Kong’s potential to

accumulate risk as a result of increased origination and trading activities in the city. In

focusing on refining the current tax rules as proposed in this paper, Hong Kong will better

position itself to attract transactions with a real Hong Kong nexus or connection.

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3. Looking Ahead

In the current environment of significant political and economic uncertainties following

Brexit and political developments in other economies, fiscal stimulus in the major economies

as well as growth consolidation in many emerging markets and Mainland China, it is

pertinent that Hong Kong continues to enhance its competitiveness as a key financial centre

so as to maintain its status as a key regional and global financial hub.

Since the global financial crisis, Hong Kong has actively implemented and proposed changes

to its regulatory environment to align its standards with international benchmarks while

monitoring a robust level of investor protection.

In promoting Hong Kong as a leading international financial products origination and trading

hub, it is crucial that Hong Kong’s tax rules do not deter global businesses from considering

Hong Kong as a jurisdiction in which business should carry on and further develop.

Hong Kong’s source based tax system is generally favourable to companies that set up

business in Hong Kong; however, certain changes are needed to promote the use of Hong

Kong as an international origination and trading hub for financial products transactions.

We believe the recommendations advocated in this paper will help Hong Kong move toward

being the preferred financial product origination and trading location for international and

regional financial institutions, hence we respectfully request that the Government give these

recommendations favourable consideration.

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Appendix

Example 1: A Hong Kong based broker/dealer may issue a derivative in the form of a put

option to a client providing exposure to the price fluctuation in a Mainland China company

listed on the Shanghai Stock Exchange. As a hedge, the Hong Kong based broker/dealer may

buy and sell the relevant Mainland China company shares on the Shanghai Stock Exchange

under the Shanghai-Hong Kong Stock Connect program. This may give rise to gain from the

call option be taxable in Hong Kong while the corresponding loss on the hedge position not

deductible as the latter may be considered offshore sourced when transacted on an exchange

outside of Hong Kong under current rules.

Example 2: The commodities trading department of a Hong Kong bank may take a

proprietary position in some physical copper through their Hong Kong team. As a hedge, the

Hong Kong bank may enter into a copper futures contract over the Chicago Mercantile

Exchange in the United States. Similar to Example 1, there may be a risk that the physical

position leg of the transaction is considered Hong Kong sourced and subject to Hong Kong

tax, while the futures leg executed on an offshore exchange is considered non-Hong Kong

sourced, thus the opposing economic outcomes of the primary trade versus the hedge trade

may give rise to a Hong Kong tax leakage.

About the Financial Services Development Council

The Hong Kong SAR Government announced in January 2013

the establishment of the Financial Services Development Council

(FSDC) as a high-level and cross-sector platform to engage the

industry and formulate proposals to promote the further

development of Hong Kong’s financial services industry and map

out the strategic direction for development. The FSDC advises

the Government on areas related to diversifying the financial

services industry, enhancing Hong Kong’s position and functions

as an international financial centre of our country and in the

region, and further consolidating our competitiveness through

leveraging the Mainland to become more global.

Contact us

Units 3104-06, 31/F, Sunlight Tower

248 Queen’s Road East

Wan Chai, Hong Kong

(852) 2493 1313

www.fsdc.org.hk