Profits Tax Exemption Conditions for Hong Kong Family Trusts: Defining Qualifying Investments

The 2025-26 Hong Kong Budget, delivered on 26 February 2025 by Financial Secretary Paul Chan, introduced a critical clarification that has reshaped the planning landscape for family offices and trusts: the Inland Revenue (Amendment) (Tax Concessions for Family Offices) Bill 2025. This legislative package, now gazetted and undergoing its second reading in the Legislative Council, codifies the profits tax exemption for family-owned investment holding vehicles (FIHVs) held by single-family offices (SFOs). For HNW and UHNW families with assets exceeding USD 10 million, the defining question is no longer whether a trust can be tax-exempt, but what assets it can hold and how the qualifying conditions must be met. This article dissects the precise statutory conditions under the proposed section 20AN of the Inland Revenue Ordinance (IRO), focusing on the definition of qualifying investments and the specific asset thresholds that determine exemption eligibility.

The Statutory Framework: Section 20AN of the IRO

The proposed section 20AN creates a profits tax exemption for a qualifying FIHV, defined as a corporation, partnership, or trust that is wholly owned by a single family and whose assets are managed by a qualifying SFO. The exemption applies to profits derived from qualifying transactions in specified assets, provided the FIHV meets the minimum asset threshold and the SFO satisfies the central management and control (CMC) test.

Defining the Qualifying FIHV

A FIHV must be a legal entity whose sole purpose is the holding and management of the family’s investment assets. Under the Bill, “wholly owned by a single family” means that at least 95% of the beneficial interest in the FIHV is held, directly or indirectly, by members of the same family. The Inland Revenue Department (IRD) has confirmed in its 2025 legislative briefing that the family definition extends to lineal descendants and their spouses, covering up to four generations from a common ancestor. This structure is critical for trusts: a trust settled by a family patriarch for the benefit of his children and grandchildren qualifies, provided no external beneficiaries hold more than 5% of the economic interest.

The Minimum Asset Threshold

The exemption is not automatic. The FIHV must hold total assets of at least HKD 240 million (approximately USD 30.8 million) at the end of each year of assessment. This threshold, set out in the Bill, is a hard floor. Assets below this level disqualify the FIHV from the exemption for that year, regardless of the nature of the transactions. The IRD’s 2025 explanatory memorandum explicitly states that asset valuation must follow Hong Kong Financial Reporting Standards (HKFRS) and be audited annually. For trusts holding illiquid assets such as private company shares or real estate, valuation reports from a qualified professional valuer are required.

Qualifying Investments: The Core of the Exemption

The exemption covers profits from “qualifying transactions” in “qualifying investments.” The Bill defines qualifying investments through a closed list, meaning any asset not explicitly included is taxable. This list is narrower than the general profits tax exemption for offshore funds and requires careful structuring.

Specified Asset Classes

The qualifying investments are divided into four categories under the proposed Schedule 16B to the IRO:

1. Securities: Shares, stocks, debentures, bonds, and other securities listed on a stock exchange recognised by the Hong Kong Monetary Authority (HKMA) or the Securities and Futures Commission (SFC). This includes Main Board and GEM listings on HKEX, as well as major exchanges in the US (NYSE, NASDAQ), UK (LSE), and Singapore (SGX). Private company shares are excluded unless they are held through a qualifying fund structure.

2. Derivatives: Futures, options, swaps, and other derivative contracts traded on a recognised exchange or over-the-counter (OTC) if the counterparty is a financial institution regulated by the HKMA or an equivalent overseas authority. The 2025 Bill specifically includes OTC derivatives but requires that the transaction be entered into for hedging or investment purposes, not speculation.

3. Foreign Exchange and Commodities: Spot and forward contracts in foreign currencies, and commodities traded on a recognised exchange. Physical gold and bullion are excluded unless held through an exchange-traded fund (ETF) or a qualifying derivative.

4. Private Equity and Venture Capital: This is the most significant expansion in the 2025 Bill. Qualifying investments now include shares in unlisted private companies incorporated in Hong Kong or any jurisdiction with which Hong Kong has a double tax agreement (DTA). The DTA requirement is critical: for a trust holding shares in a Cayman Islands or BVI company, the exemption applies only if the company’s underlying business is conducted in a DTA jurisdiction. This effectively limits the exemption to investments in Hong Kong, Mainland China (via the DTA with the PRC), and other treaty partners such as the UK, Singapore, and Japan.

The 5% De Minimis Rule for Non-Qualifying Assets

A FIHV may hold non-qualifying investments, but only up to 5% of its total assets at the end of the year of assessment. Any profit from a non-qualifying investment is fully taxable, and if the 5% threshold is breached, the entire FIHV’s profits for that year become taxable. This de minimis rule, confirmed in the IRD’s 2025 practice note, is a strict liability test. For a trust with HKD 240 million in assets, this means non-qualifying assets cannot exceed HKD 12 million. Common non-qualifying assets include direct real estate holdings, art, collectibles, and cryptocurrencies not traded on a recognised exchange.

Central Management and Control: The SFO Requirement

The exemption is conditional on the FIHV’s assets being managed by a qualifying SFO. The SFO must be a private company incorporated in Hong Kong that provides investment management services exclusively to the single family. The CMC test requires that the SFO’s key management decisions are made in Hong Kong, meaning the board of directors must meet in Hong Kong and the investment committee must be physically present in the territory.

The SFO’s Qualifying Activities

The SFO must carry out “investment management activities” as defined in the Bill. These include portfolio management, risk management, and the execution of trades. The SFO must employ at least two full-time employees in Hong Kong who are qualified investment professionals, as defined by the SFC’s Guidelines on the Regulation of SFOs (2024). The IRD has stated in its 2025 guidance that outsourcing to third-party asset managers is permitted, but the SFO must retain ultimate decision-making authority. For trusts, this means the trustee cannot delegate investment discretion to an external manager without the SFO’s approval.

The Family Office Exemption for Trustee Services

A separate but related provision in the Bill exempts trustee fees paid by the FIHV to a qualifying SFO from profits tax. This is a critical cost-saving measure. The trustee, typically a licensed trust company under the Trustee Ordinance (Cap. 29), can charge management fees to the FIHV without triggering a tax liability, provided the SFO meets the CMC test. The IRD has confirmed that this exemption applies retroactively from the 2022-23 year of assessment, aligning with the original family office policy announced in the 2022 Policy Address.

Practical Structuring Considerations

The interaction between the FIHV exemption and the trust structure requires careful planning. The trust must be the legal owner of the FIHV, but the beneficial interest must be held by the family members. This is typically achieved through a unit trust or a discretionary trust where the trustee holds the shares in the FIHV on trust for the family.

Jurisdictional Choices for the Trust and FIHV

The trust itself can be established in Hong Kong, Jersey, Guernsey, or the Cayman Islands, but the FIHV must be a Hong Kong resident for tax purposes. This means the FIHV’s CMC must be in Hong Kong. For a trust settled in the Cayman Islands, the FIHV must be a Hong Kong-incorporated company or a registered non-Hong Kong company with its CMC in Hong Kong. The IRD’s 2025 position paper states that a FIHV incorporated in the BVI but managed from Hong Kong will qualify, provided the directors are Hong Kong residents and board meetings are held in Hong Kong.

The Asset Holding Structure

For trusts holding private equity investments, the structure typically involves the FIHV holding shares in a Hong Kong holding company, which in turn holds the underlying operating companies. The DTA requirement for private equity means that the underlying operating companies must be in a DTA jurisdiction. For a family with a Mainland Chinese business, this is straightforward: the Hong Kong holding company qualifies under the Hong Kong-Mainland DTA. For a family with a US business, the US-Hong Kong DTA applies. However, for a family with a business in a non-DTA jurisdiction such as the UAE or Saudi Arabia, the private equity exemption does not apply, and the trust must either hold the investment through a qualifying fund structure or accept taxability.

Actionable Takeaways

1. Verify the asset threshold immediately: Any family trust with assets below HKD 240 million must either consolidate additional family assets into the FIHV or accept that the profits tax exemption will not apply for the 2025-26 year of assessment.

2. Audit the investment portfolio for non-qualifying assets: Direct real estate, art, and cryptocurrencies must be held in a separate vehicle or capped at 5% of total assets to avoid triggering full taxability on the entire FIHV’s profits.

3. Establish the SFO’s CMC in Hong Kong: The SFO’s board must meet in Hong Kong, and at least two full-time investment professionals must be physically present in the territory. Outsourcing to an external asset manager is permitted only if the SFO retains final investment authority.

4. Review the underlying operating companies for DTA coverage: For private equity holdings, each operating company must be incorporated or have its business conducted in a jurisdiction with a DTA with Hong Kong. Non-DTA investments must be restructured or held through a separate taxable entity.

5. Engage a licensed trust company with SFO experience: The trustee must be familiar with the IRO’s section 20AN requirements and the IRD’s 2025 practice notes. Errors in the trust deed or the FIHV’s constitutional documents can disqualify the exemption retroactively.