QFII, RQFII holders face $4bn tax headache

It has been estimated that holders of QFII and RQFII quotas could be facing a $4 billion bill after authorities ruled they would be subject to 10% capital gains tax on investments retrospectively. 

The move was seen as offering long-term clarity after years of uncertainty over the issue, although under-provisioned mutual fund managers could be challenged to pay the charges. 

At the same time some foreign-domiciled firms will enjoy a CGT exemption due to double-tax agreements between China and their place of domicile, including Hong Kong, Luxembourg, Singapore and the US. 

The industry was informed of the CGT charge last Thursday. It will apply to investments made between November 17, 2009 and November 16, 2014 under the qualified foreign institutional investor scheme and the renminbi qualified institutional investor scheme.

They were told about it during a compliance session organised by the Asset Management Association of China (Amac) and Beijing's local taxation bureau, which sits under China’s State Authority of Taxation (SAT).

However, no official statement has been made on the matter. Fund managers have been given until the end of July this year to make a tax filing or apply for an exemption. 

The levy means foreign investors using QFII or RQFII will have to pay 10% tax on gross profits made from equity investments. Pure bond investments will not be taxed, while gains made on convertible bonds will be taxed after they are converted. 

Francois Perrin, head of greater China equities at BNP Paribas Investment Partners (BNPP IP), said it was positive to have clarification that no charge would be levied on capital gains for QFII investments made from 2002 to November 2009.

The QFII scheme was launched in late 2002, while RQFII went live nine years later in 2011. The Shanghai-Hong Kong Stock Connect trading link launched on November 17 last year. 

But Shanghai-based consultancy Z-Ben Advisors and BNPP IP both said it was still unclear whether the tax would be applied on gross or net profits.

Jeremy Ngai, a tax consultant at PwC, said it was likely to be on gross profits, which he suggested investors had been aware of for some time. 

Z-Ben estimated that mutual fund managers would need to pay $3-4 billion in total if SAT collects CGT based on gross profits. 

Authorities have been reluctant to clarify the CGT issue since QFII and RQFII were launched. When Stock Connect was initiated last year, SAT and the China Securities Regulatory Commission (CSRC) issued a notice confirming CGT exemption under the cross-border trading link, but stated QFII and RQFII exemption was temporary. It added that trades made prior to Stock Connect's launch would not enjoy CGT exemption.  

Ngai said industry players were waiting for more details, including filing procedures. “It is finally time to settle the issue," he noted. "Large fund houses were aware of this issue and have made tax provisions, while some managers may have a problem of under-provision." 

Ngai has previously pointed out that fund managers had made different CGT assessments up until now, with some setting aside 5-10% of their capital gains while others made no provisions in the belief there would be a full CGT exemption, as reported.

The tax bills will have varying impacts on institutions. “In the short term this could discourage investor interest in QFII-backed funds as under-provisioned managers may need to claw back funds from NAV [net asset value] to pay the tax,” said Ivan Shi, an analyst at Z-Ben Advisors. 

However, BNPP IP's Perrin said the CGT clarification should be welcomed. “Fund managers can now better optimise their product range and ensure protection of their clients’ investments." 

Z-Ben has predicted that managers specialising in segregated accounts will be hardest hit by the measures, saying those who had lent out their QFII and RQFII quotas to other investors could be liable for the profits they had made.

Managers who paid CGT would be provided with a tax certificate to would make it easier for them to repatriate capital in the future, Shi noted.  

In all, there were 265 institutions holding $69.7 billion QFII quotas as of last Friday. There were 103 institutions holding Rmb311.5 billion ($49.7 billion) worth of RQFII quotas as of last Friday.