Asia-Pacific Investment Fund Structures ALTA: Asia-Pacific's Leading Tax Advisers1

I. INTRODUCTION

Most Asian-Pacific investment funds are established in the Cayman Islands in the form of a limited partnership, unit trust, or less common, a corporation, managed offshore under the Cayman Islands regulatory regime that is easy for investment managers to comply with. These fund structures have been in existence for a long period of time, and are viewed as market-standard fund structures by most American and global investors.

Such Cayman funds are sometimes structured to claim benefits, thereby reducing the effective tax rates of the fund with regards to investments into high tax jurisdictions in Asia – Pacific, such as Japan, Australia, China, India, and South Korea. Numerous Asian jurisdictions, such as South Korea, Indonesia, China and India, have adopted strong general anti-abuse tax legislation, and anti-treaty shopping and indirect transfer rules, which are designed to impose taxation on foreign funds which claim tax treaty benefits or engage in tax-efficient exit strategies which the investment jurisdiction tax authorities use to challenge. Notable examples include India and South Korea tax examiners who have often used such rules to aggressively challenge treaty benefits claimed by Cayman funds, and China's State Administration of Taxation ("SAT"), which often asserts its right to tax sales of offshore holding companies by Cayman funds, under China's indirect rules.

In addition to such domestic tax legislation, the OECD backed initiative to tackle Base Erosion and Profits Shifting (“BEPS”) and the Multilateral Instrument (“MLI”) have challenged conventional offshore structures that are primarily tax driven. Action 7 requires nations who sign on to the MLI to elect which test must be satisfied by taxpayers claiming treaty benefits. For example, Japan and Singapore, both signatories to the MLI, have adopted the principal purpose test, which requires the funds to have a non-tax principal business purpose to support the claim for a treaty benefit.

In addition to these important tax considerations and developments, institutional and high net worth investors are increasingly hesitant to invest into Asia-Pacific funds established in the Cayman Islands, due in large part to the negative market perceptions created by disclosures of confidential offshore company information, such as the . Even before these public press disclosures, European pension funds, financial institutions, and institutional investors adopted investment policies which preclude them from investing into funds established in offshore jurisdictions, making it impossible for them to invest in large investment funds targeting Asia using traditional Cayman entities. Such European investors usually can only invest into Asia-Pacific funds established in Luxembourg (often as a SCSp) which severely limits the ability of many such European investors to invest into the Asia-Pacific market. The practical ability for many Asia-based investment managers targeting the Asia-Pacific region to establish Luxembourg funds is limited (or in some cases

1 Stephen Banfield and Eric Roose, Withers (Singapore and Tokyo); Mark Gao and Peter Ni, Zhonglun (Shanghai); Manual Makas, Greenwoods (Sydney); and Jay Shim, Lee & Ko.

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impossible), since the investment management teams for such Asia focused funds are generally based in Asia, usually in Singapore and Hong Kong.

In response to these significant tax developments and negative public perceptions of offshore jurisdictions such as the Cayman Islands, fund tax advisors to Asian investment funds are increasingly moving towards recommending to their clients that future Asia-Pacific funds be established in Singapore. Singapore has a highly attractive funds tax regime and extensive tax treaty network, and an investment management regulatory regime administered by the Monetary Authority of Singapore (MAS) which is highly regarded by investors and as respected as the equal of regulatory authorities of respected funds jurisdictions, such as Luxembourg and the United States.

This article focuses on the forms of Singapore funds today (as well as the so called S-VACC, to be adopted into law very shortly) and how Asian-Pacific funds established in Singapore, or the traditional Cayman fund, structure their investments into Australia, China, Japan and South Korea.

II. SINGAPORE INVESTMENT FUNDS

A. INTRODUCTION

Singapore continues to gain prominence as global funds centre. According to a survey conducted by the Monetary Authority of Singapore ("MAS") in 2016, Singapore had reached S$2.7 trillion of assets under management ("AUM"). This amount grew to S$3.3 trillion by the end of 2017. Approximately 70% of the AUM is invested into the Asia-Pacific Region which demonstrates the position of Singapore as a hub for the deployment of regional capital. A number of factors have contributed to the success of Singapore as a preferred asset management hub. These include geographic proximity to investors and investment opportunities, a pro-business environment, progressive and careful regulatory oversight, and a conducive tax regime.

B. COMMON FUND STRUCTURES

Singapore based asset managers manage a broad range of offshore and domestic investment structures. Cayman limited partnerships are commonly used as master pooling vehicles by alternative asset managers. These funds typically pool into intermediate corporate sub-funds which include Singapore companies established on an asset-by-asset or collective basis. The economic substance associated with a local fund manager supports a claim by these entities for access to Singapore's expansive network of agreements ("DTA").

A growing trend is the replacement of offshore master pooling vehicles and feeder funds with onshore entities. This is in part a response to international initiatives such as BEPs and an increasing aversion of institutional investors to structure through tax haven jurisdictions for reputational reasons.

It is possible to build an entirely onshore investment structure with the equivalent flexibility of tried

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and tested offshore structures using entities which may be established under Singapore law. The entity types are based on the common law trinity of companies, partnerships and trusts though have recently been augmented by the introduction of the variable capital company. This modular quality to Singapore fund structures is key to their appeal and flexibility. This is supported by the suite of local tax incentives which can be used to reduce the imposition of Singapore tax on repatriated investment flows and realisation gains.

In addition to unlisted alternative funds with a regional mandate, REITs and registered business trusts are popular listed vehicles for investments into mature real estate and infrastructure assets respectively. Different investment structures are also seen for investments into Singapore real estate. The suite of fund tax incentives which are described below do not exempt income and gains deriving from Singapore real estate.

C. VARIABLE CAPITAL COMPANY

The introduction of the VCC is intended to further enhance Singapore's appeal as an international fund management hub. It expands Singapore's existing toolbox of domestic vehicles and brings it into closer alignment with competitor jurisdictions such as Hong Kong, Luxembourg, Ireland and traditional offshore jurisdictions. Enabling legislation was passed into law in October 2018 and is expected to become operative shortly.

The key features of the VCC may be summarised as follows:

(a) A VCC must be a collective investment scheme as this term is defined within the Singapore Securities and Futures Act (Cap 289) ("SFA"). An earlier proposal to require a minimum of two investors in a VCC was scrapped by the MAS in response to industry feedback. The MAS describe a VCC with multiple cells as an 'umbrella VCC'. They have confirmed that it is possible for an umbrella VCC to consist of both open-ended and closed-end funds as its sub-funds.

(b) A VCC must appoint a fund manager which is licensed under the SFA. Certain exempt fund managers, including registered fund management companies, may also manage a VCC.

(c) Investors can directly invest into the VCC as members and hold shares that are transferable and redeemable. It can be expected that a transfer of the shares in a VCC will be subject to Singapore stamp in the typical manner.

(d) VCCs are required to appoint an auditor to audit their accounts on an annual basis. Each sub-fund will be required to prepare separate financial statements, which must be audited and prepared in accordance with a single accounting standard across all sub-funds. There is no need for a VCC to have an audit committee.

(e) A VCC which is an Authorised Scheme or Restricted Scheme under the SFA will be required to appoint a custodian, subject to various conditions. The MAS specifically reference an exemption for

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VCCs which are used as private equity and venture capital fund vehicles. This aligns with the current position for such funds under the SFA.

(f) A VCC will have variable capital which is fundamental in facilitating investment redemptions.

(g) A VCC can register and segregate its assets into different sub-funds held within the same legal entity. A VCC can then use each sub-fund to invest and directly hold a portfolio of different investments. The VCC Act provides for several measures to mitigate against cross-cell contagion, so that liabilities against a sub-fund may be prevented from being claimed against another sub-fund.

(h) The register of members of a VCC does not need to be made public.

(i) A VCC can access the suite of tax incentives available under the Singapore Act (Cap 134) ("ITA"). It may also apply for a certificate of tax residency, and is intended to be able to access benefits under Singapore's network of DTAs.

(j) Foreign corporate entities may also apply to be redomiciled into Singapore as a VCC. This concept is broadly consistent with redomicilation provisions which were introduced into the local Companies Act in early 2017.

D. TAXATION OF FUNDS MANAGED IN SINGAPORE

The corporate in Singapore is currently 17%. The charge to tax is semi-territorial and applies to income that is either Singapore sourced, or is foreign-sourced and is remitted into Singapore. This basis of taxation clearly creates a risk that the activities of a local fund management company may cause a tax exposure for the entities which it may manage. This risk extends to realisation gains which run the risk of being characterised as being revenue in nature - particularly when made by a fund with a relatively short investment time horizon.

A number of incentives are included within the ITA to mitigate the risk of Singapore taxation at the fund level and the impediment that this tax impost would otherwise represent for the development of the local industry. There are three main incentives which are commonly relied upon.

I. Enhanced-Tier Fund Incentive

A fund managed out of Singapore may potentially apply for approval under the Enhanced-Tier Fund Scheme of Section 13X of the ITA. A fund approved by the MAS under this scheme is exempt from Singapore tax on 'specified income' derived from 'designated investments'. These are both defined terms and encompass a broad range of the financial assets and associated income and gains. The main omissions from the scope of this exemption are income and gains in relation to Singapore immovable property, distributions from Singapore REITs and limited types of Singapore sourced interest income.

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The tax incentive under Section 13X is available for the life of the fund provided that the approval conditions are met and continue to be satisfied. The MAS grants approval under Section 13X on a discretionary basis and the following minimum conditions must be satisfied at the time of application:

 The fund is managed or advised by a Singapore fund manager. This is a company that is either licensed or exempt from licensing for fund management under the SFA.

 The Singapore fund manager must employ three ‘investment professionals’. This term is defined as an individual who earns at least S$3,500 per month and is substantively engaged in fund management activities.

 The fund must have a size of at least S$50 million. This may be satisfied on a committed capital basis for certain real estate, private equity and infrastructure funds.

 The fund must incur local business spending of at least S$200,000 per annum.

Domestic funds that are structured as VCCs may also avail of the Section 13X exemption if the relevant conditions are satisfied.

II. Offshore Fund Incentive

An offshore fund which has appointed a Singapore fund manager may potentially apply for approval under Section 13X if the conditions of that scheme are met. As an alternative, it may rely upon the offshore fund incentive of Section 13CA of the ITA where applicable.

The requirements of the offshore fund incentive are built around the definition of a ‘prescribed person.’ This can be a fund established as a company, a trust or it can also be the managed account of an individual. Partnerships are treated as pass-through for the purposes of this incentive which means that the relevant criteria is applied at the partner level. The following conditions apply:

 The fund must not be resident in Singapore at any time during the financial year.

 It cannot be 100% held by Singapore persons directly or indirectly at the end of the financial year. The concept of a ‘Singapore person’ is broadly defined and includes Singapore citizens, the local permanent establishments of foreign persons as well as resident entities.

 A fund cannot have a in Singapore other than that which may be created by virtue of the appointment of a local fund manager.

A key part of the offshore fund incentive is a separate financial penalty regime. This penalty operates to claw-back tax saved at the fund level where Singapore corporate investors hold more than a certain percentage of the fund. This percentage is 30% if a fund has less than 10 owners, or 50% if the fund has 10 or more owners.

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III. Singapore Resident Fund scheme

The Singapore resident fund scheme is established by Section 13R of the ITA. It is essentially the equivalent of the offshore fund incentive for Singapore incorporated and resident fund vehicles. The scope of the under this scheme is the same as the other fund incentives of Section 13X and Section 13CA. The main approval conditions of the Singapore resident fund scheme are as follows:

 The fund is a company incorporated and resident in Singapore.

 The fund must be managed by a Singapore fund manager.

 The fund cannot be 100% held, directly or indirectly, by Singapore persons.

 The fund has annual business spending of more than S$200,000;

 The fund is administered by a Singapore-based fund administrator;

Financial penalty provisions apply under the Singapore resident fund scheme as they do to offshore funds relying upon Section 13CA. This will be relevant where a Singapore corporate investor holds more 50% of a widely held fund.

Domestic funds structured as VCCs will also be able to apply for approval under the Section 13R scheme.

E. TAXATION OF SINGAPORE FUND MANAGERS

Fund managers are subject to Singapore tax at the standard rate of 17%. Income derived from carrying on fund management activities in Singapore will be taken to be Singapore-sourced and therefore taxable as it arises.

Fund managers in Singapore need to comply with the arm's length principle in the computation of their management or advisory fees, and with recently introduced documentation requirements. The question of transfer pricing is particularly apt in the context of intra-group sub-advisory and delegation arrangements. Goods and Services Tax potentially applies at the rate of 7% on the services provided by a Singapore fund manager, though a number of modifications and concessions are relevant.

I. Financial Sector Incentive - Fund Management

A fund manager having at least three investment professionals and with S$250m under management may apply to the MAS for approval under the Financial Sector Incentive- Funds Management scheme. The MAS may grant approval under this scheme where a fund manager provides a business plan demonstrating growth in headcount, AUM and business spending.

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Approval under the FSI-FM reduces the rate of Singapore tax on qualifying fee income derived by a fund manager to 10%. This includes fees paid by funds which have been approved under the Sections 13R or 13X schemes, or which satisfy the requirements of Section 13CA of the ITA.

II. Carried interest

The taxation of carried interest in Singapore is not settled, and there are no specific provisions within the ITA which provide any form of safeharbour or legislative clarity. By its nature carried interest is a benefit typically enjoyed by investment professionals in their personal capacity and is not paid through a fund management entity. The risk is that the carried interest entitlement of an individual could be recharacterised as personal services income and brought to tax at higher personal rates of taxation.

It is not uncommon for Singapore based investment professionals to participate in offshore carry structures where preferred returns flow via a waterfall distribution through the general partner of an offshore limited partnership. Where the general partner is itself an offshore company, some investment professionals will take the position that dividends which are paid by the offshore general partner are foreign sourced income for Singapore tax purposes. This income is then potentially exempt in the hands of an investment professional resident in Singapore. Other structures are typically more conservative and may even involve carried interest flow through a fund manager and paid across to investment professionals in the form of taxable performance bonuses.

III. AUSTRALIA INVESTMENT TAX STRUCTURES

A. INTRODUCTION

The Managed Investment Trust (“MIT”) is the preferred vehicle for passive foreign investment into Australia due to the potential for a concessional 15%2 tax rate to apply to returns to foreign investors. The Government is however currently proposing to introduce integrity measures that limit the circumstances where this concessional withholding tax rate applies. This summary assumes that the integrity measures will be introduced in the form that they are being proposed.

B. QUALIFICATION CRITERIA FOR A MIT

The MIT is an Australian unit trust with various qualification criteria which limit the circumstances in which foreign investors can benefit from the lower tax rate. The three key qualification criteria for a MIT include the requirement that it has an Australian investment manager, is widely held and makes only certain types of passive investments. These key requirements and the remaining qualification criteria are discussed below.

1. Australian Investment Management

2 A lower rate of 10% is also available in respect of the income of a MIT where that MIT is considered a clean building MIT.

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In order for MIT investors to qualify for the lower tax rate, a ‘substantial proportion’ of the investment management activities carried out in relation to certain assets of the trust must be carried out in Australia. Relevant assets are those situated in Australia, listed on an Australian stock exchange and taxable Australian property (broadly, assets whose value is primarily derived from Australian real estate).

Activities that constitute investment management for this purpose include undertaking market analysis and identification of potential investments, due diligence of potential acquisitions and providing recommendations on the asset mix of the trust (i.e. buy and sell recommendations). In determining whether such activities are performed in Australia, a substance-over-form approach is applied. This means appointing an Australian investment manager which subcontracts its role to a non-resident manager will not be acceptable. Further, appointing a non-resident manager that purports to make decisions in Australia on a fly-in, fly-out basis will also not be acceptable.

Importantly however, while the investment manager has to be in Australia, the exercise of an authority by a foreign unit holder to approve or decline the investment manager’s recommendations from outside of Australia should not cause a breach of this test. Further, the investment management test is applied annually having regard to the services provided in each year of income. Therefore, if a non-resident entity is involved in the decision associated with the establishment of the trust, the trust may still become a MIT in subsequent years of income if the ongoing management of the fund is assumed by an entity in Australia.

Accordingly, in order for a foreign investor to utilise a MIT, they must be prepared to have the investment management functions associated with the MIT in Australia, noting that limited foreign oversight is permitted.

2. Widely Held Ownership

Another key MIT qualification requirement is that the trust has to meet certain minimum membership requirements. The precise number of members required varies based on whether the trust is considered retail or wholesale. Retail trusts require at least 50 members while wholesale funds require at least 25 members.

In determining the number of members, there is a special deeming rule for certain unitholder’s known as ‘qualified investors’. Broadly, in recognition of their status as institutional investors, qualified investors are deemed to be more than one member calculated as their percentage interest held in the MIT (referred to as their MIT participation interest) multiplied by 50. Note that for this purpose, you are required to trace through trusts but not other entities (eg companies or limited partnerships).

Qualified investors broadly include:

 Australian complying superannuation entities and foreign superannuation funds with at least 50 members;

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 Australian life insurance companies;

 Foreign life insurance companies;

 another MIT;

 foreign collective investment vehicles that are regulated and have at least 50 members;

 certain foreign government pension funds;

 certain government entities/agencies; and

 wholly- owned subsidiaries of the above mentioned entities.

A separate alternative widely held membership test is also available to retail funds and registered wholesale funds. If these funds don’t satisfy the 50 or 25 member requirement (respectively), they will still be considered widely held if qualifying investors hold a MIT participation interest of 25% or more and no single non-qualifying investor holds a MIT participation interest of 60% or more.

3. Restriction on Permitted Activities

The final key qualification requirement of a MIT is that it must only engage in what is considered passive investment. This requirement will be failed if either the trust, or an entity whose affairs or operations the trust controls, conducts activities not considered passive.

The activities which are considered passive include:

 Investing in land primarily for the purpose of deriving rent; and

 Investing or trading in a range of specified financial instruments including loans, bonds shares, units, futures and forwards.

Importantly, trading of land is not considered passive and only investing for the purpose of deriving rent is permitted. This requirement is interpreted strictly by the Australian Taxation Office (“ATO”) precluding property trusts from qualifying where features of an investment indicate the primary intention to derive a gain on sale of the property rather than rent.

Therefore a MIT would not suit foreign investors seeking to deviate from the passive activities mentioned above or to control entities that do.

4. Other Key Qualification Requirements

The MIT’s other key qualification requirements include:

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(a) The trust must be a managed investment scheme (“MIS”) as defined in section 9 of the Corporations Act 2001 (Cth) (“Corporations Act”). Broadly, this requires that the MIT has at least two members and members cannot have day-to-day control over the operations of the fund.

(b) If the trust is a wholesale fund, then the trustee and/or investment manager must satisfy certain licensing requirements as set out in the Corporations Act.

(c) The trustee of the trust must be an Australian resident or the ‘central management and control’ of the trust must be in Australia.

(d) The trust must not be “closely held.” This means that 20 or fewer persons for retail funds, or 10 or fewer persons for wholesale funds must not have a 75% or greater MIT participation interest. Note that for the closely held test, units held by qualified investors are excluded. Therefore, a trust can never be closely held if qualified investors own more than 25% of the units in the trust. Further, a foreign resident individual cannot have a MIT participation interest of 10% or more in the trust. In determining the MIT participation interest of the foreign resident individual, it is necessary to trace through all types of entities.

C. KEY FEATURES

The other key features of the MIT may be summarised as follows:

(a) The lower tax rate afforded to foreign investors in a MIT applies to net rental income and capital gains derived by the MIT where3:

(i) The foreign investor is resident in a country that has a regulated exchange of information agreement with Australia;

(ii) The income or gain is not from residential real estate;

(iii) The income or gain is not from agricultural assets;

(iv) The income is not from certain cross staple arrangements.

(b) The tax imposed on investors in a MIT is in the form of a final withholding tax payable by the MIT. While this removes Australian compliance obligations (such as the obligation to prepare an Australian tax return) for the foreign investor, it also means that any expenses (such as funding costs) incurred by the foreign investor cannot reduce the Australian tax payable.

(c) The concessional MIT withholding tax rate only applies to distributions by a MIT. Therefore, if an investor sells units in the MIT and a taxable gain arises, that gain is not eligible for the concessional MIT tax rate.

3 Otherwise, the net rental income and capital gains are taxed at 30%.

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D. CONCLUSION

The MIT is an established vehicle used for foreign passive investment into Australia, due primarily to the concessional tax rate of 15% that it affords. However, investors will need to ensure the various qualification criteria are satisfied.

IV. CHINA INVESTMENT TAX STRUCTURES

A. INTRODUCTION - Offshore Funds Investment in China

Under PRC Enterprise Income Tax (“EIT”) laws, a PRC tax resident enterprise is subject to PRC EIT on its worldwide income and a non-PRC tax resident enterprise is subject to PRC EIT on its PRC sourced income only. Meanwhile, an offshore fund is generally considered a non-PRC tax resident enterprise no matter it is incorporated as a limited liability company or a partnership, provided that the offshore fund is incorporated outside of China and does not have effective management in China.

With respect to the treaty benefits, if the offshore fund (incorporated as either a limited liability company or a partnership) is considered a tax resident of the jurisdiction that has an applicable tax treaty with China, the fund would enjoy treaty benefits. If not, depending on the tax treaties between China and the jurisdictions of the offshore funds, the applicable treaty-based benefits may be different. Especially, based on the updated interpretation on partnership’s eligibility for treaty benefits, a foreign partner of an offshore partnership is not allowed to claim treaty benefits in China unless specifically permitted under the applicable tax treaty (e.g., China-France tax treaty)4.

B. TAXATION OF FUND INVESTMENT IN CHINESE REAL ESTATE

An offshore fund’ investment in Chinese real estate is typically structured by using multi-tiered offshore special purpose companies to hold a Chinese project entity (“PRC Project Company”). An direct investment in the PRC real estate from offshore in legally not allowed currently. The PRC Project Company is commonly formed as a wholly foreign owned enterprise (“WFOE”). To the extent that there are two or more investors jointly investing in the same PRC Project Company, the joint venture platform is usually established outside of China.

1. Applicable to the PRC Project Company for Purchase of Chinese Real Estate

The PRC Project Company is liable for a 0.05% (“SD”) of the total contractual purchase price for the purchase of property directly or the company that holds the property, which is due at the time the agreement is executed.

In addition, if the PRC Project Company purchases the property directly, upon signing the real estate property transfer agreement, the PRC Project Company acquiring the property will be subject to deed tax (“DT”) in China on the total transfer price (excluding the value added tax (“VAT”)), at a rate of 3% to 5%, depending on the location.

4 Announcement [2018] No.11 issued by the State Administration of Taxation of the PRC, Article 5(2).

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2. Profit Repatriation

There are several ways to repatriate profits out of China and back to the funds, including but not limited to dividends and interest.

2.1 Dividends

For dividend distributions made by the PRC Project Company, it must meet certain legal and tax requirements in China.

With respect to the legal requirements, as a WFOE, the PRC Project Company can make dividend distributions only after the following three conditions are satisfied: (i) full contribution of the registered capital; (ii) settlement of the tax payments and completion of the tax filings with the tax authority for the relevant taxable year; and (iii) completion of the foreign exchange control process on outbound remittance. In addition, as a WFOE, the PRC Project Company may not make any dividend distribution unless it has accumulative profits available for distribution (defined under accounting rules). Furthermore, before any dividend distributions are made, the PRC Project Company would normally need to contribute 10% of its after-tax net profits into itsmandatory legal reserve fund unless the amount accumulated in the legal reserve fund has reached 50% of the PRC Project Company’s total registered capital.

From a PRC tax perspective, dividend distributions made by the PRC Project Company to its non-PRC tax resident shareholder are subject to a 10% withholding tax (“WHT”), unless reduced by an income tax treaty. If the non-PRC tax resident shareholder is eligible for tax benefits, the non-PRC tax resident shareholder and the WFOE (as a withholding agent) may directly apply the reduced WHT rate on a self-assessment basis, and file certain prescribed forms and supporting documents with the tax authorities at a later stage5.

2.2 Interest

In general and as a special regulatory restrictiona WFOE characterized as a real estate company is not allowed to borrow funds from a foreign lender (related or unrelated).

To the extent that a cross-border loan is legally permissible, the interest would be subject to a 10% WHT unless reduced by an income tax treaty. In addition to WHT, the interest would be subject to a 6% VAT and the VAT would be withheld by the WFOE. As an exception, VAT paid on interest would not be creditable to the WFOE and therefore become a cost.

With the reasons above, offshore real estate funds typically would not use inter-company financing as a tax efficient earning repatriation way.

3. Tax Efficient Exit Strategies

5 Announcement [2015] No.60 issued by the State Administration of Taxation of the PRC.

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Offshore funds can exit from their real estate investment in China in a number of ways, including: (i) a sale of the property owned by the PRC Project Company, followed by profit repatriation; (ii) a transfer of equity interest in the PRC Project Company; and (iii) a transfer of equity interest in an offshore special purpose company.

For the first option, a sale of property by the PRC Project Company would trigger several taxes in China, including (1) EIT at the rate of 25%, (2) VAT at 10% plus surcharges (12% on VAT payable), (3) land value added tax (“LVAT”), which is imposed at progressive rates ranging from 30% to 60%, depending on the amount of the value appreciation, and (4) 0.05% SD of the total contractual price of the real estate sale.

In comparison, for the second and the third option, the transfer of equity interest in either the PRC Project Company or the offshore special purpose company would not trigger LVAT in China and the EIT also would be reduced from 25% to 10%. The difference between the direct transfer of the PRC Project Company and the indirect transfer of the PRC Project Company through the transfer of the offshore special purpose company is that the direct transfer would additionally be subject to a 0.05% SD.

C. CONCLUSION

Offshore funds typically used multi-tiered offshore holding companies to invest in China. Capital gains from the exit are typically subject to a 10% Chinese enterprise income tax whether the exit takes place onshore or offshore because of the Chinese indirect transfer rules, unless reduced by a tax treaty. A Singaporean holding company with sufficient economic substance may be eligible for treaty benefits, such as the capital gain exemption on the transfer of a minority interest in a Chinese company (less than 25%). Partnership based treaty benefits are extremely difficult to claim due to China’s less developed rules on partnership taxation.

V. JAPAN INVESTMENT TAX STRUCTURES

A. INTRODUCTION

Japan is a high tax jurisdiction with its corporate income tax rate of 34% and 20% dividend withholding tax rates. Wealthy individuals are subject to an effective income tax rate of 55% on ordinary income. Given the high tax rates, Asia-Pacific funds investing into Japan much engage in sophisticated tax planning. The nature of the planning is generally determined by the asset class and the form of returns generated by such investment, as well as the intended exit strategy. For example, private equity funds whose investment in Japan are expected to be primarily in the form of capital gains realized upon exit, are generally structured in a manner which allows such funds making investments to avoid the capital gains . Investors in debt instruments may employ a different strategy altogether, structuring their investments to minimize interest withholding taxes and to avoid gains on the disposition of the debt by investing through Tokumei Kumai arrangements, a

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form of silent partnership structures, which can be transferred offshore free of Japan taxation.

Investment funds investing into Japan real estate generally employ two structures: (1) investment through a Tokutei Mokuteki Kaisha (TMK), which owns the real estate, or (2) investment through a Tokumei Kumiai (TK) arrangement directly into a Japanese entity which owns the real estate. Both structures are discussed in detail below.

B. JAPANESE TAXATION OF THE TMK

1. CORPORATE TAXATION OF TMK

The current effective tax rate for the TMK is approximately 34%. The TMK’s is determined in the same manner as that of other Japanese corporations, except that it should be entitled to deduct dividends declared in determining its taxable income in accordance with Article 67-14 of the Special Taxation Measures Law (the “TMK ”), assuming that all of the conditions described below (the “Dividend Deduction Requirements”) are satisfied

(a) The TMK must be registered on the Tokutei Mokuteki Kaisha Registry Book as prescribed under article 8(1) of the Asset Liquidation Law.

(b) The TMK must satisfy one of the following requirements:

(i) The aggregate amount of the issue price of its specified bonds that have been publicly offered is ¥100 million or more;

(ii) Its specified bonds are expected to be held solely by QII;

(iii) Its preferred stocks are subscribed by 50 or more investors; or

(iv) Its preferred stocks are subscribed solely by QII.

(c) The ALP describes that more than 50% of the common units of the TMK and more than 50% of the preferred units of the TMK will be offered in Japan (the "Onshore Offering Requirement"). If common unitholders renounce its right to receive dividends and residual assets, the Onshore Offering Requirement is not applicable to the common units.

(d) The fiscal year of the TMK does not exceed one year. (e) The TMK conducts its business and its incidental activities in accordance with its ALP as stipulated under article 195(1) of the Asset Liquidation Law.

(f) The TMK does not conduct any business other than the business in relation to the liquidation of its qualified assets and activities incidental thereto.

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(g) The TMK places the qualified assets in trust or entrusts the management and disposal of its qualified assets to another person.

(h) The TMK is not a family corporation as defined in the Law (if the TMK satisfies ①(B)(i) or (ii) above, then the TMK is exempted from this requirement.).

(i) More than 90 percent of the TMK’s “distributable amount” for the tax year has been declared as dividends to its unit holders.

(j) The TMK is not a general partner of a Goumei Gaisha (Japanese general partnership company) or a Goushi Gaisha (Japanese limited partnership company).

(k) The TMK does not own any assets other than those qualified assets as set forth in Article 200(2) of the Asset Liquidation Law that are listed in the ALP and if the TMK incurs any borrowings, such borrowings shall only be provided by a QII, and not by any person who has made a specified investment in the TMK.

On the sale or other taxable disposition of the Property, the TMK will realize capital gain or loss equal to the difference between the amount of the consideration received by the TMK and the TMK’s tax basis in the Property sold on the date of the transaction. Capital gains of the TMK are taxable at normal corporate income tax rates. The TMK should be entitled to claim a deduction for dividends declared that in total are equal to any capital gain recognized, as the TMK meets the Dividend Deduction Requirements. The withholding tax rate applicable to the dividends from capital gain is the same as that applicable to the dividends from operating income.

Capital gains from the sale of the Property relating to the land should be subject to “land surtax” at the rate of 10% where the land has been held for five years or less, or 5% where it has been held for a period longer than 5 years, although the surtax is suspended for sales occurring on or before March 31, 2020. However, under the surtax law, if the TMK meets the Dividend Deduction Requirements, the TMK is not subject to the 5% surcharge tax.

In the event that the TMK generates a net loss in any year, such loss may be carried forward to reduce its taxable income in the subsequent ten years provided that it has obtained a “blue form” taxpayer status and files tax returns on a timely basis. A “blue form” return filer is an entity that maintains its accounting records in accordance with Japanese Generally Accepted Accounting Principles, and has obtained approval from the tax authorities to file a blue return.

2. CONSUMPTION TAXATION OF TMK

The TMK is generally treated as a consumption taxpayer, if either:

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(a) the TMK’s taxable sales in the base year (i.e., the fiscal year two years before the current fiscal year, the “Base Year”) is more than ¥10 million6, or

(b) the TMK does not have the Base Year and the corporation’s stated capital is ¥10 million or more at the beginning of the current fiscal year7, or

(c) the TMK has filed a tax report to elect to be a consumption taxpayer with the relevant local tax office.

The current rate of the is 8%. The sale of a building (or the sale of the beneficial trust certificate representing a beneficial interest in a building) is subject to consumption tax of 8%. On the other hand, rents on residence and the sale of a land (or the sale of the beneficial trust certificate representing a beneficial interest in a land) are not subject to consumption tax.

If the TMK is a consumption taxpayer, consumption tax paid can be creditable against consumption tax received depending on the TMK’s taxable sales ratio. If the creditable amount exceeds consumption tax received, the excess will be refunded.

C. JAPAN TAXATION OF SINGAPORE COMPANY

Investment into Japan real estate by funds are often structured through the TMK owned by Singapore subsidiaries of the fund managed in a manner which allows the Singapore corporation (Singapore Co) to take claim the low 5% dividend withholding tax rate under the Japan –Singapore tax treaty. Such structures can result in the fund realizing effective tax rates as low as 6.5% to 13.5% for real estate investments in Japan.

Singapore Co, as a Singapore private limited company, should be treated for Japan income tax purposes as a foreign corporation. As such, dividends paid by the TMK to Singapore Co with respect to preferred units will be subject to a withholding tax rate of 20.42%8 on the gross amount of the dividend under the domestic tax law.

This withholding tax however may be reduced to 5%9 under the Japan - Singapore tax treaty (the "Tax Treaty"), provided that Singapore Co satisfies the following requirements: (1) it qualifies as “a

6 Even if taxable sales in the Based Year are ¥ 10 million or less, a corporation whose taxable sales in the first six months of the preceding fiscal year are over ¥ 10 million will be a consumption taxpayer. In this case, the amount of total salaries can be used instead of the amount of taxable sales in determining the consumption tax status. 7 Even if the corporation does not have a Base Year and the corporation's stated capital is less than ¥10 million at the beginning of the current fiscal year (the “Newly Established Small Corporation”), if the Newly Established Small Corporation meets the following requirements, it is treated as a consumption taxpayer. (i) As of the beginning date of either of the first two fiscal years of the Newly Established Small Corporation, it is more than 50% owned by a corporation whose (or its related parties') taxable sales in the Base Year exceeds ¥500 million. (ii) The Newly Established Small Corporation is established on or after April 1, 2014. 8 In addition to the 20% withholding tax, 2.1% of Special Reconstruction Income Tax will be imposed until December 31, 2037. 9 The special reconstruction tax does not apply to the tax treaty rate of 5%.

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resident of Singapore” under the Tax Treaty, (2) it is the “beneficial owner of the dividend” under the Tax Treaty, and (3) it owns at least 25% of the voting shares of the TMK during the period of six months immediately before the end of the accounting period for which the distribution takes place. .

Japan and Singapore have signed the MLI.10 Both Japan and Singapore opted for the Principal Purpose Test for the prevention of treaty abuse (Article 7). To safely claim Singapore reduced dividend withholding tax rate, the basis for the Singapore structure must meet the Principal Purpose Test.

Japanese tax law taxes capital gains realized by foreign persons who sell the shares of a Japanese company which holds 50% or more of the value of its assets in the form of Japanese real estate (“JRPRHC”); provided that, immediately prior to the tax year in which the sale occurs, such foreign investor owned more than 2% (or more than 5% of the shares if the company is listed) of the shares in such Japanese company (the “Japan FIRPTA Law”). Foreign persons who are subject to the but do not have a permanent establishment in Japan would be taxed at the rate of approximately 25%. Because the TMK will hold primarily Japan real estate and Singapore Co will hold more than 2% of the units of the TMK, the Japan FIRPTA Law will apply to a sale of the common and preferred equity units in the TMK by Singapore Co.

D. JAPANESE TAXATION OF TK ARRANGEMENT.

A tokumei kumiai (TK) relationship is based on a contractual agreement between the operator of the business in Japan and an investor who agrees to provide cash or assets for use in the business. Under the Japanese Commercial Code, assets and liabilities of the business are solely those of the operator (i.e., the investor has no ownership interest in the assets or any liability for obligations of the business). Furthermore, the investor is to be a “silent partner”, which means it is not permitted to participate in the management or decision making of the business.

In contrast to the TK arrangement, a Ni-nin Kumai (NK) is a partnership formed under the Japanese Civil Law for the purpose of carrying out the mutual goals of its partners. As such, its partners jointly own the assets of the enterprise, are severally liable for obligations of the enterprise, and are permitted to jointly participate in the management and decision making of the business.

An important distinction between an NK and a TK arrangement is the degree of the investor’s participation in the management and the decision making of the business. Accordingly, if the TK investor and the operator in Japan strictly abide by the terms of the TK agreement (which expressly provide that the operator holds the property of the business in its own capacity as the operator, and has the sole right to manage the business and all actions, decisions, consents, approvals, determinations and elections required or permitted to be made with respect to the business), the TK investment structure should be respected as a valid TK arrangement.

However, if the TK investor participates in the management or decision making of the operator’s

10 Japan has deposited the instruments of ratification with the OECD on September 26, 2018, but Singapore has not deposited the instruments of ratification with the OECD as of the date of this tax opinion.

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business, directly or indirectly, there is a tax risk that the Japanese tax authorities may attempt to re-characterize its status into that of a partner in a NK. If the tax authorities successfully re-characterize the status of the TK investor into that of an NK partner, the foreign TK investor and the operator in Japan would be treated as partners in the NK, in which case, the foreign TK investor will be treated as having a permanent establishment in Japan and will be subject to national and local corporate tax at the rate of approximately 34% on its allocable share of profits or gains of the TK business.

E. JAPAN TAX CLASSIFICATION OF SINGAPORE LIMITED PARTNERSHIP

Japan tax law does not contain foreign entity classification rules. However, case law does exist which provides guidance on how a Singapore limited partnership should be characterized for Japan tax purposes.

On July 17, 2015, the Supreme Court ruled that a limited partnership established under the law of the state of Delaware should be treated as a corporation for Japanese tax purposes based on the following criteria (the "Criteria")

(a) An entity should be examined under that foreign country's laws and regulations or operation thereof to establish whether or not it would receive the status of a 'legal person' under the Japanese laws. If this cannot be determined, then (b) The nature of the entity should be determined based on whether or not it has rights and obligations under the foreign country's relevant laws and regulations by examining the legislative purpose or context of the governing law.

Based on the legal characteristics of a Singapore limited partnership, the Singapore limited partnership should be treated as pass-through entities rather than corporations for Japanese tax purposes.

VII. SOUTH KOREAN INVESTMENT FUND TAX STUCTURES.

A. INTRODUCTION

Savvy global real estate investors have long been aware of potential investment opportunities in the Korean real estate market. However, when compared to other Asian countries, the tax costs associated with investing in and exiting from Korea have proven to be a major challenge. Moreover, recent tax trends driven by the BEPS Action Plans and the current administration’s neutral stance in respect of FDI has resulted in the elimination or reduction of many tax incentives which often benefitted foreign real estate investors. That said, a foreign investor using a well-developed investment structure that includes careful consideration of the potential taxes that may arise from investing in Korean real estate may avoid the pitfalls of prohibitive or duplicative taxes that many investors fall prey to. The following is a brief summary of the key tax issues that should be

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considered in this regard.

B. TAX TREATY PLANNING

Like many developed countries, Korea has a vast tax treaty network with over 90 effective tax treaties with tax jurisdictions around the world. In the context of investing into Korean real estate, some of these tax treaties work better than others to avoid permanent establishment and also eliminate or reduce withholding taxes on interest, dividend and capital gains. However, as is the recent trend around the world, Korean tax authorities will heavily scrutinize tax treaty structures to determine if the treaty claimant is entitled to any benefits claimed under a tax treaty. In this regard, the main focus tends to be whether the treaty claimant has sufficient substance in the jurisdiction where it is a tax resident such that under the Korean withholding tax rules, the treaty claimant can be regarded as the “beneficial owner” of the income received or gains realized. Accordingly, any attempt to design a structure as an afterthought, by e.g., establishing an entity in a tax treaty jurisdiction (“Newco”) and then transferring or assigning the buyer’s rights or ownership of Korean assets to Newco following negotiations and communications with the seller from a third country, is likely to viewed as an artificial arrangement used for treaty shopping purposes, and thereby disregarded for Korean tax purposes. The result is that any income or gain in respect of the Korean investment will not be viewed as beneficially received by Newco and instead, treat the shareholders or ultimate investors of Newco as the beneficial owner. This would potentially result in full domestic capital gains tax in Korea which would trigger a withholding tax and other tax compliance requirements. Moreover, under the Multilateral Instrument (“MLI”), which the Republic of Korea is one of the signatories of, such structure would also fail the Principal Purpose Test (“PPT”) and the Limitation on Benefits (“LOB”) provisions designed to prevent abusive use of tax treaties.

Given the recent trends at both the OECD and non-OECD jurisdictions, it is not surprising that all tax treaty structures could face aggressive tax audits from the Korean tax authorities. Hence, it would be of paramount importance that the “substance” requirements for beneficial ownership be met by the treaty claimant. In this regard, it is important to note that the term “substance” not only mean legal and economic substance in the general OECD sense. For Korean tax purposes, substance also requires: 1) physical substance, such as office and other facilities demonstrating capability to manage investments in Korea; 2) HR substance, meaning that the treaty claimant has sufficient human resources (including right technical skills at the right levels) to manage the investments in Korea; and 3) management substance, meaning that there should be sufficient communication, interaction and oversight by the treaty claimant demonstrating management and control of the investment (and if the paper trail leads to another entity located in a third country, the treaty claimant could be treated as established solely for tax purposes and thereby denied any tax treaty benefits).

C. AMENDMENT TO THE OVERSEAS INVESTMENT VEHICLE (“OIV”) RULE

Often an overseas fund based in one jurisdiction establishes a holding company structure in another jurisdiction for non-tax (e.g., fund management, fund raising and regulatory, etc.) reasons but then find itself in a worse-off position for tax purposes than if it had invested directly. An OIV is similar

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to a collective investment vehicle (“CIV”) and is broadly defined as an overseas legal entity designed to raise or collect funds through an investment offering, which manages investment assets, derives value from the acquisition and disposition of such as assets, and distributes income or gain from investments to its investors. Hence, partnerships, LLCs and other types of non-corporate CIVs such as trusts should qualify as an OIV. This rule was originally promulgated in 2012 to allow look-through treatment of OIVs established in non-tax treaty jurisdictions to their ultimate investors so that they can claim treaty benefits that are available under the treaties between their jurisdictions and Korea. However, the Korean Supreme Court subsequently ruled that an offshore fund established in the Cayman Islands for the purpose of raising funds and investing such funds into Korea can be treated as the beneficial owner of Korean source income. And since the Cayman Islands do not have any tax treaty with Korea, the Korean source income was fully taxable at the domestic tax rate. Consequently, the Korean tax authorities begin to apply a double-standard in the case of testing whether a Cayman Islands entity should be treated as the beneficial owner, while disregarding the beneficial ownership principle that the Korean tax authorities had previously developed for determining whether a foreign person can be entitled to treaty benefits and if not, allowing a look-through to the ultimate investors to determine whether treaty benefits are available under the treaties between the investors’ jurisdictions and Korea.

To remove the double standard applied to OIVs established in jurisdictions such as the Cayman Islands, the Korean Ministry of Economic and Finance (“MOEF”) revised the OIV rule in late 2018 (but effective beginning January 1, 2020). Under the tax law amendment, an OIV can only be treated as a corporate entity for Korean tax purposes if any of the following three conditions are met: 1) The entity has legal personality (e.g., indefinite life) under the law of the country in which it was incorporated; 2) the entity is only comprised of partners or members with limited liability; or 3) the entity has the same or similar characteristics to a company as defined under the Korean Commercial Code (“KCC”). Hence, the fact an entity can hold assets, can be a party to a lawsuit, or has rights and obligations separate from its members or partners will no longer result in it being treated as a corporate entity (and potentially as the beneficial owner of Korean source income). Moreover, the MOEF stated that the character of Korean source income earned by a non-corporate foreign entity is retained and tested at the level of each investor. If, for example, the OIV only discloses a portion of its partners/investors, then only that portion of the income would be taxed at the investor level and the remainder would be taxed at the OIV level. Finally, the MOEF stated that so long as the OIV is a company type (i.e., not a trust or partnership type), it would be treated as the beneficial owner if: 1) the OIV is liable to tax in its jurisdiction of residence and the OIV was not established to avoid/reduce tax on Korean source income; or 2) the OIV is respected as the beneficial owner under an applicable tax treaty. In respect to the first condition, it would appear that the tax law amendment was designed to specifically override the Supreme Court decision referred to above as the Cayman funds are not subject to corporate income tax in the Cayman Islands. As to the second condition, it appears to be designed to remove the double standard in determining whether an entity is a beneficial owner when it is established in a tax treaty jurisdiction.

D. DOMESTIC STRUCTURING CONSIDERATIONS IN RESPECT OF REAL ESTATE INVESTMENTS

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A direct acquisition of a Korean real estate by a foreign investor is not tax-efficient from a Korean tax perspective because it can trigger permanent establishment risk (corporate level tax) and in certain cases, the branch profits tax. In light of the recent tax law changes which have resulted in the increase of the top marginal corporate income tax to 27.5% (including local tax) and the potential exposure to the Korean legal and regulatory risks, sophisticated investors are likely to establish a tax-efficient Korean legal vehicle to hold its Korean real estate. To avoid these issues, foreign investors will establish a Korean entity under the Korean Commercial Code (“KCC”) to hold and operate the real estate investment (“Opco”).

Generally, the above structure would lead the foreign investors to being subject to two layers of taxation in Korea – first at the Opco level at the potential top marginal corporate income tax rate of 27.5% (including local tax) and, second when the Opco distributes its earnings by way of dividends (or interest) at the domestic statutory withholding tax rate of 22% (including local tax). However, in respect to qualified real estate investment, if the Opco were to be established in compliance with the Financial Investment Services and Capital Markets Act (“FISCMA”) and approved by the Financial Supervisory Service (“FSS”), then Opco would be entitled to a special dividend paid deduction (“DPD”). Under the DPD rule, if the Opco declares or distributes dividends in the amount of not less than 90% of its distributable income for accounting purposes (under K-GAAP or K-IFRS), the amount of such dividends would also be deductible against Opco’s taxable income. While some taxable income may remain if there is any book/tax difference (and setting aside the legal reserve required under the KCC), the availability of DPD would generally mean that Opco would be exempt from corporate income tax in Korea.

Another, alternative structuring option would be to establish an investment trust, rather than a company. Although it would still be governed and regulated under FISCMA, it is a non-taxable, pass-through vehicle and is often preferred by investors when investing in real estate. There is, however, a concern as to whether a distribution from a trust would qualify for the lower withholding rate on dividends which is available in many treaties. Still, in addition to avoiding the 0.48% (1.44% in certain cases) capital registration tax payable on the amount of par value of shares which are registered with the court as paid-in-capital for corporate entities and also not being subject to any legal reserve requirement, an investment trust is considered to be easier and less costly to establish and operate. However, use of leverage is generally not permitted except in certain cases.

Finally, there are other investment vehicles that can be established under different bodies of law which also allow for pass-through treatment for corporate income tax purposes, but these not as popular as the structures discussed above.

E. Exit and Korean capital gains tax considerations

Historically, foreign investors exit from their investments in Korea by selling the shares in Opco. Generally, the domestic capital gains tax, at the lesser of 11% of the gross proceeds or 22% of net capital gains, may have been avoided under certain tax treaties so long as the seller met the beneficial ownership test. However, most modern Korean tax treaties specifically allow Korean tax authorities to tax the gains from disposition of Korean real estate rich-company shares. Moreover, unless treaty protected, such shares are taxed in a manner similar to gains realized by a Korean permanent

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establishment, i.e. subject to corporate income tax of up to 27.5%. Accordingly, the better option may be for Opco to sell its real estate investment and then repatriate all the gains as dividends to its treaty-based shareholder. In such case, the dividends would generally be subject to a withholding tax rate of 5% ~ 15% (under most Korean tax treaties). Following the complete distribution of earnings, Opco could then be liquidated which would allow the investment principal o be repatriated to the shareholder free of any further Korean tax. Under such structure, the entire tax leakage in respect of profits generated from Korean real estate investment would be between 5% ~ 15%. And in many cases, given the low level of foreign taxes paid (i. e., withholding tax) in Korea, foreign tax credits may also be available in the jurisdiction where the shareholder/holding company is located, or in the jurisdictions where the ultimate investors of the holding company are resident in.

VIII. CONCLUSION

In response to recent significant tax developments and negative public perceptions of tax haven offshore jurisdictions such as the Cayman Islands, fund tax advisors to Asian investment funds are increasing moving towards recommending Asia-Pacific funds established in Singapore. Singapore has a highly attractive funds tax regime and extensive tax treaty network, and an investment management regulatory regime respected by investors. All forms of Singapore funds (as well as the S-VACC, to be adopted into law very shortly), provide a highly tax efficient and low tax risk platform for investments into Australia, China, Japan and South Korea.

END

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