China gave six hedge funds the right to raise funds in yuan for international investments earlier this year in the experimental Qualified Domestic Limited Partner (QDLP) program in Shanghai, a first step toward opening the country’s markets and internationalizing its currency. Now that the program has had a few months to get going, Kenny Lam, tax partner at PricewaterhouseCooper Shanghai, explains what this means for asset managers.

China

“While the QDLP program provides a new window of opportunity for both overseas hedge funds and Chinese domestic investors, there are a number of issues that need to be managed by asset managers,” he writes. “Asset managers need to be alert that Chinese investors are far from mature as compared with investors in more developed markets like the US and UK.”

QDLP poses new tax challenges for asset managers

Lam explains that asset managers should consider hiring local staff to help find investors, but they also need to figure out the best fee structure to maximize after-tax performance. He recommends collective investment schemes that are allowed in the Chinese tax code, but the best structure isn’t obvious, giving asset managers an opportunity to differentiate themselves by figuring out a better structure.

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Creating regional offices also poses a challenge for managers trying to limit their tax exposure. “There are often circumstances where regional offices send their employees to support the operation of the Onshore FMC,” writes Lam. “[Asset managers] need to consider putting these people under dual employment of the two entities or under a secondment arrangement. Such consideration would not only help alleviate the Chinese individual income tax of these persons but also manage the risks of creating a taxable presence of the regional offices in China.”

China intends to expand QDLP, but not quickly

Lam is optimistic about the future of the QDLP program, and although China has always approached economic liberalization cautiously, it has indicated that it intends to expand the QDLP beyond the initial $50 million worth of yuan currently permitted as long as the country doesn’t have a bad experience with the first six hedge funds. As QDLP expands, these types of questions about fund structure in China will become more and more important for hedge funds that are looking for new sources of capital.