There's one big issue that's seldom out of the minds of China fund managers or directors of China funds, and the resolution of it could have a big positive (or negative) effect on their funds.
But continuation of the status quo, of ‘kicking the can down the road', will just make the resolution an even bigger conundrum.
The issue is capital gains tax. For almost five years, funds have had to leave 10% of gains from China A-share trades in accounts with their brokers as a “withholding tax”. That's where the befuddlement begins.
Firstly, the calculation of the tax bill is indistinct. Is it a tax on gross capital gains, or can you net-off losses? It seems only fair that you could net-off loss-making trades (such as in the US), but nobody is really sure because the original rules did not clarify this important issue.
Secondly, who wants this tax? The China Securities Regulatory Commission says it doesn’t. China’s Ministry of Taxation says it doesn’t. China’s Ministry of Finance says, "Yes please." So who is physically going to collect it?
Thirdly, if the tax is applied, from what date is it applicable? Is it 2003, when the concept originally arose? Or from 2006/2007, when the brokers started accumulating the withholding tax? Or is it from now or some specified date in the future? If they attempt to collect the tax retrospectively, the accounting knock-on effects become nightmarish. If they agree to collect only in the future, then the windfall to China A-share funds could be massive.
Fourthly, the money withheld is denominated in dollars. With the appreciation of the RMB, there isn’t enough set aside to pay the bill. If China says, "Pay up," the brokers would have to go back to the funds and ask for more cash, and some of those funds no longer exist.
So there's a big lump sum that grows every day in Hong Kong’s brokerages. If refunded to the funds, it would be a $2-$3 billion gain, and huge smiles from them as their net asset values take a leap. That cash would probably be invested back into the China markets.
If the Chinese government takes the money, so be it. But if the Chinese tax man says he wants the shortfall caused by the renminbi’s appreciation, then the fund managers may feel slightly vexed.
“Our view is that the capital gains tax should be claimed by the Chinese government with immediate effect and going forward, but should not be retroactive and the sums already accumulated in the brokerage and reserve accounts should be refunded,” says Aaron Boesky, CEO of Marco Polo Pure Asset Management in Hong Kong.
In this resolution there would be a boost to China-focused funds and an opportunity for China to begin collecting solid tax revenue.
The fund managers are seeing these credit balances rise and rise and try to pressure their brokers to push for resolution, but what can the latter do to persuade the people who will make the final decision? It's not easy. In fact, it's a big mess and getting bigger.
What is needed is a difficult, and pragmatic, political decision from China.