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Hong Kong’s latest proposal for 0% carried interest tax on Private Equity Funds

Insight 20 January 2021

Hong Kong’s latest proposal for 0% carried interest tax on Private Equity Funds

The tax concession on carried interest was first mentioned in February 2020 with the Hong Kong Government releasing its first proposals in August 2020 to provide a tax concession for carried interest in private equity funds with carried interest earned and managed in Hong Kong, but the concessionary tax rate was not specified.

Following an initial proposal, the Treasury Bureau submitted its latest proposal to the Legislative Council Panel of Financial Affairs on 4 January 2021 for the concessionary profits tax rate for carried interest to be set at 0%, which is expected to be introduced into the Legislative Council in late January 2021.

If the bill is passed, the concessionary tax rate will take effect for eligible carried interest received by or accrued to qualifying carried interest recipients on or after 1 April 2021.

This will be an enhancement and development for the private equity hub in Hong Kong and will further strengthen the Hong Kong asset management industry and its position as the financial centre in Asia, following the introduction of a unified tax exemption for funds (“UFE”) under the Inland Revenue Ordinance (“IRO”), effective 1 April 2019, and a Limited Partnership Fund (“LPF”) under the Limited Partnership Fund Ordinance (“LPF Ordinance”), effective 31 August 2020.

To differentiate carried interest from other types of management fees/remunerations received by investment professionals, this paper proposes to define “eligible carried interest” as a sum received by or accrued to a person by way of profit-related returns subject to a hurdle rate which is a preferred rate of return on investments in the fund.

The eligible requirements from this proposal applies to:

  • A licensed corporation under Part V, Securities and Futures Ordinance (Cap. 571) (“SFO”), or an authorised financial institution under Part 1, Schedule 5, SFO;
  • A person who is not licensed but providing investment management services in Hong Kong to a HKMA Certified Investment Fund which is a “qualified investment fund” under UFE;
  • An individual deriving assessable income from employment with qualifying persons with reference to the above or their associated corporation/partnership, by providing investment management services in Hong Kong to the Certified Investment Fund.

Any person who meets the above requirements will be eligible for tax exemption with the conditions that Substantial activities requirements are fulfilled.

It is proposed that in order for concessionary tax treatment to apply, a qualifying carried interest recipient must have, in the opinion of the Commissioner of Inland Revenue, an adequate number of qualified full-time employees and operating expenditure incurred in Hong Kong. This includes:

  • an average of two or more full-time employees in Hong Kong who carry out the Investment Management Service; and
  • the operating expenditure incurred in Hong Kong for the provision of the Investment Management Service for each year of assessment concerned is HK$ 2 million or more.

The carried interest must be earned in respect of eligible services for the purposes of the Certified Investment Fund. Eligible services include:

  • seeking funds from external investors or potential external investors;
  • researching and advising on potential investments to be made;
  • acquiring, managing or disposing of property and investments; and
  • acting with the view of assisting an entity in which the Fund has made an investment to raise funds.

It is  proposed tax concession applies to eligible carried interest payers who meet the following requirements:

  • the Fund which falls within the meaning of "fund" under section 20 AM of the Inland Revenue Ordinance (IRO);
  • the Fund is certified by the Hong Kong Monetary Authority (HKMA) as a Certified Investment Fund;
  • in the case of a non-resident fund, an authorised local representative must be appointed to be responsible for providing the necessary information to the IRD and the HKMA on behalf of the Fund.

Carried interest distributed by eligible Innovation and Technology Venture Fund Corporations (ITVF Corporation) is also included in the proposal.

The concessionary tax treatment is to be ring fenced to eligible carried interest arising from qualifying transactions only. Transactions include:

  1. in shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a private company specified under Schedule 16C to the IRO;
  2. in shares or comparable interests of a special purpose entity (SPE) or interposed SPE which is solely holding (whether directly or indirectly) and administering one or more investee private companies;
  3. in shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by an investee private company held by a SPE or interposed SPE at (b) above; or
  4. incidental to the carrying out of the qualifying transactions above.

Carried interest from hedging transactions that form part and parcel of the Qualifying Transaction and the profits on the hedging transactions are embedded in the profits or loss on the Qualifying Transaction may also be eligible.

To prevent tax abuse, the HKMA will administer a certification scheme and the Fund will need to go through a HKMA certification process, together with relevant documents and information required by HKMA before concessionary tax treatment will apply. HKMA will assess applications based on the information provided, whether the investments and substantial activities requirements are likely to be met.

In the year where there is a distribution of eligible carried interest, an external auditor would need to be engaged to verify that substantial activities requirements are met and the carried interest distribution fulfils the conditions under the tax concession regime.

For qualifying carried interest recipients subject to profits tax (i.e. qualifying carried interest recipients), it is proposed that only the net carried interest after deducting any outgoings and expenses and depreciation would be eligible for the tax concession. Any loss sustained is not available for set-off against any of the assessable profits for the year or any subsequent year of assessment if the concessionary tax rate is zero.

Other matters

20 January 2021

In addition to the proposed tax concession regime for carried interest, the proposal places enhancements to the unified fund exemption rules regime. Under the current unified fund exemption rules, special purpose entities are only allowed to hold and administer eligible shares in investee private companies, but not other financial assets. It is proposed to allow SPEs to hold and administer assets of a class specified in Schedule 16C to the IRO and allow SPE to carry out transactions in such assets on behalf of the fund.

Read the full discussion paper here

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If you want to find out more about tax concession on carried interest, let’s talk. We would be delighted to speak with you to discuss how Sanne can assist. For more information please contact Catherine or Wendy directly.

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Catherine Law Head of Business Development, APAC - Hong Kong
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