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

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.