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.
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:
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:
The carried interest must be earned in respect of eligible services for the purposes of the Certified Investment Fund. Eligible services include:
It is proposed tax concession applies to eligible carried interest payers who meet the following requirements:
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:
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.
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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