Hong Kong Private Equity awaits confirmation of carried interest tax concession
25 March 2021 - The Hong Kong Government has introduced a notable series of amendments* to fund legislation over the past 18 months to boost the competitiveness of Hong Kong as an international PE fund hub.
The new Limited Partnership Fund (‘LPF’) regime replaces a scarcely used limited partnership vehicle in Hong Kong and has clearly been adopted to ensure Hong Kong remains competitive with other major fund domicile jurisdictions by becoming a regional PE hub. And it seems to be working: the Hong Kong Monetary Authority’s (‘HKMA’) has confirmed that over a hundred LPFs have been set up as of this Chinese lunar New Year’s festive period.
Yet one piece of the puzzle is still missing - the clarification on the treatment and taxation of carried interest.
Under the new regime, private funds - including PE and venture capital funds - can be registered in the form of limited partnerships in Hong Kong. A fund qualifying for registration under the LPF regime must be constituted by one general partner, who has unlimited liability in respect of the debts and liabilities of the fund, and at least one limited partner with limited liability. Certain eligibility requirements, as described in the Limited Partnership Fund Ordinance (LPFO), must be met by the LPF.
But in order to further appeal to Hong Kong managers, the proposed tax rate of carried interest would also have to be competitive with other fund domicile jurisdictions. For this purpose, the Inland Revenue (Amendment)(Tax Concessions for Carried Interest) Bill 2021 (the ‘Bill’) was gazetted as per January 29, 2021.
If enacted by the Legislative Counsel, the Bill provides for eligible carried interest received by or accrued to qualified recipients to be taxed retrospectively from April 1, 2020, at a proposed concessionary tax rate of 0%. If adopted, this would also exclude 100% eligible carried interest from employment income and in turn Hong Kong salaries tax.
In order to qualify for this proposed rate, an eligible fund must apply for upfront certification by the HKMA. The HKMA will certify the fund is making only PE investments and ensure at least two full-time qualified employees are carrying out investment management activities, based in Hong Kong, with operational expenditure of at least HK$ 2 million in each year of assessment. Further, the fund must fall under the definition of a fund within the meaning of Section 20AM Inland Revenue Ordinance.
Subject to anti-avoidance provisions, the carried interest distributed must broadly speaking:
- Be eligible carried interest
- Originate from a qualified carried interest payer
- Result from a qualifying transaction of a certified investment fund and
- The recipients must be qualified carried interest recipients.
Further details are available in the Bill. We also strongly advise consulting your tax advisor for guidance, given the complex nature of the Bill.
*Firstly with the introduction of the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Ordinance 2019, also known as the Unified Fund Exemption regime (‘UFE’), as per August 1, 2019. Essentially a qualifying fund within the meaning of DIPN 61 will not be assessable for profit tax provided these profits arise from ‘qualifying transactions’ and these transactions are carried out in Hong Kong by a ‘specified person’ or in the case where the fund is considered a ‘qualified investment fund’. Qualifying transactions are further specified in Cap. 112 IRO Schedule 16C. Certain exclusions do apply; for instance, for Hong Kong property. The tax exemption has been made broadly applicable and applies to both Hong Kong domiciled funds and non-Hong Kong domiciled funds, provided certain criteria are met. Secondly, an amendment to the Hong Kong limited partnership regime was consulted in detail by the industry and resulted in the Limited Partnership Fund Ordinance (Cap. 637) (‘LPFO’) being brought into effect as per August 31, 2020.