Hong Kong to introduce carried interest concessions

“With a view to attracting more private equity funds to domicile and operate in Hong Kong, we plan to provide tax concession for carried interest issued by private equity funds operating in Hong Kong subject to the fulfillment of certain conditions. We will consult the industry on the proposal, and the relevant arrangement will be applicable starting from 2020-21 upon completion of the legislative exercise,” Chan said in his budget statement.

AVCJ understands the Hong Kong Venture Capital & Private Equity Association (HKVCA) has been invited to participate in the consultation exercise.

Some industry participants hoped Chan would go further than announce a plan for legislation. However, identifying the issue by name represents a step forward. Speaking at the HKVCA’s Asia forum last month, Chan said he recognized there were concerns about tax policy. Only the Financial Services and the Treasury Bureau (FSTB), a government advisory group, addressed the issue directly, saying a proposal was in the works that would keep Hong Kong competitive.

Asian PE firms usually establish funds and investment management entities in the Cayman Islands and then advisory entities in Hong Kong and other locations. The 2% management fee accrues to the holding company and cash is remitted to the advisory entities to cover costs plus a little extra. This is taxed as income at 16.5%. Carried interest is deemed a capital gain, so there is no tax at all.

However, in 2016, the Inland Revenue Department (IRD) stated that carried interest received by the investment manager outside of Hong Kong could be targeted under anti-avoidance provisions and taxed as income onshore, at the corporate or individual level.

The government has previously introduced highly targeted tax breaks for certain segments of the financial services industry, usually with a view to discouraging relocation to rival jurisdictions. Legislation is soon expected to pass into law that will see the profit tax rate for shipping leasing managers providing services to non-associate companies reduced from 16.5% to 8.25%. Similar concessions are already offered to corporate treasury centers to discourage flight to Singapore.

Singapore is encouraging private equity firms to relocate operations from Hong Kong. The Southeast Asian nation already has an onshore funds framework, while fees derived from managing or advising funds are taxed at a concessionary rate of 10% instead of the standard corporate income tax rate of 17%. Carried interest is not taxed, though there is no government view on the matter.

Chan also flagged up “the preparation of new legislation on the establishment of a limited partnership regime that meets the operational needs of funds, so as to encourage the setting up of private equity funds in Hong Kong.” The FSTB previously expressed hopes that an updated limited partnership ordinance would pass into law this year.

Steps have already been taken to make it easier for private equity firms to carry out meaningful activities in Hong Kong without triggering permanent establishment from a taxation perspective. In addition, the government has asserted that fund managers carrying out certain activities locally should be licensed by the Securities & Futures Commission, though much remains to be resolved in this area. Most HKVCA members are currently not licensed.

Enabling private equity firms not only to operate freely in Hong Kong but also domicile their funds in the territory is integral to bringing every part of the management and investment process onshore. Global regulatory pressure is pushing investors in this direction as part of efforts to combat tax evasion. For example, Cayman is proposing tougher rules for private fund registrations – including the appointment of a locally-based auditor – while economic substance legislation requires fund management entities to establish more meaningful local operations.

Darren Bowdern, a partner in KPMG’s Hong Kong tax practice, described Chan’s remarks on carried interest as a “welcome development that has been a long time in the making,” adding that the introduction of concessions would be in line with the tax treatment of carried interest in other international financial centers.

“Given that many jurisdictions incentivize the tax treatment of carried interest to attract funds to establish locally, it is important that Hong Kong places itself on a competitive footing. With a comprehensive legislative framework around the taxation of carried interest, together with a broader regulatory framework supporting investment limited partnerships establishing in Hong Kong, the city should be well placed to remain Asia’s leading financial center,” he said.

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• Topics
• Greater China
• Regulation
• GPs
• Hong Kong (China)
• tax