Lawmakers endorse Hong Kong's fund domicile ambitions

Having received Legislative Council approval on July 10, the law will come into effect at the end of August.

Hong Kong introduced an open-ended fund structure in 2018, but the existing limited partnership legislation – enacted more than a century ago – was widely acknowledged as unworkable in the present day. The new structure is similar in many respects to the Cayman Islands limited partnerships popular with many industry participants.

The ultimate objective is to encourage private equity firms to bring every part of the management and investment process – the fund, the fund management entity, the various vehicles used to make downstream investments – onshore.

This is in line with the Organization for Economic Cooperation & Development's (OECD) ongoing crackdown on investors using jurisdictions purely for the pursuit of favorable tax treatment. Cayman, for example, has introduced stricter oversight measures for private funds, including registration and local audit requirements. Some fund management entities must also have more meaningful local operations.

Increasingly, investors must demonstrate local substance if they want to use a certain jurisdiction. Hong Kong's proposition – much like that of Singapore, which already offers a local fund structure – is that it makes sense to consolidate activities close to where investments are made rather than have substance in a separate jurisdiction for the sake of compliance. The question is whether GPs, and their LPs, are willing to abandon tried and tested structures.

The Legislative Council brief on the Limited Partnership Fund Bill notes that it is "vital to grasp the opportunity of potential shifting of fund structures and activities from offshore to onshore, as a result of Base Erosion and Profit Shifting (BEPS) package of the OECD which requires taxation to happen where asset management activities take place."

The brief also highlights the importance of the legislation in terms of job creation within the fund management and service provider industries, and the role that private equity can play in supporting innovation in the Greater Bay Area. It notes that approximately 560 GPs – with combined assets under management of $160 billion – were operating in Hong Kong as of year-end 2019.

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.

However, concerns remain about the treatment of carried interest in Hong Kong. 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 since sought to reassure the industry, with Financial Secretary Paul Chan promising in his budget statement earlier this year that an appropriate tax regime would be put in place. Separately, the Financial Services and the Treasury Bureau (FSTB), a government advisory group, said a proposal was in the works that would keep Hong Kong competitive.

Industry participants observe that the introduction of concessions would be in line with the tax treatment of carried interest in other international financial centers.

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• Topics
• Regulation
• Fundraising
• Greater China
• Hong Kong (China)
• Fund formation
• tax