Hong Kong reaffirms carried interest pledge

Lam said in her annual policy address that tax concessions would be available to private equity funds operating in Hong Kong “subject to the fulfillment of certain conditions.” She added: “[We] are formulating the legislative proposal with the aim of introducing an amendment bill into the LegCo [Legislative Council] shortly.”

Speaking at the AVCJ Forum last week, Anson Law, a senior manager for market development at Hong Kong Monetary Authority (HKMA), said the bill would likely go before legislators early next year. He noted that, regardless of when the policy comes into force, Hong Kong’s financial secretary has already indicated that it would take retrospective effect from April 2020.

A consultation paper on the treatment of carried interest was released in August. It said the rate of taxation would be highly competitive, based on international tax standards. Qualification is contingent on having sufficient local economic substance, including at least two investment professionals – or one investment professional and one back office executive – and no less than HK$3 million ($387,000) in annual local expenditure. HKMA will be responsible for validating funds.

The Hong Kong Venture Capital and Private Equity Association (HKVCA) made several recommendations regarding the definition of carried interest and qualifying funds and the scope of strategies classified as private equity. It also sought clarification as to whether concessions would be available to funds regardless of whether they take advantage of Hong Kong’s profits tax exemption and to parallel structures used for co-investment.

Moreover, HKVCA took issue with the HK$3 million minimum spend, observing this is unreasonably high for some angel and venture capital funds, especially as some advisors or managers act for multiple funds. It suggested amending the requirement to whichever is smaller out of at least HK$3 million in local expenditure and at least 50% of total fund management fees.

Historically, carried interest has been deemed a capital gain in Hong Kong, so there is no tax at all. In 2016, the Inland Revenue Department (IRD) turned this assumption on its head, stating 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.

Providing greater transparency on carried interest tax treatment is the last of several initiatives undertaken by Hong Kong to attract private equity managers. The fund-level tax exemption makes it easier for PE firms to carry out meaningful activities locally without triggering permanent establishment from a taxation perspective. Meanwhile, updated limited partnership legislation passed into law earlier this year, giving managers the option of domiciling their funds in the territory.

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 seen as being 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.

Lam mentioned several other initiatives intended to strengthen Hong Kong's position as an international financial center. These included deepening mutual access between Hong Kong and mainland China's financial markets, promoting real estate investment trusts (REITs), and nurturing family office business.

In terms of family offices, InvestHK will set up a dedicated team to promote Hong Kong as an asset management destination and offer one-stop support services to family offices interested in establishing a presence in the territory.

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