Investors question eligibility for HK carried interest tax concession

Regulatory authorities are currently finalizing the legislation with a target introduction date of February, although measures will take retrospective effect from April 2020. The proposed tax rate for eligible carried interest is zero, versus a standard corporate rate of 16.5%. Moreover, carried interest will be excluded from employment income for salaries tax calculations.

Patrick Yip, vice chair of Deloitte China, commended the Hong Kong authorities for clarifying that carried interest will be treated as capital gain rather than income for investors that meet local economic substance criteria. However, he told the Hong Kong Venture Capital & Private Equity Association’s (HKVCA) Asia forum that certain investors and structures may not meet qualification requirements set out in the proposed legislation.

A paper issued by the government earlier this month identifies four types of transactions to which the tax concession can apply. They essentially cover investments in private companies made directly from funds or through special purpose vehicles. “If you are investing in a fund-of-funds, that might not get you to one of those four transactions,” Yip said.

Family offices, meanwhile, might meet the requirements in terms of transaction type but fail to qualify for the exemption because they invest as single entities rather than as collective investment schemes. Yip called on the Inland Revenue Department (IRD) and the Hong Kong Monetary Authority (HKMA) – which will be responsible for validating whether investors qualify for the concession – to allow more leeway for family offices.

Various other potential obstacles have yet to be resolved, from who qualifies as a recipient of carried interest to whether the local substance requirements – including a minimum HK$2 million ($258,000) in local expenditure – apply per fund or per firm. However, John Levack, vice chairman of HKVCA, said that he had received most industry feedback on carried interest treatment for fund-of-funds and other LPs based in Hong Kong.

“There is typically a carry that is not 20% of the profit but smaller, and that should be eligible as well,” he said. “If you are looking through a fund and all its investments are qualifying investments, could you have a carried interest concession on the fund investment?”

Providing transparency on carried interest tax treatment is part of a broader effort by Hong Kong to attract private equity managers. The territory has also introduced a fund-level tax exemption that makes it easier for PE firms to operate locally without triggering permanent establishment from a taxation perspective and it has updated limited partnership legislation to give managers the option of domiciling their funds in Hong Kong.

The government and other advisory bodies have previously noted that the private equity firms contribute to local employment because they rely on a supply chain of downstream third-party service providers, from lawyers to bankers to accountants. Levack stressed the importance of the upstream element as well: it is easier for fund managers to raise capital if target LPs also have a local presence.

“Paul Chan [Hong Kong’s financial secretary] was talking about how the government is keen to build on the amount of work done in Hong Kong and a key element of the whole private equity network is the LPs. If we can encourage LPs to base themselves in Hong Kong it does wonders for the GP community and will help build that strength in the future,” Levack said.

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