Hong Kong introduces tax exemption for private equity

An amendment to the Inland Revenue Ordinance was passed by the special administrative region's legislative council on July 13 and came into effect on July 17. A government spokesperson said the move was intended to attract fund managers to expand their business in Hong Kong and stimulate demand for local asset management, investment and advisory services.

The exemption means that PE firms with funds domiciled offshore no longer have to set up structures designed to avoid triggering permanent establishment in Hong Kong and becoming liable for local tax. As a result, more substantive activity can take place locally, rather than ancillary support work.

It should also make it easier to access the tax treaty network: funds must meet local substance requirements to qualify for treaty benefits and this could be done without risking local tax liability.

The tax exemption - plus plans for open-ended investment company (OEIC) structures through which fund managers could raise Hong Kong-domiciled funds - was announced by Hong Kong's financial secretary in his 2013 budget statement. Subsequently, the Financial Services Development Council (FSDC) released more detailed proposals as to how these broad goals can become concrete policies.

Notably, the government has compromised on licensing. The initial proposal allowed managers licensed by the Securities and Futures Commission (SFC) to take advantage of the tax exemption, and the FSDC expressed a desire for a mechanism that can include unlicensed managers as well. It is estimated that only half the managers operating in Hong Kong are currently licensed.

The amendment says the exemption applies to transactions carried out by SFC-licensed entities or by an "offshore fund is a qualifying PE fund." A qualifying fund must have more than four investors; the capital commitment made by investors must exceed 90% of aggregate capital commitments; and the portion of net proceeds from transactions that accrue to the originator must not exceed 30% of the total proceeds.

Guidance issued by the government added: "The amendment ordinance extends the profits tax exemption to those offshore PE funds whose managers do not conduct activities regulated by the SFC and hence are not SFC-licensed persons. Most of the bona fide offshore PE funds managed in Hong Kong will qualify for the tax exemption."

The exemption also includes Hong Kong-based special purpose vehicles (SPVs) controlled by offshore funds. This is particularly important in terms of enabling Hong Kong to serve as a hub for investments across the region.

With a view to stopping local companies using offshore fund structures to convert taxable profits to non-taxable income via an offshore fund structure, managers or the SPVs under their control must not hold any Hong Kong properties or carry out any business in Hong Kong within a stipulated time limit.

John Levack, chairman of the Hong Kong Venture Capital and Private Equity Association's technical committee, described the amendment as "a positive step to enhance the attractiveness of Hong Kong as a private equity hub for new arriving PE firms and as a way of deepening the engagement for firms already operating in Hong Kong and simplifying their operating structure."

There are more than 400 private equity firms with some form of operation in Hong Kong, according to AVCJ Research. As of year-end 2014, total capital under management was $110 billion, which represents 19% of the Asia total.

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