Grounded Ingenuity | Refined Results

January 11, 2021
By Gavin Cumming
Following its proposal to introduce a concessionary tax rate for carried interest earned from Hong Kong private equity funds, on January 4, 2021, the Hong Kong Government announced that eligible carried interest will be charged at a profits tax rate of 0% and that 100% of eligible carried interest will be excluded from employment income for the calculation of salaries tax. In this article, we provide an overview of the latest developments. In our earlier article, Hong Kong Private Equity Funds: Carried Interest Tax Concession Proposal, we outline the initial proposal released in August, 2020. Anyone interested in more information about this area can speak to our private equity lawyers and private equity tax lawyers.

On January 4, 2021, the Hong Kong Government announced that under its latest proposal on the carried interest tax concession, it would set the tax rate at 0% and that an amendment bill to enact the latest proposal is expected to be introduced into the Legislative Council in late January 2021. As proposed, the concessionary tax rate will have retrospective effect, meaning that eligible carried interest received by or accrued to qualifying carried interest recipients on or after April 1, 2020 will, in essence, be exempt from Hong Kong profits tax.

This tax concession dramatically enhances the competitiveness of Hong Kong in attracting private equity funds to set up and be managed in Hong Kong, undoubtedly at the expense of the Cayman Islands which continues to suffer as a result of the latest international taxation standards, including anti-base erosion and profit shifting (“BEPS”) measures, set by the Organisation for Economic Co-operation and Development (“OECD”).


In 2019, Hong Kong ranked second in Asia after the Mainland in terms of the total capital under management by private equity funds (excluding real estate funds).

The Hong Kong Government has been actively developing Hong Kong as a leading private equity hub. It launched a new limited partnership fund (“LPF”) regime on August 31, 2020. Since then, 73 LPFs have been registered in Hong Kong.

Equally important, the Hong Kong Government introduced a new tax exemption (“Unified Funds Exemption”) which exempts privately offered funds, including LPFs and other private equity funds, from the payment of profits tax in respect of assessable profits derived from private equity transactions, subject to meeting the relevant exemption conditions.

With the private equity fund structure and tax neutrality for private equity funds addressed, the Financial Secretary turned in his 2020-21 Hong Kong budget speech to private equity management groups, with a plan to provide a tax concession for carried interest paid by private equity funds operating in Hong Kong subject to the fulfilment of certain conditions. However, at that time, the plan neither specified the tax rate under the tax concession nor did it specify the conditions for eligibility.

Following the release of a paper in August, 2020 to outline conditions for eligibility and an industry consultation conducted from August, 2020 to September, 2020, on January 4, 2020, the Financial Services and the Treasury Bureau submitted its briefing paper to the Legislative Council Panel on Financial Affairs regarding the proposed tax concession for carried interest. This paper confirmed that the proposed concessionary profits tax rate for carried interest would be 0%.

Eligible Carried Interest

Consistent with the August proposal, in order to differentiate carried interest from other types of management fee and remuneration received by investment professionals, the latest proposal defines “eligible carried interest” as a sum received by or accrued to a person by way of profit-related return subject to a hurdle rate.

However, the latest proposal clarifies that the hurdle rate, which is a preferred rate of return on investments in the fund, will be as stipulated in the agreement governing the operation of the fund. In the prior August proposal, it was unclear if the hurdle rate was fixed at 6%.

As in August, the term “profit-related return” has three conditions:

  • the eligible carried interest must arise only if there are profits for a period on the investments, or on particular investments, made for the purposes of the certified investment fund, or there are profits arising from a disposal of investment of the fund;

  • the eligible carried interest paid would vary by reference to the profits; and

  • the returns to external investors must be determined by reference to the same profits.

If there is no significant risk that a sum of at least a certain amount would not be received by or accrued to the person concerned, the said amount will not regarded as “carried interest".

Qualifying Carried Interest Payer

As in the August proposal, the latest proposal provides that the tax concession will apply to eligible carried interest distributed by an eligible private equity fund, meaning a fund which falls within the meaning of “fund” under section 20AM of the Inland Revenue Ordinance (“IRO”). Private equity funds will normally fall under this section if they are eligible for relief under the Unified Funds Exemption.

Carried interest distributed by Innovation and Technology Venture Fund Corporations (“ITVF Corporation”) will also be eligible for the concessionary tax rate.

Consistent with the August proposal, a fund must be certified by the Hong Kong Monetary Authority (“HKMA”) (thereby becoming a “certified investment fund”) and, in the case of a non-resident fund, an authorised local representative must be appointed to be responsible for providing the necessary information to the Inland Revenue Department and the HKMA on behalf of the fund.

Qualifying Transactions of Certified Investment Funds

Consistent with the August proposal, the concessionary tax treatment will be ringfenced to eligible carried interest arising from qualifying transactions in private equity only. Carried interest arising from private equity transactions which qualify for relief under the Unified Funds Exemption will qualify for the concessionary tax rate. The latest proposal specifically clarifies that carried interest from disposals of interests in holding companies of private equity portfolio companies are eligible.

In summary, for the tax concession to apply, eligible carried interest must arise from transactions:

  • in shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a private company specified under Schedule 16C to the IRO;

  • in shares or comparable interests of a special purpose entity (“SPE”) or interposed SPE which is solely holding (whether directly or indirectly) and administering one or more investee private companies;

  • in shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by an investee private company held by a SPE or interposed SPE described in (b); or

  • incidental to the carrying out of the foregoing qualifying transactions

Qualifying Carried Interest Recipients

The latest proposal keeps the same eligibility requirements outlined in August, 2020 for the recipient of carried interest, namely:

  • a corporation licensed or registered by the the Securities and Futures Commission ("SFC") for any regulated activity, including Type 1 (dealing in securities), Type 4 (advising on securities) or Type 9 (asset management);

  • a person providing investment management services in Hong Kong to a certified investment fund which is a “qualified investment fund” , meaning a fund that is eligible for exemption under the Unified Funds Exemption but that is not managed or advised by an SFC licensed or registered firm; and

  • an individual deriving assessable income from the employment with the qualifying persons referred to above by providing investment management services in Hong Kong to the certified investment funds on behalf of the qualifying persons.

Provision of Investment Management Services

The latest proposal still requires that the carried interest be earned in respect of eligible services. Such services include:

  • seeking funds for the purposes of the certified investment fund from external investors and potential external investors;

  • researching and advising on potential investments to be made for the purposes of the certified investment fund;

  • acquiring, managing or disposing of property and investments for the purposes of the certified investment fund; and

  • acting for the purposes of the certified investment fund with a view to assisting an entity in which the fund has made an investment to raise funds.

Substantial Activities Requirements

The latest proposal relaxes the requirement for substantial activities in Hong Kong. This requirement is intended to enable compliance with international BEPS initiatives which ensure that beneficiaries of a preferential tax regime undertake core income generating activities in the jurisdiction providing the regime.

While a qualifying carried interest recipient (that is not an employee of another qualifying carried interest recipient) must still have, in the opinion of the Commissioner of Inland Revenue, an adequate number of qualified full-time employees and operating expenditure incurred in Hong Kong, the minimum annual operating expenditure incurred in Hong Kong for the provision of the investment management services has been reduced to HK$2 million. The minimum operating expenditure previously proposed in August was HK$3 million.

HKMA Certification and On-going Monitoring Mechanism

As outlined in the August proposal, the HKMA will administer a certification scheme and funds will have to go through a certification process before concessionary tax treatment will apply to their eligible carried interest distributions. To apply for certification, a fund or the local authorised representative of a non-resident fund must submit an application to the HKMA, together with relevant documents and information as required by the HKMA.

The HKMA will assess, based on the information provided, whether the fund makes private equity investment and whether the local employment and local spending requirements of the carried interest recipients are likely to be met. A letter of certification will be issued by the HKMA if it is satisfied that the relevant criteria are met.

In a particular year of assessment where there is a distribution of eligible carried interest, an external auditor should be engaged to verify that the relevant substantial activities requirements imposed on the carried interest recipients are met in the relevant year(s) of assessment, and that the distribution fulfils the conditions under the tax concession regime.

Deduction of Expenses and Loss Not Available to Set Off

For qualifying carried interest recipients subject to profits tax (i.e. qualifying carried interest recipients who are not employees of another qualifying carried interest recipient), it is proposed that only the net carried interest, after deducting any outgoings and expenses and depreciation, would be eligible for the tax concession. Also, any loss sustained will not be available for set off against any of the assessable profits for the year or any subsequent year of assessment if the concessionary tax rate is zero.

Anti-avoidance Provisions

To prevent tax abuse, if the Commissioner of Inland Revenue is satisfied that the main purpose, or one of the main purposes, of a person entering into the arrangement is to obtain a tax benefit, the concessionary tax treatment would not apply to the person concerned.

The legislation will also specify that a management fee (even if disguised as eligible carried interest) received by qualifying carried interest recipients would not be eligible for tax concession. By contrast, the tax position of a management fee was unclear under the Initial Proposal.

Further Tax Enhancements

In addition to the proposed tax concession regime for carried interest, it is proposed to make certain enhancements to the profits tax regime for privately offered funds in order to facilitate the operation of funds in Hong Kong.

At present, it is common for funds to hold financial assets other than private companies using SPEs established by the fund. However, an SPE, as currently defined under the IRO, is only allowed to hold and administer investee private companies, but not other financial assets.

To address the industry’s concern, it is proposed to allow an SPE to hold and administer assets of a class specified in Schedule 16C to the IRO and to carry out transactions in such assets on behalf of the fund.

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