Hong Kong’s potential as a new hub for private credit funds

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Authored by: Sarah Lau

With the Hong Kong Government’s commitment to creating a conducive environment for the wealth and asset management industry and to develop Hong Kong as an international asset management hub, the Financial Services and Treasury Bureau has, on 25 November 2024, issued a long-awaited industry consultation paper (Consultation) dealing with proposed changes to the unified fund exemption regime (UFR), the family-owned investment holding vehicle (FIHV) tax concession regime and the carried interest tax concession regime.

We highlight below some of the proposed changes that may help bring private credit funds and debt funds back to Hong Kong.

Background – Under the current UFR, there is no profits tax exemption for private credit funds as “loans” are not included as qualifying investments under Schedule 16C of the Inland Revenue Ordinance (Cap. 112) (IRO) (which covers a list of qualifying assets exempt from the payment of profits tax) and interest income from “loan” transactions are not considered incidental income. In addition, the Inland Revenue Department (IRD) has long considered that the holding of debt instruments (for instance, debentures, loan stocks, bonds or notes) to earn interest income to fall outside the definition of a qualifying transaction and that the receipt of interest income from such instruments would be an incidental transaction subject to a 5% threshold.

The restrictions under the current UFR in relation to the loan and private credit investments and 5% threshold on interest income derived from the holding of debt instruments have long undermined the attractiveness of Hong Kong as a destination for setting up private credit funds in comparison to other competing jurisdictions.

Proposed changes to include loans and private credit investments as qualifying assets/transactions under UFR – Amongst others, the Consultation proposes to expand the list of qualifying assets under the UFR to include loans and private credit investments. This would make transactions in loans and private credit investments (and interest income from the holding of such instruments) eligible for profits tax exemption under the UFR. In addition, the Consultation proposes to expand income exempt from profits tax to include all income from qualifying transactions (including interest income from bonds, marketable debt securities, loans and private credit investments), therefore removing the previous 5% threshold.

The above proposals would be a positive move to bring private credit funds and debt funds back to Hong Kong.

Without prejudice to the above, the Consultation mentions that an exclusion list will be formulated setting out in detail income not qualifying for tax exemption and the industry is yet to have sight of the full list of excluded investments contemplated.

It is also noteworthy that the Consultation proposed to introduce a new anti-round tripping provision catered for loan and private credit investments where an insurance business, a money lending business Hong Kong and/or an insurance business, either alone or jointly with associates has a beneficial interest of 10% or more in a tax-exempt fund (or any percentage if the fund is the person’s associate), then such persons will be deemed to have derived assessable profits in respect of income derived by the fund from loan or private credit investments.

FIHVs – The tax concession regime for FIHVs is largely modelled on the UFR. The proposed changes set out above, if adopted, will also be brought across to the FIHV tax concession regime.

Carried interest – The Consultation has proposed, amongst other changes, to broaden the types of transactions that can generate eligible carried interest under the carried interest tax concession regime beyond private equity transactions to cover profits arising from all classes of assets specified under Schedule 16C of the IRO which are exempted from profits tax under the UFE regime (which will include loan and private credit investments), other non-taxable income (such as dividend income and offshore income) and other taxable income.

This could possibly represent positive news for fund managers with strategies in private credit who may be eligible under the revamped carried interest concession regime to be introduced provided that other qualifying conditions are met.

Our view – Overall the proposed amendments under the Consultation represent an encouraging move for the asset management industry in particular from the perspective of private credit fund managers. This may open up possibilities for developing Hong Kong into a new hub for private credit investments and making Hong Kong domiciled fund structures such as open-ended fund companies (OFCs) and Hong Kong limited partnership funds (HKLPFs) a more attractive and viable option for loan and private credit investments in the near future.