Hong Kong’s Legislative Council’s Panel on Financial Affairs discussed tax concessions for carried interest in its meeting on 4 January 2021, following the publication of a discussion paper by the Financial Services and the Treasury Bureau (FSTB). The FSTB’s paper sets out proposals to offer a zero percent concessionary tax rate for eligible carried interest distributed by eligible private equity funds operating in Hong Kong.
It is expected that an amendment bill will be introduced into the Legislative Council in late January 2021, with the concessionary tax treatment to take retrospective effect for eligible carried interest received by or accrued to qualified carried interest recipients on or after 1 April 2020. The move is a welcome step towards the development of Hong Kong as a premier private equity fund hub and to supplement the introduction of the limited partnership fund regime in August 2020.
Eligible carried interest
Under the proposed framework, the tax concession would only apply to eligible carried interest distributed by a fund falling within the meaning of a “fund” under the Unified Fund Exemption Regime. The fund would also need to be certified by the Hong Kong Monetary Authority. A non-resident fund would need to appoint an authorised local representative for liaising with the regulators.
The term “eligible carried interest” would be defined as a sum received by or accrued to a person by way of “profit-related return” subject to a hurdle rate (as provided in an agreement governing the operations of the fund) meeting the three conditions:
(a) the eligible carried interest must arise only if there are profits;
(b) the eligible carried interest paid would vary by reference to the profits; and
(c) the returns to external investors are also determined by reference to the same profits.
The tax concession would apply to eligible carried interest arising from transactions in shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a private company or an investee private company held by a special purpose entity (SPE) or an interposed SPE; or transactions in shares or comparable interests of an SPE which is solely holding and administering one or more investee private companies (Qualifying Transactions). Transactions incidental to the carrying out of QualifyingTransactions will also be eligible provided they do not exceed 5% of total trading receipts.
Eligible carried interest recipients
The FSTB’s paper proposes that the concessional tax rate will apply only to qualifying carried interest recipients in respect of “investment management services” provided in Hong Kong for the certified investment fund. Such services are proposed to include seeking funds; researching and advising on potential investments; acquiring, managing or disposing of property and investments; and assisting an entity in which the certified investment fund has made an investment to raise funds.
Under the framework, the following persons may be classified as qualifying carried interest recipients:
|(a)||a corporation licensed under the Securities and Futures Ordinance (SFO) or a financial institution authorised to conduct regulated activity (SFO licensed person<span>);< span=””></span>);<>|
|(b)||a non-SFO licensed person that provides investment management services in Hong Kong or arranges for such services to be carried out in Hong Kong for a “qualified investment fund” under the Unified Fund Exemption Regime; and|
|(c)||employees deriving assessable income from qualifying persons under (a) or (b) above by providing investment management services in Hong Kong to certified investment funds.|
In addition to the above, a qualifying carried interest recipient would also need to meet substantive activities requirements including employing not less than an average of two full-time employees in Hong Kong to carry out the investment management services, and operating expenditure incurred in Hong Kong for investment management services should be HK$2 million or more.
Re-domiciliation of overseas corporate funds Hong Kong
The Legislative Council’s Panel on Financial Affairs is scheduled to discuss an important development relating to Hong Kong’s open-ended fund companies and limited partnership funds. The re-domiciliation mechanism for foreign funds has been included in the panel’s February discussion agenda. The aim is for legislative proposals to be introduced to the Legislative Council in the second quarter of 2021.
In the consultation conclusions on proposed enhancements to the open-ended fund companies regime (Consultation Conclusions) issued by the Securities and Futures Commission (SFC), the SFC indicated that new provisions under the SFO to cater for re-domiciliation of existing overseas corporate funds to Hong Kong would be introduced, in a bid to promote and establish Hong Kong as an asset management hub in Asia.