Inland Revenue Ordinance (Cap. 112)
Tax Concessions for Carried Interest in Hong Kong
10 May 2021 | by LexisNexis Hong Kong
The Hong Kong SAR Government wishes to shape Hong Kong as a premier private equity (“PE”) fund hub. On 29 January 2021, the Government published the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Bill 2021 (the “Bill”) in the Gazette. The amendment of the Inland Revenue Ordinance (Cap. 112) (“IRO”) aims to provide tax concessions for carried interest distributed by eligible PE funds operating in Hong Kong. The Bill proposed that eligible carried interest be taxed at 0% for profits tax while 100% of eligible carried interest would be excluded from employment income for the purpose of salaries tax calculation.
If the Bill is passed by the Legislative Council, the tax concessionary treatment will take retrospective effect and apply to eligible carried interest received by or accrued to qualifying recipients on or after 1 April 2020.
Eligibility Criteria for Carried Interest
Eligible carried interest is defined as a sum received by or accrued to a person by way of profit-related return subject to a hurdle rate which is a preferred rate of return on investments in the fund. In order to benefit from the tax concession regime, there are key requirements to be met:
- Qualifying Carried Interest Payer
- Qualifying Carried Interest Recipients
- Qualifying Transactions of Certified Investment Funds
- Substantial Activities Requirements in Hong Kong
- The HKMA’s Certification and Ongoing Monitoring Mechanism
Qualifying Carried Interest Payer
The eligible carried interest should be distributed by a fund within the meaning of “fund” under section 20AM of the IRO. The fund must be certified by the Hong Kong Monetary Authority (“HKMA”). For non-resident fund, an authorised local representative must be appointed to provide the necessary particulars and information to the Inland Revenue Department and the HKMA on behalf of the fund.
The Government also proposed that the Innovation and Technology Venture Fund (“ITVF”) Corporation can be included as a qualifying carried interest payer and the return distributed by the ITVF Corporation will be eligible for tax concessions.
Qualifying Carried Interest Recipients
The Bill set forth the following qualifying person providing investment management services to a certified investment fund or ITVF Corporation in Hong Kong, or arranging the relevant services to be carried out in Hong Kong, should be eligible for the concessionary tax treatment:
- a corporation or an authorized financial institution licensed or registered under Part V of the Securities and Futures Ordinance (“SFO”) for carrying on a business in any regulated activity defined under Part 1 of Schedule 5 to the SFO;
- a person (not covered in i. above) providing investment management services or arranging such services to be carried out in Hong Kong to a certified investment fund that is a “qualified investment fund” or the ITVF Corporation; and
- an individual deriving assessable income from the employment with the qualifying persons in i. or ii. above or their associated corporation or associated partnership by providing investment management services in Hong Kong to the certified investment funds or the ITVF Corporation on behalf of the qualifying persons.
Qualifying Transactions of Certified Investment Funds
The concessionary tax treatment will be ringfenced to eligible carried interest arising from certain qualifying transactions in PE only, which are transactions:
- in shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by
- a private company under Schedule 16C to the IRO; or
- an investee private company held by a special purpose entity (“SPE”) or interposed SPE at (b); or
- in shares of, or comparable interests in a SPE or an interposed SPE that is solely holding (whether directly or indirectly) and administering one or more investee private companies; or
- incidental to the carrying out of the qualifying transactions above.
Substantial Activities Requirements in Hong Kong
The Bill proposed that two requirements must be satisfied for tax concessions. Qualifying carried interest recipients mentioned above must have, in the opinion of the Commissioner of Inland Revenue, adequate number of qualified full-time employees and operating expenditure incurred in Hong Kong for the relevant years of assessment, including:
- on average, at least 2 full-time qualified employees in Hong Kong carrying out the specified investment management services during the basis period for each year of assessment; and
- at least HK$2 million of operating expenditure incurred in Hong Kong for the provision of the specified investment management services during the basis period for each year of assessment.
The HKMA’s Certification and Ongoing Monitoring Mechanism
Funds must go through a certification process administered by the HKMA before concessionary tax treatment apply to eligible carried interest distributions. The HKMA would issue a letter of certification if it is satisfied that the relevant criteria are met.
Where there is a distribution of eligible carried interest in a year of assessment, an external auditor should be engaged to verify that:
- the relevant substantial activities requirements imposed on the carried interest recipients are fulfilled; and
- the distribution fulfills the specified conditions under the tax concessionary regime.
The auditor’s report should be kept at the fund’s local office or with the local authorised representative of a non-resident fund for inspection if needed. The qualifying carried interest recipients and certified investment fund should share the information to the Commissioner of Inland Revenue on the distribution of eligible carried interest and keep sufficient records.
Other than the proposed tax concession treatment for carried interest, the Bill also proposed the new unified fund exemption regime be amended with regards to the investment scope of the SPEs of an investment fund. The Bill permits SPEs to:
- hold and administer assets of a class specified in Schedule 16C to the IRO; and
- carry out transactions in such assets on behalf of the fund.
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