Oversight - Proposed Hong Kong Tax Concession for Carried Interest

The asset management industry is widely seen as key to Hong Kong's growth as a financial center for Asia. In recent years, the Hong Kong Government has accordingly undertaken a number of initiatives to help Hong Kong develop as a leading asset management hub. These initiatives have included the introduction of:

• a unified tax exemption for funds (Unified Fund Exemption) under the Inland Revenue Ordinance (IRO), effective 1 April 2019, that ensures that funds domiciled in or managed from Hong Kong are treated in the same way as offshore funds and are therefore generally exempt from Hong Kong profits tax in the same way; and
• a Limited Partnership Fund (LPF) vehicle under the Limited Partnership Fund Ordinance (LPF Ordinance), effective 31 August 2020, that will enable fund sponsors to establish funds in Hong Kong which are substantively similar to exempted limited partnerships registered in the Cayman Islands.

The LPF Ordinance and the availability of LPFs as an option for fund establishment is clearly aimed at the private equity (PE) industry. However, notwithstanding the Hong Kong Government's best efforts to promote the PE fund industry, the continuing uncertainty surrounding the treatment of carried interest distributions (Carried Interest) for the purposes of taxation has arguably limited Hong Kong's attractiveness as a PE hub.

A Carried Interest refers to the general partner's (GP's), investment manager's or investment adviser's share of the profits of a fund. The profits are usually calculated after the principal amount and a small interest (in percentage terms) on such principal amount (such interest is also commonly known as "preferred return" or "hurdle rate") is returned to each limited partner (LP) investor. In accordance with the PE market practice, the rate of such Carried Interest is usually 20% of the net profits. The main point of Carried Interest is to align the interest of the GP, investment manager or investment adviser with that of the LP investors.

After months of anticipation following the Financial Secretary's budget speech in February 2020, the Hong Kong Government released its proposals to provide a tax concession for Carried Interest on 7 August 2020 (Paper). This Oversight considers the tax concession proposals in respect of Carried Interest set out in the Paper.