Carried Interest Income Tax exempted in HK
In April 2021, the Hong Kong Inland Revenue Department (IRD) passed the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Bill 2021. The legislation sets a 0% rate for eligible carried interest for individuals and employees that pay profits tax and salaries tax in Hong Kong.
Carried interest has previously been treated as a form of taxable income in Hong Kong because it was considered a fee for advisory and administrative services for locally domiciled funds, which is subject to Hong Kong profits tax. While this may apply to most hedge funds, carried interest from private equity funds is a form of capital gains allocation, and as such exempt from taxation, similar to returns generated in a Limited Partnership Fund.
Enacting legislation to allow tax concessions for carried interest is part of a broader initiative over the past several years to enhance Hong Kong’s competitiveness as a leading jurisdiction for funds. This includes the Limited Partnership Fund Ordinance, Unified Funds Exemption and streamlined regulations governing hedge funds.
The legislation retrospectively applies from April 1, 2020 onwards, and the following conditions should be satisfied:
- Tax Concession Basic Requirements:
- The Fund is locally domiciled in Hong Kong and certified by the Hong Kong Monetary Authority (“HKMA”)
- The fund should subscribe to private investments, including shares, stocks, bonds and notes issued by a company incorporated in Hong Kong or an overseas jurisdiction.
- Local substance requirement:
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- 2 or more full-time employees during the year
- Minimum operational expenditure of HK$2 million
- Application Process
The application process involves two levels of assessment after auditing the company’s statements preparing the documentation. Funds are initially certified by the HKMA, and then reviewed by the Inland Revenue Department (“IRD”).
Funds should be certified by the HKMA for every tax year for which an applicant claims a concession on carried interest., This requires an annual application in most cases. The application process involves submitting a completed form along with an auditor report and other required documentation. The deadlines are set for May 2nd, August 1th, and November 15th, depending on the reporting period for each year.
Upon submitting the application, the HKMA will take two months to review the documentation and officially certify the fund if it meets the requirements. The IRD will then be informed of the application result.
The IRD will further assess funds certified by the HKMA, in order to verify if they fall under the legal definition of a fund set forth in section 20AM of the Inland Revenue Ordinance, and review the specific carried interest on which the applicant claims tax concessions, in order to determine eligibility.
Eligible Carried Interest is defined as an amount paid to a person in the form of profit returns subject to a hurdle rate, which is the minimum required rate of return on an investment, to be set internally by the fund. There is currently no established benchmark for hurdle rates, and the rates should therefore be clearly set in the fund’s governance agreement.
Meeting the certification requirements does not guarantee the outcome of an application for tax concessions on carried interest. The IRD may further assess the local economic substance of each applicant on a discretionary basis depending on the circumstances.
In addition to meeting the employment and expenditure requirements, applicants for tax concession on eligible carried interest should ensure that their income is generated from providing specified investment services to certified funds in Hong Kong. Funds will be subject to ongoing monitoring even after submitting audited statements and receiving certification and approval from the HKMA and IRD. Therefore, all documentation (including the auditor’s report) should be kept on hand.
Hong Kong’s onshore fund environment is rapidly emerging as one of the world’s most competitive jurisdictions. As the trend away from offshore financial structuring continues to gain momentum, private equity funds will increasingly choose to domicile in leading financial hubs, where they can benefit from world class services and accelerate their pace of growth under an efficient tax regime.
Should you have any enquiries about claiming tax concessions or setting up or administering an equity fund in Hong Kong, we are always available for an initial consultation.
