Hong Kong: Proposal for tax treatment of carried interest includes 0% tax rate

Hong Kong: Tax treatment of carried interest

A discussion paper on a proposed concessional tax treatment of carried interest for funds includes a 0% tax rate for eligible carried interest” distributions.


Draft legislation for the proposed measures is expected to be introduced in January 2021, and if the bill is passed, this concessionary tax treatment could apply to eligible carried interest received by or accrued to qualifying carried interest recipients on or after 1 April 2020.

KPMG observation

This private equity-related development would further expand on the incentives provided under the fund tax exemption provisions (unified fund exemption rules) for private equity and other alternative funds.  

Eligible distributions

The tax framework would apply to carried interest paid by a fund that is subject to the definition a “fund” in the unified fund exemption rules. The fund would also need to apply to the Hong Kong Monetary Authority to certify that the 0% tax rate could apply to future carry distributions.   

The 0% rate would apply to distributions paid out of profits from transactions in shares, stocks, debentures, loan stocks, bonds or notes of, or issued by, a private company; or transactions in shares or comparable interests in special purpose entities or inter-posed special purpose entities that directly or indirectly hold interests in private companies.  

Profits from transactions incidental to the conducting qualifying transactions would also be eligible, provided they do not exceed 5% of total trading receipts.  Qualifying transactions would, however, need to meet the conditions for exemption from profits tax under the unified fund exemption rules.

The proposed tax concession for carried interest could apply to a broad range of alternative funds, including private equity, real estate, infrastructure, and private credit and debt funds. Currently, the proposed framework would only apply to carried interests from investments in private companies, notwithstanding the fact that permanent establishment funds invest in a broad range of investments, both public and private. 

KPMG observation

Tax professionals expect that the concessional carried interest treatment could apply to carried interest arising from exits in private companies by way of IPO, or from “take private” transactions in publicly listed companies that become private companies.

Eligible carried interest recipients

The proposal provides that the concessional tax rate would apply on carried interest paid for management services provided in Hong Kong by:

  • Corporations licensed under Part V of the Securities and Futures Ordinance, or an authorized financial institution registered under Part V for carrying on business in any regulated activity as defined in Part 1 of Schedule 5 to the Securities and Futures Ordinance
  • Persons who are not so licensed but who provide advice to a “qualified investment fund”
  • Individuals deriving assessable income from employment with either of the above or their associated corporations or partnerships by providing investment services in Hong Kong to the fund

The types of investment management services that would have to be performed in Hong Kong include:

  • Raising capital for the fund
  • Deal sourcing and advising on potential investments
  • Executing on acquiring, managing and disposing of property and investments
  • Assisting entities into which the fund has made investments

KPMG observation

By allowing carried interest payments to be paid directly or indirectly to Hong Kong fund managers and employees who may not be part of the structure, fund groups might be able to simplify their carried interest structures. Nevertheless, eligible carried interest payments would need to be correctly pooled and traceable so they can be properly identified in the hands of eligible recipients.

Substantial activities requirements

The concession includes some substance conditions that it seems most funds would easily satisfy. The Inland Revenue Department would need to be satisfied that the fund manager in Hong Kong has an adequate number of employees, including an average of two or more employees over each year, and average operating expenditure incurred in Hong Kong of HK$2 million per annum.

Hurdle rate

Eligible carried interest distributions would only be able to be made after the preferred return to limited partners has been made in accordance with the rate prescribed in the agreement governing the operation of the fund.

IRD involvement

The Inland Revenue Department (IRD) would still retain the right to deny the tax concession if it considers that main purpose, or one of the main purposes, of a person entering an arrangement is to obtain a tax benefit.  Specific provisions would also be introduced to management fees, and disguised management fees would not be eligible for the concessional rate.

KPMG observation

Historically, the IRD has taken an overly restrictive interpretation on the fund tax-exemption provisions, and has taken a broad approach to taxing carried interest arrangements and ignoring the technical basis for non-taxability of carried interest distributions.  

Certification and verification

The fund would need to apply to the Hong Kong Monetary Authority for certification, and the Hong Kong Monetary Authority would then need to certify whether investments and local substance requirements are likely to be met. Further, in the year eligible carried interest distributions are made, an external auditor would need to be engaged to verify that the substantial activities requirement is met, and the conditions for the regime have been met.

KPMG observation

Certification by the Hong Kong Monetary Authority could possibly bring integrity into the process and also bring Hong Kong in line with the approach of the Monetary Authority of Singapore.  

Expenses and losses

For qualifying carried interest recipients subject to profits tax (i.e., the fund management entities under Part V of the Securities and Futures Ordinance), carried interest payments would first need be netted off against outgoings and expenses and depreciation to arrive at the net carried interest eligible for the concession. This means that such expenditure would not be deductible against assessable management fee income earned by the fund manager. Further, any loss sustained would not be able to be carried forward for offset against future assessable profits.

KPMG observation

It remains to be seen whether expenditure incurred by the fund manager could be apportioned between eligible carried interests (resulting in non-deductible expenditure) and non-eligible carried interests (resulting in deductible expenditure).

Other matters

In addition to the proposed 0% tax rate, the discussion paper proposes broader enhancements to the unified fund exemption rules regime which are unrelated to the taxation of carried interest.  Currently under the unified fund exemption rules, special purpose entities are only permitted to hold and administer eligible shares in investee private companies, but not other financial assets. Thus, the fund itself is required to hold other investments that are available under the unified fund exemption rules in order to avail of exemption from profits tax. In particular:

  • The special purpose entity would be able to hold and administer assets of any class under Schedule 16C of the Inland Revenue Ordinance
  • The special purpose entity would be permitted to carry out transactions in such assets on behalf of the fund

For more information, contact KPMG’s Global Head of International Tax:

Rodney Lawrence | +1 (312) 665 5137 | rlawrence@kpmg.com

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