Carried interest tax concessions set to strengthen Hong Kong SAR’s private equity industry
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Carried interest tax concessions set to strengthen Hong Kong SAR’s private equity industry

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Michael Wong, Darren Bowdern and Anthony Pak of KPMG China explain how regulatory developments in the private equity space will ensure that Hong Kong SAR remains a leading jurisdiction for offshore funds to establish their regional platforms.

After years of lobbying with the government of the Hong Kong Special Administration Region (Hong Kong SAR government) and the Hong Kong Inland Revenue Department (IRD), the tax concessions for carried interest are now effective, retrospectively, from April 1 2020. They provide for a 0% tax rate for qualifying carried interest, further to the passage of the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Bill 2021 (the Bill) in April 2021.

Carried interest was treated as a ‘fee’ and taxed in Hong Kong SAR

Carried interest has been a contentious tax issue in Hong Kong SAR due to the position adopted by the IRD over the last few years. The IRD’s position in Departmental Interpretation & Practice Note 51 is that carried interest can be attributed to the manager or advisor in Hong Kong SAR and treated as profits derived from management or advisory services in Hong Kong SAR, meaning that it falls within the tax net. This IRD view appears to have been influenced by the way in which hedge funds compensate their top personnel with performance fees, which at first glance bears similarities to the use of carried interest by other investment fund asset classes, but is in fact different.

For many hedge funds, performance-related remuneration is structured as a fee and taxed in the hands of the recipients in the same way as management fees. However, for most other investment fund asset classes such as private equity, real estate and infrastructure funds, carried interest represents a share of the underlying investment gains. It is distributed as an allocation from the fund, similar to the way in which investment returns are distributed to other limited partners. The investment returns to such limited partners are exempt from tax in Hong Kong SAR.

Hence, regardless of the type of fund, the IRD’s view is that carried interest should be treated as a fee and subject to tax in the hands of the manager or the advisor operating in Hong Kong SAR. In practice, the amount taxed by the IRD is determined based on a transfer pricing analysis to determine how much of the ‘fee’ relates to functions performed in Hong Kong SAR.

Hong Kong SAR as Asia’s leading asset management and private equity hub

In the 2020-21 Budget, the Financial Secretary of the Hong Kong SAR government acknowledged the importance of the private equity industry as a key driver of economic activity in Hong Kong SAR. The industry directly and indirectly employs a substantial number of people in Hong Kong SAR associated with investing for, as well as managing and servicing the private equity sector.

Given the importance of the private equity and broader asset management industry to Hong Kong SAR’s economic growth, the Hong Kong SAR government has undertaken a range of initiatives to help Hong Kong SAR maintain its status as Asia’s leading asset management and private equity hub. These initiatives have included:

  • The introduction of a new open-ended fund regime that allows hedge funds (among others) to domicile in Hong Kong SAR;

  • The introduction of an unified funds exemption (UFE) in early 2019 that ensures private equity funds managed from Hong Kong SAR are treated as exempt; and

  • In late 2020, the planned introduction of a Limited Partnership Fund Law (LPF law) that will enable fund sponsors to establish private equity and other funds in Hong Kong SAR.

To further enhance Hong Kong SAR’s attractiveness as a private equity hub and resolve the uncertainty on the taxation of carried interest, the Hong Kong SAR government introduced the tax concession regime for carried interest in early 2021. The Secretary for Financial Services and the Treasury, Christopher Hui, after the passage of the Bill said, “The tax concession regime for carried interest would attract more private equity funds to operate and be managed in Hong Kong SAR, thus boosting more investment management and related activities, which will bring business opportunities to various professional services and economic benefits to Hong Kong SAR.”

Overview of tax concession regime for qualified carried interest

The Bill confirms that eligible carried interest distributions are to be taxed at a 0% rate for qualifying persons who are subject to profits tax, and for qualifying employees subject to salaries tax.

Qualifying carried interest broadly includes carried interest received from gains from investments in private companies. With some exceptions, a gain on an investment in a public company or from any other non-private company investment should not qualify. The concession will therefore be restricted to private equity-type investments only.

The concession involves a number of conditions that need to be satisfied in order for the carried interest to qualify for the concession. These include being a qualified recipient, the need to comply with headcount and operating expenditure substance requirements, as well as the need for the fund be certified by the Hong Kong Monetary Authority (HKMA) and the IRD.

What distributions are eligible?

The concession applies to carried interest paid by funds that fall within the meaning of a ‘fund’ in the UFE. The 0% rate applies to distributions paid out of profits from transactions in shares, stocks, debentures, loan stocks, bonds or notes of, or issued by, a private company. It also covers transactions in shares or comparable interests in special purpose entities (SPEs) or inter-posed SPEs who directly or indirectly hold interests in private companies.

However, the Bill restricts eligible carried interest arising from gains from transactions in SPEs to the extent the SPE holds shares in a private company.

Carried interest distributions must be profit-related returns. On the face of it, they can be paid out of realised, or unrealised profits, provided that hurdle rates of return for limited partners are fulfilled in accordance with the fund’s constituent documents. However, the provisions do refer to a ‘minimum amount’ of carry distributions being subject to ‘significant risk’, otherwise the minimum amount will not be subject to concessional treatment. The Bill does not prescribe how to determine what risk is ‘significant’ or how to ascertain the ‘minimum amount’, although it would appear that the requirement aims at carving out profits comprising guaranteed returns from the tax concession.

Profits from transactions incidental to the carrying out qualifying transactions will also be eligible, provided they do not exceed 5% of total trading receipts. Qualifying transactions will, however, also need to meet the conditions for exemption from profits tax under the UFE.

Currently, the Bill applies to carried interest from investments in private companies, notwithstanding the fact that private equity funds invest in a broad range of investments, both public and private. However, in practice, we expect that the concessional treatment may apply to carried interest arising from exits in private companies by way of an initial public offering (IPO), or from ‘take private’ transactions in publicly listed companies that become private companies.

Who can receive eligible carried interest recipients?

The concessional tax rate will apply for carried interest paid for management services provided in Hong Kong SAR by:

  • Corporations licensed under Part V of the Securities and Futures Ordinance (SFO), or an authorised financial institution registered under Part V for carrying on business in any regulated activity as defined in Part 1 of Schedule 5 to the SFO;

  • Persons who are not so licensed but who provide advice to a ‘qualified investment fund; or

  • Individuals deriving assessable income from employment with (a) or (b) above or their associated corporation or partnership by providing investment services in Hong Kong SAR to the fund.

The types of investment management services that must be performed in Hong Kong SAR, include the following:

  • Raising capital for the fund;

  • Deal sourcing and advising on potential investments;

  • Executing tasks on acquiring, managing and disposing of property and investments; and

  • Assisting entities into which the fund has made investments.

Substantial activities requirements

The concession includes some substance conditions which most funds should easily satisfy. The IRD must be satisfied that the fund manager in Hong Kong SAR must have an adequate number of employees, including an average of two or more employees over each year, and average operating expenditure incurred in Hong Kong SAR of HK$2 million per annum (approximately US$257,000).

IRD involvement

The IRD will 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 will also be introduced to management fees, and disguised management fees, will not be eligible for the concessional rate.

It is hoped that the involvement of the HKMA in the certification process and the ability for the IRD to consult with the HKMA to ascertain whether particular investment management services are eligible, will alleviate any concerns the industry may have on the IRD challenging genuine carry arrangements.

Anti-avoidance provisions will also apply to nullify the tax benefits of arrangements which have as their main purpose, or one of the main purposes, recharacterising management fees as concessionally taxed carried interest payments. This test appears in line with the multi-lateral instrument ‘principle purpose test’, and is arguably a lower threshold than the general anti-avoidance provision section 61A of the Inland Revenue Ordinance.

Certification and verification

The fund will need to apply to the HKMA for certification, and the HKMA will 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 will need to be engaged to verify that the substantial activities requirement is met, and the conditions for the regime have been met.

Certification by the HKMA should bring integrity into the process and also bring Hong Kong SAR in line with the approach of the Monetary Authority of Singapore. It can be seen that the industry is embracing this requirement.

Expenses and losses

For qualifying carried interest recipients subject to profits tax (i.e. the fund management entities under Part V of the SFO), carried interest payments must first 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 will not be deductible against assessable management fee income earned by the fund manager. Further, any loss sustained will not be able to be carried forward for offset against future assessable profits.

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

Other matters

In addition to the proposed 0% tax rate, the Bill includes certain enhancements to the UFE regime which are unrelated to the taxation of carried interest. These are a positive development for the industry and have been sought for many years.

Going forward

Overall, the concessional tax treatment for carried interest distributions should be welcomed by the industry. Whilst acknowledging the HKMA’s need for a base level of information to satisfy itself that the fund will operate as intended under the concession, it is hoped that the level of detail required is not excessive. Otherwise this may cause many existing offshore funds to question whether it will be worth providing such information – particularly given that the IRD may have a greater involvement in the certification process that previously envisaged. Earlier consultation documents indicated that the HKMA would administer the concession and that the IRD would only consult with the HKMA to consider if investment management services are eligible.

If the HKMA can strike the right balance with satisfying itself that the concession will not be abused, and encourage the fund management industry to get on with utilising the various tax concessions, Hong Kong SAR should continue as a leading jurisdiction for offshore funds to establish their regional platforms.

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Michael Wong



KPMG China

T: + 86 10 8508 7085


Michael Wong is an M&A tax partner in the Beijing office, who is also the national leader of the deal advisory and M&A tax teams in KPMG China. This encompasses the national outbound tax practice serving state and privately-owned Chinese companies in relation to their outbound investments.

Michael has extensive experience leading global teams advising on large-scale overseas M&A transactions in the energy and power, mining, financial services, manufacturing, infrastructure and real estate sectors.

Michael graduated from the University of Auckland and is a fellow of the Hong Kong Institute of Certified Public Accountants and a member of CPA Australia.

Darren Bowdern



KPMG China

T: +852 2826 7166


Darren Bowdern is a partner in KPMG’s Hong Kong SAR tax practice. He has more than 25 years’ experience of serving institutions in a wide range of industries in Hong Kong SAR and the Asia-Pacific region.

Darren heads up the M&A tax practice in Hong Kong SAR. He has been advising on transactions in the Asia-Pacific region with respect to tax matters, including due diligence reviews, investment holding structures and advising on cross-border transactions. Many of these projects consist of tax effective regional planning including consideration of direct and indirect taxes, capital and stamp duties, withholding taxes and the effective use of double taxation agreements. He also has extensive experience in working with the mainland Chinese market, including structuring acquisitions of investments in mainland China. In addition, he advises on establishing direct investment, private equity and other investment funds in Hong Kong SAR and advises clients in a wide range of industries.

Darren graduated from the University of Melbourne and is a fellow of the Hong Kong Institute of Certified Public Accountants and a member of the Chartered Accountants Australia and New Zealand.

Anthony Pak



KPMG China

T: +852 2847 5088


Anthony Pak is an M&A tax partner in the Hong Kong SAR and Shenzhen, KPMG China offices, who has more than 20 years of experience in advising multinational and local clients on tax advisory and compliance matters. He has been specialised in M&A activity from a Chinese tax perspective since 2006.

Anthony has engaged in various buy-side and sell-side tax due diligence work across a wide range of industries, including real estate, machinery, manufacturing, trading and distribution, retail, and pharmaceuticals.

Anthony is a graduate of accounting from the City University of Hong Kong. Prior to joining KPMG, he worked for another Big Four accounting firm.

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