Guidelines Released: Certification of Funds for Carried Interest Tax Concession

The introduction of the carried interest tax concession regime under the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Ordinance 2021 was a significant milestone for the asset and wealth management industry in Hong Kong*. Such regime provides for profits tax and salaries tax concessions in relation to eligible carried interest received by, or accrued to, qualifying persons and qualifying employees on or after 1 April 2020 from their provision of investment management services to “certified investment funds”. For a recap of the details of the carried interest tax concession regime, please refer to our earlier publications Proposal on Hong Kong's carried interest tax concession regime and Hong Kong fund industry updates: Carried interest tax concession regime and the OFC and REIT Grant Scheme. 

In light of the regime and after months of anticipation, the Hong Kong Monetary Authority (“HKMA”) has issued relevant guidelines including the Guideline on Certification of Funds under Schedule 16D to the Inland Revenue Ordinance (Cap.112)^[1] (“Guideline on Certification of Funds”) on 16 July 2021 and the Guideline on Auditor’s Report for Application for Certification of Funds – for Funds and their Investment Managers^[2] (“Auditor’s Report Guidelines”) on 31 August 2022 to assist funds in applying for carried interest tax concessions. These guidelines provide a much more simplified process as compared to the original proposals in the consultation papers.

This client alert summarises the key requirements under the Guideline on Certification of Funds and Auditor's Report Guidelines (together, the “Guidelines”).

Guideline on Certification of Funds

A “Certified Investment Fund” as defined under schedule 16D to the Inland Revenue Ordinance (Cap. 112) (“IRO”) means a fund within the meaning of section 20AM of the IRO that is certified by the HKMA to be in compliance with the certification criteria as set out by the HKMA. In this regard, the HKMA has published the Guideline on Certification of Funds which sets out its criteria for certification of funds and other relevant matters – the two main criteria are as follows: 

• Investments: The fund has invested in the following classes of assets during the period beginning on the day when the qualifying person begins to carry out investment management services for a fund and ending on the day when the eligible carried interest is received by, or accrued to, that qualifying person (“Applicable Period”):
  • shares, stocks, debentures, loan stocks, funds, bonds or notes (“Specified Securities”) of, or issued by, either a private company or an investee private company; or
  • shares of, or comparable interests in, a special purpose entity or an interposed special purpose entity that holds and administers one or more investee private companies and no other assets of a class specified under schedule 16C to the IRO.
• Minimum Activity Requirements: The qualifying person has satisfied the following requirements during the basis period for each year of assessment falling within the Applicable Period:
  • having an average number of at least two full-time qualified employees in Hong Kong who carry out investment management services; and 
  • having a total amount of operating expenditure of HK$2 million or more incurred in Hong Kong for the provision of investment management services.

In addition, a qualifying person has to satisfy the “adequacy test” conducted by the Commissioner of the Inland Revenue Department (“IRD”) in relation to the abovementioned “Minimum Activity Requirements” in order to be eligible for tax concessions. It is also worth noting that apart from the HKMA’s certification, the IRD will also assess whether the certified fund falls within the meaning of “fund” under section 20AM of the IRO in processing the claim for tax concessions, along with its consideration of all other relevant provisions under the IRO.

In terms of the application process, a fund is required to apply for certification from the HKMA for each relevant year of assessment to enjoy the tax concession benefits. The application for certification may be submitted after eligible carried interest has been received by, or accrued to, a qualifying person for a particular year of assessment. The application should be made on or before the applicable deadline which is determined based on the qualifying person’s accounting year-end date as follows:

Pre-application screening is also available for a fund to apply for the purpose of assessing whether it would meet the certification criteria. Such screening is optional and will not affect the outcome of the certification application.

Auditor's Report Guidelines

To apply for certification, a fund must submit a completed certification application form and an auditor’s report (“Auditor’s Report”) to the HKMA. As part of the process, the fund or its investment manager is required to engage a certified public accountant (practising) (“Practitioner”) to prepare the Auditor’s Report in accordance with the Hong Kong Standard on Related Services 4400 (Revised) Agreed-Upon Procedures Engagements.^[4]

It is important to note that the responsible party of the fund or the investment manager (such as the director and company secretary of the fund if the fund is a company; and the general partner if the fund is a partnership) (“Responsible Party”) is responsible for providing true and accurate information and documents to assist the Practitioner in preparing the Auditor’s Report. To assist the HKMA in determining whether a fund has met the abovementioned criteria on “Investments” (under the Guideline on Certification of Funds), the Responsible Party must:

• select any one acquisition of Specified Securities which has been disposed;
• provide to the Practitioner the relevant information and/or documents in relation to the selected Specified Securities, for example:
  • the executed sale and purchase agreement in respect of the acquisition and disposal of the Specified Securities;
  • ownership structures diagrams showing information such as the description of the Specified Securities, acquisition date and the percentage of the fund’s participation interests or equity interests in the issuer of the Specified Securities; and
  • specific information (such as principal activity, place of incorporation and entity type) in respect of each entity under the ownership structure diagrams; and
• (for each special purpose entity, interposed special purpose entity and issuer of the Specified Securities under the ownership structure diagrams) provide documents such as a copy of the audited financial statements (for the financial year in which carried interest was declared) and a copy of the certificate of incorporation (including Form NAR1 for a company incorporated in Hong Kong) or a written representation (for an entity not incorporated in Hong Kong) to demonstrate the entity’s principal activity and that it is a private company.

Whilst the documents (other than the ownership structure diagrams) provided to the Practitioner are not required to be provided to the HKMA when submitting the Auditor’s Report, the HKMA may also request any further information or materials as it deems fit. 

Looking Forward

The Guidelines have signified the Hong Kong government’s continuing effort in promoting the exciting tax incentive under the carried interest tax concession regime.  Funds and investment managers are encouraged to take advantage of this streamlined certification process in considering Hong Kong as the jurisdiction of domicile for investment funds. We are confident that there will be further measures introduced in the future to enhance Hong Kong’s competitiveness and promote Hong Kong’s status as a leading regional and global asset management centre for private equity funds.

For a more detailed discussion about how your funds business may benefit from the carried interest tax concession regime or for any assistance required in setting up or expanding your funds business, please do not hesitate to contact us.

*Any reference to “Hong Kong” or “Hong Kong SAR” shall be construed as a reference to "Hong Kong Special Administrative Region of the People's Republic of China".

References 

[1] For a full copy of the Guideline on Certification of Funds under Schedule 16D to the Inland Revenue Ordinance (Cap.112), please refer to: https://www.hkma.gov.hk/media/eng/doc/key-functions/Guideline_on_Certification_of_Funds_under_Schedule_16D_to_the_Inland_Revenue_Ordinance.pdf

[2] For a full copy of the Guideline on Auditor’s Report for Application for Certification of Funds – for Funds and their Investment Managers, please refer to: https://www.hkma.gov.hk/media/eng/doc/key-functions/Guideline_on_Auditors_Report_for_Application_for_Certification_of_Funds_for_Funds_and%20the_Investment_Managers.pdf

[3] In the event the prescribed deadline is a Saturday, Sunday or a public holiday, such deadline will automatically be extended to the next business day.

[4] For a full copy of the Hong Kong Standard on Related Services 4400 (Revised) Agreed-Upon Procedures Engagements, please refer to: https://www.hkicpa.org.hk/en/Standards-and-regulation/Standards/Members-Handbook-and-Due-Process/HandBook/Volume-III--Auditing-and-Assurance-Standards/Revised-HKSRS-4400-Engagements-to-Perform-Agreed-Upon-Procedures