Hong Kong fund industry updates: Carried interest tax concession regime and the OFC and REIT Grant Scheme

Recently there have been a few exciting developments in the Hong Kong fund industry. This client alert provides an update on the enactment of the carried interest tax concession regime for private equity funds, as well as subsidies to be granted to eligible open-ended fund companies (OFCs) and real estate investment trusts (REITs).

Carried interest tax concession regime

On 7 May 2021, the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Ordinance (Ordinance) came into operation, and introduced the much anticipated tax concession regime for carried interest distributed by eligible private equity funds operating in Hong Kong (the Carried Interest Tax Concession Regime) to their fund sponsors.

Under the Carried Interest Tax Concession Regime, eligible carried interest will be taxed at 0% profits tax rate and all of the eligible carried interest would also be excluded from the employment income for the calculation of the investment professional's salaries tax.

The Carried Interest Tax Concession Regime, coupled with the introduction of the limited partnership fund regime which came into force on 31 August 2020, aim to attract more private equity funds to operate and be managed in Hong Kong, while leveraging the unique advantages that Hong Kong has to offer.

For a more detailed discussion on the background, framework and implications of the Carried Interest Tax Concession Regime, please refer to our earlier publications (Proposal on Hong Kong's carried interest tax concession regime. We list out in the table below a summary of the key requirements under the Carried Interest Tax Concession Regime:

Subject	Key requirements
Eligible carried interest	A sum received by or accrued to a person by way of profit-related return subject to a hurdle rate which is a preferred rate of return on investments in the fund; and The Ordinance does not specify the ratio of the hurdle rate, therefore the hurdle rate can be determined as 0%.
Tax rate for eligible carried interest	"Eligible carried interest" will be taxed at a 0% profits tax rate; and All of the eligible carried interest would also be excluded from the employment income for the calculation of the investment professional's salaries tax.
Qualified fund/carried interest payer	The eligible carried interest should be distributed by a fund which fulfills the definition of "fund" under section 20AM of the Inland Revenue Ordinance (applies to private equity funds managed in Hong Kong or outside Hong Kong), and the fund must be certified by the Hong Kong Monetary Authority ("HKMA"); Certified affiliated corporations or joint ventures who are providing investment management services in Hong Kong; and ITVF Corporations
Qualifying transactions	The carried interest tax concession regime must occur from private equity transactions, specifically stocks, debentures, loan bonds, funds, bonds or notes issued by private companies.
Qualifying carried interest recipients	Only persons providing investment management service to a HKMA certified investment fund in Hong Kong or arranging such services to be carried out in Hong Kong are considered qualifying carried interest recipients; These recipients include SFC licensed corporations, unlicensed entities that provide investment management services to a "qualified investment fund" defined under the unified tax exemption for funds regime or the ITVF Corporation; and Persons employed by the foregoing entities or their affiliated corporations or joint ventures providing investment management services in Hong Kong.
Substantial activities in Hong Kong	Qualifying carried interest recipients must demonstrate they are undertaking core income generating activities in Hong Kong; Having two or more full-time employees in Hong Kong who carry out the investment management services; and The operating expenditure incurred in Hong Kong for the provision of the investment management services for each year of tax assessment shall be HK$2 million or more.

Subsidies available to eligible OFCs and REITs

Introduction

The Securities and Futures Commission (SFC) announced on 10 May 2021 the implementation of the Hong Kong Government's grant scheme to subsidise the setting up of OFCs and REITs in Hong Kong (Grant Scheme). The purpose of the Grant Scheme is to reinforce Hong Kong's role as a leading capital raising venue and its status as an international asset and wealth management centre by encouraging a broader range of investment vehicles.

Details of the Grant Scheme

Application period for OFC and REIT applicants

The Grant Scheme is valid for application for a period of three years, from 10 May 2021 to 9 May 2024. As the Government has allocated funding of HK$270 million to the Grant Scheme (as announced by the Financial Secretary in the 2021-22 Budget Speech), the Grant Scheme will operate on a first-come-first-served basis, meaning the application period may be curtailed when the initial funding is fully committed.

Although the Grant Scheme will operate on a first-come-first-served basis based on the submission time of the grant application, the SFC will only take up an application if the applicant has submitted all relevant documents that meet applicable requirements and has submitted the application within the relevant application deadline. Application documents may be returned by the SFC if they are not in good order.

Eligible applicants

Investment managers of OFCs: An Investment manager of an OFC, who has successfully incorporated the OFC or re-domiciled the non-Hong Kong fund corporation in Hong Kong as an OFC on or after 10 May 2021, may apply for a grant under the Grant Scheme on behalf of the OFC.
REIT managers: A REIT manager may apply for a grant under the Grant Scheme on behalf of a SFC-authorised REIT listed on the Stock Exchange of Hong Kong Limited (SEHK) on or after 10 May 2021 with a minimum market capitalisation of HK$1.5 billion (or equivalent) at the time of listing. For a REIT which is also listed outside Hong Kong, the minimum market capitalisation of its units listed on SEHK should be HK$1.5 billion (or equivalent) at the time of listing.

Grant amount

The grant amount will be equivalent to 70% of eligible expenses (see below for an explanation of eligible expenses) for each application, with the following conditions:

OFC: Subject to a cap of HK$1 million per OFC and a maximum of three OFCs per investment manager.
REIT: Subject to a cap of HK$8 million per REIT.

Eligible expenses

Eligible expenses must be expenses paid to Hong Kong-based service providers in relation to the incorporation of an OFC, re-domiciliation of a non-Hong Kong fund corporation to Hong Kong as an OFC or listing of a REIT on SEHK. Examples of eligible expenses include:

OFC

REITS

Fees charged by law firms or legal advisers for legal work in relation to the incorporation or re-domiciliation of an OFC, including (i) the drafting of legal documents and offering documents of the OFC and (ii) work done in relation to the authorisation of an OFC with the SFC.

Fees charged by auditors, accountants or tax advisors for accounting and/or tax services in relation to the incorporation or re-domiciliation of an OFC.

Fees charged by fund administrators, corporate service providers or company secretaries for incorporation or re-domiciliation services in relation to the set-up of an OFC, including work done for all filings necessary for the incorporation or re-domiciliation or registration of an OFC.

Fees charged by regulatory consultants for work done in relation to the incorporation or re-domiciliation of an OFC and the authorisation of an OFC with the SFC.

Listing agent fees in the case of listed OFCs.

Underwriting commissions charged by underwriters for the listing of a REIT.

Fees charged by law firms or legal advisors for legal work in relation to the listing of a REIT, including (i) the drafting of legal documents and offering circular of the REIT and (ii) work done in relation to the authorisation of a REIT with the SFC.

Fees charged by auditors, accountants or tax advisors for accounting and/or tax services in relation to the listing of a REIT.

Fees charged by the valuer of a REIT to produce valuation report on properties for the listing of a REIT.

Expenses paid to marketing agencies or consultants for advertisement and marketing related services for the listing of a REIT, including roadshow expenses.

Listing agent fees.

The following are not considered eligible expenses:

Statutory fees such as registration or application fees to the SFC and expenses incurred in relation to an application to the SFC for the licensing or registration of an investment manager.
Costs incurred in the establishment of a sub-fund under a pre-existing umbrella OFC and listing fees to the SEHK.
Audit fees paid to accounting firms in relation to the annual audit review.

Minimum operation condition

The Government reserves the right to claw back the grant if:

the OFC commences winding-up or applies for termination of registration within two years from the date of its incorporation or re-domiciliation; or
the REIT is delisted from SEHK or suspended from trading within two years of its listing date.

Whether a suspension of trading warrants a clawback of grant will be considered on a case-by-case basis. An example from the SFC's Frequently Asked Questions is that a temporary trading suspension of a REIT due to pending announcements will not generally give rise to a clawback of grant. On the other hand, a grant awarded may be clawed back if a REIT has been suspended from trading on SEHK for a continuous period of 18 months within 2 years of its listing date.

Application process and deadline

An applicant must submit the Grant Scheme application form together with the required supporting documents to the SFC within three months from (as applicable):

the date of the certificate of incorporation or re-domiciliation issued by the Companies Registry for private OFCs;
the authorisation date for public OFCs (the public OFC may submit to the SFC a duly signed and completed "Confirmation of Intention to Apply for a Grant" as part of its initial product application submission); or
the listing date of the REIT.

Conclusion

We believe the Grant Scheme provides much welcomed incentives for the asset and wealth management industry in Hong Kong. Along with the facilitative tax environment created by the Carried Interest Tax Concession Regime, we foresee market players which are exploring onshore options to view Hong Kong as an increasingly attractive place of domicile for funds.

For a more detailed discussion about the eligibility to take part in the Grant Scheme or other general enquiries on the Grant Scheme, 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".