Hong Kong carried interest tax implications for private equity

Oct 11, 2021
Private equity International tax Global services

In recent years, private equity (PE) funds are gaining popularity amongst investors and have become a key impetus to the growth of asset and wealth management business. PE funds play a pivotal role in channeling capital, talents and expertise into corporations, especially pre-initial public offering (IPO) companies and unicorns. Management fees and carried interest are commonly structured as a distribution to fund executives through limited partnership arrangements, and the related tax treatment is one of the major considerations dominating the selection of jurisdiction for fund domiciliation and day-to-day management.

Hong Kong

Current tax treatment

Under the Hong Kong Inland Revenue Department’s (IRD) prevailing practice, if a fund executive provides services in Hong Kong, management fees and carried interest from the limited partnership would be chargeable to salaries and taxed as employment income or profits tax as service income if the distributions are not genuine investment returns. The IRD will apply the general anti-avoidance provisions to counteract any tax benefits obtained and will charge fees derived from the provision of management services in Hong Kong.

The Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Bill 2021

On Jan. 29, 2021, the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Bill 2021 (TCCI) was published in the Gazette. The Hong Kong Legislative Council passed TCCI into law on April 28, 2021. TCCI provides tax concessions for carried interest distributed by eligible PE funds operating in Hong Kong. Under TCCI, qualifying carried interest recipients are eligible for zero percent profits tax rate on net eligible carried interest after deducting any relevant depreciation and outgoing expenses. Remuneration for related employees paid out of the eligible carried interest received by a qualifying recipient is excluded from the salaries tax calculation at a rate of one hundred percent.

TCCI applies retrospectively to eligible carried interest amounts received or accrued by qualifying recipients on or after April 1, 2020.

The eligibility criteria for the tax concession are outlined below:

Qualifying transactions

The concessionary tax treatments are confined to eligible carried interest arising from profits on investments, on particular investments, or on a disposal of investments that are earned from qualifying transactions in relation to PE funds only. This includes the following:

  1. Shares, stocks, debentures, loan stocks, funds, bonds, or notes of, or issued by, a private company specified under Schedule 16C to the Inland Revenue Ordinance (IRO).
  2. Shares or comparable interests of a special purpose entity (SPE) or interposed SPE that only holds and administers one or more investee private companies.
  3. Shares, stocks, debentures, loan stocks, funds, bonds, or notes of, or issued by an investee private company held by an SPE or an interposed SPE from item 2 above.
  4. Transactions incidental to the carrying out of the above qualifying transactions, subject to a 5% threshold.

The profits arising from the above in-scope transactions should meet all the relevant tax exemption conditions under the Unified Tax Exemption (UTE) for the Funds Regime in the IRO before the carried interest is eligible for the tax benefits.

Subject to the facts and circumstances, certain hedging transactions forming part of the PE transaction and the relevant profits that are embedded in the profit or loss on the PE transaction for the calculation of eligible carried interest may also qualify.

Qualifying carried interest

TCCI defines “eligible carried interest” as a sum received by, or accrued to, a person by way of a profit-related return1 subject to a hurdle rate which is a preferred rate of return on investments in the fund which is stipulated in the agreement governing the operation of the fund.

Qualifying carried interest payer

Qualifying carried interest payer includes certified investment funds and the Innovation and Technology Venture Fund Corporation (ITVFC). A certified investment fund is a fund that falls within the definition of ‘fund’ under IRO section 20AM and certified by the Hong Kong Monetary Authority. For a non-resident fund, an authorized local representative must also be appointed.

Qualifying carried interest recipient

Qualifying carried interest recipient includes the following persons who provide investment management services (e.g., fundraising, research and advising on potential investments, and acquiring, managing or disposing of property or investments). The carried interest must be paid by a qualifying carried interest payer in Hong Kong or must arrange for the relevant services to be carried out in Hong Kong:

  1. A corporation or an authorized financial institution licensed/registered under the Securities and Futures Ordinance; and
  2. A person (including a natural person, corporation, partnership, trustee, whether incorporated or unincorporated, or body of persons), other than (1) above, carrying out investment management services, or arranging such services to be carried out in Hong Kong, for a certified investment fund which is a “qualified investment fund” defined under the UTE regime or ITVFC.

For each year of assessment for the period from the date when the qualifying carried interest recipient begins to perform investment management services to the date when the carried interest is received or accrued, it is subject to the following substantial activities requirements:

Substantial activities requirements


Average number of full-time qualified employees in Hong Kong who carry out the investment managements services

Not less than 2

Annual operating expenditure incurred in Hong Kong for the provision of investment management services

Not less than HK $2 million

Qualifying employee

An employee will qualify for the benefit if the employee is employed by a qualifying carried interest recipient (or any associated entities that carry on a business in Hong Kong) by providing investment management services in Hong Kong to a qualifying carried interest payer on behalf of the qualifying carried interest recipient. The salaries tax concession will only apply to the extent that the amount received by the employee is paid out of eligible carried interest that is exempt from profits tax under the concession.

Other points to note

  • TCCI includes a specific a ‘main purpose’ provision. This provision states that profits derived by a qualifying carried interest recipient would not be eligible for the tax benefit if the main purpose, or one of the main purposes, of the person entering into the arrangement is to obtain a tax benefit.
  • In the year of the carried interest distribution, the entity will need to engage an external auditor to verify ·       that the relevant substantial activities requirements are met and that the distribution fulfills the specified conditions under the concessionary tax regime.
  • A qualifying carried interest recipient is required to provide information to the IRD relating to any eligible carried interest that it received, and details regarding any employees who received eligible carried interest.
  • The qualifying carried interest payer must keep sufficient records for seven years in order to enable a complete and accurate understanding of accruals and carried interest payments.


Hong Kong is a viable domicile for PE funds given its active initial public offering market for PE-backed companies and its proximity to mainland China, which offers a stream of deal flow. Amid the economic slowdown from the global pandemic, the Hong Kong government has increased efforts to boost the city’s role as a leading PE hub in Asia. The introduction of the new UTE Regime and the concessionary tax treatment on carried interest provides significant contractual flexibility, simplified procedures and preferential tax treatments to the industry. It should attract more PE funds to operate in Hong Kong, thereby generating a greater demand for investment management and other related professional services (including financial, legal, and accounting services). TCCI will help foster Hong Kong’s position as Asia’s premier fund hub for PE.

The United States

Prior to the Tax Cuts and Jobs Act (TCJA) of 2017 (effective for calendar year 2018 and forward), carried interest was treated in the same manner as any other allocation of income from a partnership (or other entity treated as a partnership for US tax purposes, including many LLCs). Therefore, if a PE fund recognizes long-term capital gains, or qualified dividends (both tax-favored items) with respect to an investment and allocates those to the manager (or an affiliate) in respect of its carried interest, the manager would receive the same tax treatment as the investors. This proved controversial, and many proposals to alter this treatment were introduced over the years. The TCJA introduced a new provision, which modifies the required holding period to recognize long-term capital gains attributable to carried interests to three years, from one year. Note that this does not affect all tax-favored PE exits; qualified dividends remain unaffected, as well as certain gains recognized on sales of business assets (section 1231 gains). Although many PE investments are held for greater than three years, add-on investments to existing portfolio companies can cause a portion of an otherwise longer-term investment to have a partially shortened holding period. Planning strategies exist which may mitigate the impact of this new holding period provision. Looking forward, various proposals from leading Democrats (who currently control both Congress and the Presidency) would further limit the availability of carried interest to attract tax-favored characteristics. One proposal would re-characterize any capital gains, qualified dividends, or section 1231 gains attributable to carried interests as ordinary income. Another, more recent proposal would treat the holder of a carried interest as receiving an implied loan from the limited partners and charge the carry holder with imputed interest income on an annual basis, based on a relatively high deemed rate, along with a simultaneous equal capital loss. Capital losses can generally only offset other capital gains (plus $3,000, to an individual), and are otherwise carried forward.

RSM continues to monitor these developments and will publish additional thought leadership if one or more proposals nears enactment. Unlike Hong Kong which is expanding preferential tax treatment of carried interest to encourage PE funds to conduct business in Hong Kong, the United States has proposed several more restrictive tax legislations. However, despite these taxpayer unfriendly provisions, the U.S. will continue to hold a lion’s share of PE funds investment.

A sum is a profit-related return if it fulfils all of the following conditions:

  • The sum arises only if there are profits for a period on the investments, or on particular investments or from a disposal of investment(s);
  • The sum paid would vary with reference to the profits; and
  • The return to external investors is also determined with reference to those profits.



RSM contributors

  • Ayana Martinez
  • Ben Wasmuth
    Senior Manager