New tax breaks a magnet for private equity funds

Many private equity fund managers are actively considering moving their bases to Hong Kong now that the city is offering tax breaks on their performance fee, says a lawyer who works with them.

In late April, the Legislative Council approved a bill that will cut the tax for carried interest to zero, which will be implemented later this year. The so-called carried interest is a share of the profits earned by PE or venture capital fund managers as compensation on investment gains.

Currently, it is subject to either profits tax at 16.5 percent or salaries tax of up to 17 percent in Hong Kong.

"It's a very pleasant surprise for industry players," said Daniel Tang, partner at international law firm Withersworldwide. Before the government revealed the tax concession plan, most people in the industry were thinking Hong Kong would cut the carried interest tax to 5 to 8 percent to match its rival Singapore, he said.

Hong Kong and Singapore have similar tax systems, but fund managers in Singapore are more aggressive in their tax planning and many don't actually pay tax for carried interest, they label the share of profit as investment return, he said.

"Hong Kong's regulators are unlikely to allow that to happen," Tang said. The Inland Revenue Department has been much more rigorous in screening contracts that are commonly used by local PE funds incorporated in tax havens like Cayman Island to pay for Hong Kong-based submanagers, he said.

The IRD introduced transfer pricing rules in 2018 to strike down cross-border tax avoidance under which it looks at the substance of the commercial transactions instead of the legal form.

The long-awaited tax exemption has removed uncertainties for investment managers, and the city now looks more attractive thanks to its more liquid stock market and its geographical proximity to the mainland, he said.

Tang saw many clients who were initially attracted by Singapore's incentives have now moved to Hong Kong. "After few years, they realized most of the incentives are one-off. But because of relative illiquidity on Singapore's stock market, they are worse off, they cannot take [advantage of] Hong Kong liquidity offered by a much broader investor base and much higher daily turnover."

The daily turnover of Hong Kong bourse was more than 15 times higher than that of Singapore's in May, according to official data. That makes it easier for PE funds to exit portfolio companies, he said.

The rise of China's new economy sector has drawn strong interest from PE funds. "We have been seeing deals that were once considered unthinkable," Tang said. For example, some China startups are now asking PE investors to sign a proxy to transfer all their voting rights to the founders. But in the past six months, at least two of Tang's clients told him to "just sign it," as long as the legal term doesn't inhibit their ability to make a good investment, he said.