May 3, 2021
Global Financial City Hong Kong: Race to the Bottom
In Tokyo’s fight for relevance as a global financial center, it faces historical competition from Western hubs (New York, London), as well as the more recent strength of regional offshore financial centers (Singapore, Hong Kong), which have long offered lower tax rates and generous subsidiaries to attract financial services businesses. In fact, Hong Kong has just reached the bottom, namely a zero percent tax rate on qualified carried interest, retroactively applied, starting on April 1, 2020.
What is carried interest?
A private equity (PE) fund is a collective investment scheme with its underlying assets primarily consisting of equity securities of private companies that are not publicly traded on a stock exchange. PE funds (including venture capital funds) are gaining popularity amongst investors and have become a key impetus to the growth of the asset and wealth management business in recent years. PE funds play a pivotal role in directing capital, talents and expertise into corporations, in particular start-ups in the innovation and technology sector.
A PE fund typically receives as remuneration an annual management fee and a return linked to the performance of an investment (“carried interest”) — traditionally, this is referred to as “2 plus 20”, implying a 2 percent fee on assets under management (AUM) regardless of performance, and a 20 percent carried interest, although the fee schedule might differ based on the investment agreement.
Previously, any management fee and carried interest derived from investment management services rendered in Hong Kong were chargeable service income for profits tax or chargeable employment income for salaries tax (as the case may be).
Why did Hong Kong take these measures?
Like other global financial centers, Hong Kong wants to promote the development of the PE fund industry. However, the growth of Hong Kong’s PE fund industry was already deemed slower than competitors’, including Singapore, so it was necessary for Hong Kong to step up its efforts to enhance its competitive edge.
In addition to the tax measures, the Administration has passed legislative proposals to allow foreign funds to re-domicile to Hong Kong as Limited Partnership Funds (LPFs) or Open-ended Fund Companies (OFCs).
Hong Kong states that PE funds have many spill-over effects like strengthening its role as an international financial and innovation center. The development of PE fund industry would not only enhance the ecosystem and value chain of Hong Kong’s financial services sector but also increase the demand for various professional services including legal and accounting services. A study conducted by the Financial Services Development Council had estimated that one PE fund job could create up to three to six new jobs in related services industries, such as accounting, legal and financial services. Also, as additional management fees paid to fund managers would be taxed in Hong Kong, additional tax revenue would be generated.
Source: Legislative Council Paper No. CB(1)633/20–21(02)
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