Introduction
Hong Kong has long been recognized as a leading global financial hub, known for its robust infrastructure, strategic geographical location, and investor-friendly policies. However, as international tax standards evolve and competition from other financial centers intensifies, Hong Kong must continuously refine its tax policies to maintain its edge.
On 25 November 2024, the Financial Services and Treasury Bureau (FSTB) issued a consultation paper outlining significant enhancements to three key preferential tax regimes: the Unified Fund Exemption (UFE), the Family-Owned Investment Holding Vehicle (FIHV) tax concession, and the Carried Interest Tax Concession. These reforms aim to expand Hong Kong’s appeal to global investors, simplify compliance, and align with international standards such as those set by the OECD.
The consultation process was closed on 3 January 2025, and feedback from industry stakeholders will play a crucial role in shaping the final policies. This article provides an in-depth analysis of the proposed changes, their implications, and their strategic importance for Hong Kong's financial ecosystem.
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Carried Interest Tax Concession Regime
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The Carried Interest Tax Concession Regime offers a 0% tax rate on eligible carried interest, promoting Hong Kong as a hub for private equity and asset management. However, the existing framework’s limitations have prompted proposed reforms to broaden its scope and streamline compliance, as outlined in the 25 November 2024 consultation paper.
Expanded Scope of Eligible Income
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The proposed changes extend the scope of Schedule 16C assets, including private credit investments, and virtual assets. It also includes non-taxable offshore income and certain taxable income, such as interest from private credit investments. This ensures the regime caters to diverse fund strategies, from hedge funds to private credit.
Flexible Payment Flows
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The removal of the requirement for carried interest to pass through a “qualifying person” allows distributions via offshore structures or SPVs. This change aligns the regime with common industry practices, simplifying operations for fund managers.
Elimination of Hurdle Rate Requirement
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By removing the need for carried interest to meet a hurdle rate—a minimum return on investments—venture capital and startup-focused funds, which often lack such provisions, can also benefit from the regime.
Simplified Certification
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The proposal eliminates HKMA certification, which duplicates IRD oversight, reducing administrative burdens and compliance costs for fund managers while speeding up access to the concession.
These reforms modernize the regime by expanding income eligibility, introducing operational flexibility, and simplifying certification. By addressing industry needs, Hong Kong is poised to strengthen its position as a global financial hub. Stakeholders have until 3 January 2025 to provide feedback.
Enhancements to the Unified Fund Exemption Regime
The UFE regime has been a cornerstone of Hong Kong’s efforts to attract global funds. By offering tax exemptions for qualifying funds, it positions Hong Kong as a preferred destination for fund managers. However, as markets evolve, the regime must adapt to accommodate emerging trends and address stakeholder concerns.
Expanding the Definition of Funds
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Under the current framework, sovereign wealth funds are included in the definition of "fund," but pension funds and endowment funds are excluded. The proposed changes address this gap:
• Pension Funds: Defined as arrangements established to provide retirement benefits and regulated under jurisdiction-specific laws.
• Endowment Funds: Funds managed for charitable organizations to support philanthropic activities.
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The inclusion of these fund types will expand the scope of the UFE regime, attracting institutional investors who play a significant role in global asset management.
Addressing Activity Ambiguity
Fund managers often engage in activities such as buying and selling assets, which could be interpreted as disqualifying the fund from tax exemptions under the current rules. The consultation proposes codifying those transactions involving Schedule 16C assets, including stocks, bonds, and other financial instruments, do not disqualify a fund, provided the exemption conditions are met. This clarification eliminates a significant area of uncertainty for fund managers.
Broadening Qualifying Investments
One of the most transformative changes is the expansion of Schedule 16C assets which determine eligibility for profits tax exemptions under the Unified Fund Exemption (UFE) regime. The updated list will include:
• Virtual Assets: The consultation suggests incorporating virtual assets into Schedule 16C, using the definition under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance. This includes cryptocurrencies, security tokens, and stablecoins, while excluding digital representations tied to non-Schedule 16C assets. This update reflects the increasing adoption of digital assets among investors.
• Non-Corporate Private Entities: To address a gap in the current framework, the paper proposes extending tax exemptions to non-corporate private entities like partnerships. This change ensures tax neutrality for transactions in these commonly used structures for private equity and venture capital investments.
• Other Proposed Additions
The proposed expansion also includes:
1. Immovable Property Outside Hong Kong: Encourages investments in global real estate markets.
2. Emission Derivatives and Carbon Credits: Supports ESG-driven investments and aligns with sustainability goals.
3. Insurance-Linked Securities: Defined under Hong Kong’s Insurance Ordinance, these securities cater to alternative investment strategies
Removing the 5% Incidental Income Threshold
Currently, incidental income such as interest exceeding 5% of total income is fully taxable. The proposal to remove this threshold simplifies compliance, particularly for funds generating significant interest income, such as bond and credit funds.
Updates to the Family-Owned Investment Holding Vehicle (FIHV) Regime
The FIHV regime, introduced in 2022, is tailored to ultra-high-net-worth families managing wealth through single-family offices. The proposed enhancements align the FIHV framework with updates to the UFE regime while addressing the specific needs of family offices.
To encourage more resident investors to participate in tax-exempt UFR funds, the deeming provisions will be relaxed for certain categories of resident persons. Specifically, the following individuals and entities will be excluded from the application of the provisions:
• Natural persons who are resident individuals.
• Resident entities are interposed between an individual investor and the fund, subject to specified conditions.
• Resident funds that are exempt from tax under the UFR regime but are beneficial owners of a fund benefiting from the UFR.
• Resident persons who would have been exempt from tax if the Schedule 16C assets were directly held in the same manner as the fund.
This relaxation aligns with the Family-Owned Investment Holding Vehicle (FIHV) regime’s tax concession, simplifying compliance for resident investors
Inclusion of New Investment Categories
The updated list of Schedule 16C assets, including loans, private credit, and virtual assets, will also apply to the FIHV regime. This alignment ensures that family offices can access the same tax benefits as other institutional investors.
Expanded Activities for Special Purpose Entities
Special Purpose Entities (SPEs) are vital for managing family wealth. The proposed changes will allow SPEs to:
• Engage in activities such as financing investee private companies.
• Perform incidental tasks related to asset management.
Introducing the De Minimis Rule
To simplify compliance, the de minimis rule proposes full tax exemption for SPEs if at least 95% ownership is held by a tax-exempt fund. While this is a step forward, industry stakeholders have suggested lowering the threshold to accommodate co-investment structures involving multiple parties.
Reforming the Carried Interest Tax Concession
The carried interest tax concession regime offers a 0% tax rate on eligible carried interest. However, procedural complexities and restrictive definitions have limited its uptake. The proposed reforms address these issues comprehensively.
Expanded Activities for Special Purpose Entities
Under the current regime, only profits from private equity transactions qualify. The proposed changes broaden this to include:
• Profits from all Schedule 16C assets.
• Non-taxable offshore income.
• Certain taxable income, such as interest from private credit investments.
Greater Flexibility in Payment Flows
The requirement for carried interest to be distributed through a "qualifying person" has posed challenges for funds utilizing offshore structures. The consultation proposes removing this requirement, allowing distributions through more flexible arrangements.
Removal of the Hurdle Rate Requirement
The hurdle rate, defined as a preferred return on investments, is often absent in venture capital and startup funds. Eliminating this requirement makes the tax concession more accessible to a broader range of funds.
Simplifying Certification
Currently, certification by the Hong Kong Monetary Authority (HKMA) is required, adding a layer of bureaucracy. The proposal to remove this requirement reduces compliance costs and accelerates access to tax concessions.
Tax Reporting and Substantial Activities Requirements
To align with international standards, the consultation introduces reporting and activity thresholds for funds claiming UFE exemptions. These measures aim to enhance transparency and prevent tax abuse.
Annual Tax Reporting
Funds benefiting from UFE exemptions will be required to file annual profits tax returns with the Inland Revenue Department (IRD). This ensures accountability and aligns Hong Kong with jurisdictions implementing similar measures.
Substantial Activities Threshold
To qualify for tax benefits, funds must:
• Employ at least two qualified individuals in Hong Kong.
• Incur a minimum of HK$2 million in annual operating expenses.
While these thresholds align with OECD guidelines, smaller funds may find them challenging to meet.
Strategic Implications for Hong Kong
These reforms reflect Hong Kong’s commitment to remaining a leader in the global financial landscape. By expanding investment opportunities, simplifying compliance, and aligning with international standards, the city reinforces its status as a hub for asset and wealth management.
Key Benefits
1. Diversified Investment Opportunities: The inclusion of virtual assets, private credit, and carbon credits appeals to modern investors.
2. Simplified Compliance: Removing thresholds and certification requirements reduces administrative burdens.
3. Global Alignment: Meeting OECD standards enhances Hong Kong’s reputation as a transparent and fair jurisdiction.
Potential Challenges
1. Substantial Activities Requirements: Smaller funds may struggle to meet employment and expenditure thresholds.
2. De Minimis Rule: The 95% ownership threshold may limit co-investment flexibility, requiring further adjustments.
Conclusion
The proposed enhancements to Hong Kong’s tax regimes represent a forward-thinking approach to strengthening its financial ecosystem. By addressing industry feedback and aligning with global best practices, these reforms position Hong Kong as a leader in asset and wealth management.
Simulated Figures for Clarity
Figure 1: Expansion of Schedule 16C Assets
| Asset Class | Current Status | Proposed Status |
| Stocks and Bonds | Included | Included |
| Loans and Private Credit | Excluded | Included |
| Virtual Assets | Excluded | Included |
| Non-Corporate Entities | Excluded | Included |
| Carbon Credits | Excluded | Included |
Figure 2: Substantial Activities Requirements
| Requirement | Threshold |
| Qualified Employees | Minimum 2 |
| Operating Expenditure | HK$2 million/year |
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