Global Private Equity Newsletter – Winter 2016 Edition: Hong Kong Profits Tax Exemption for Private Equity Funds

The Inland Revenue (Amendment) (No.2) Ordinance 2015 (the “Amendment Ordinance”) came into effect on July 17, 2015, extending Hong Kong profits tax exemption to offshore private equity (“PE”) funds.

Profits Tax Exemption prior to the Amendment Ordinance

This is a welcome development for the private equity industry since, in the past, profits tax exemption for offshore funds was only available:

• to non-resident funds (whose central management and control was outside Hong Kong);
• in respect of “specified transactions” and “transactions incidental to the carrying out of specified transactions” (narrowly, only in respect of securities, futures contracts, foreign exchange contracts, foreign currencies and exchange-traded commodities transactions and deposit-making); and
• if carried through or arranged by “specified persons” (essentially, persons licensed or registered by the Securities and Futures Commission of Hong Kong).

This exemption was not optimal for most offshore PE funds unless they used the services of “specified persons” in respect of “specified transactions.”

The Amendment Ordinance – Extension of Profits Tax Exemption

The Amendment Ordinance has revised the definition of “securities” to include securities in an eligible private company (i.e. portfolio company) incorporated outside Hong Kong which, in the 3 years preceding a transaction in securities in the portfolio company, did not carry on any business in Hong Kong or hold any immoveable property in Hong Kong (or any equity or interest in a private company holding immoveable property in Hong Kong where the value of such holding exceeds 10% of the company’s own assets).

Qualifying Offshore Private Equity Funds

The Amendment Ordinance added a new provision allowing offshore PE funds to be eligible for the profits tax exemption if:

• at all times after the final closing of the sale of their interests, the fund had at least 5 investors whose aggregate capital commitments exceeded 90% of the aggregate capital commitments made to the fund; and
• the portion of the net proceeds to be received by the originator (together with its associates (if any)), did not exceed 30% of the net proceeds arising out of the transactions of the fund.

Special Purpose Vehicles (“SPV”)

SPVs incorporated in Hong Kong and abroad which are wholly or partially owned by an offshore fund are exempted from payment of tax for SPVs in respect of their profits derived from a transaction in securities in an interposed SPV or an eligible offshore portfolio company.

Implications for the PE Industry in Hong Kong

The industry is hopeful that these changes will allow for greater flexibility for certain private equity fund management activities to be carried out in Hong Kong without the burden of possible tax liabilities. It is part of Hong Kong’s efforts to facilitate the development of the private equity sector and to strengthen Hong Kong’s position as a premier international asset management center.