Hong Kong Mulls Tax Rule Adjustments to Attract Private Credit Business

by Prasanna April 10, 2024 0 Comment

Hong Kong’s government is considering new tax rules that would give more favorable treatment to popular alternative investments including private credit and infrastructure, according to people familiar with the matter.

The suggestions, anticipated to be part of a consultation document, aim to grant tax exemptions on interest income to special purpose vehicles engaged in alternative investments such as private credit, hybrid securities, real estate, and infrastructure. Those familiar with the matter, speaking anonymously, revealed that the preliminary regulations could be released as soon as this month.

Hong Kong has traditionally been a popular spot for executives and staff of private equity and hedge funds, but it’s now facing competition from Dubai and Singapore. Despite the city rolling out fund rule reforms in recent years — including ones for carried-interest tax exemptions — the city is seeking to further increase its jurisdiction and legal infrastructure to lure more asset management businesses.

This matter has become even more pressing as Hong Kong faces economic headwinds and a lagging stock market, as well as growing geopolitical tensions between Beijing and Washington.

The race to lure alternative funds is also heating up. Assets under management in the sector are expected to grow 70% from 2021 to $23.3 trillion by 2027, according to estimates by Preqin.

In this year’s budget proposal, Hong Kong’s government revealed plans to bolster the favorable tax systems for funds, single family offices, and carried interest. This involves examining the range of tax benefits, expanding the categories of eligible transactions, and improving flexibility in managing ancillary transactions.

A spokesman for the Financial Services and the Treasury Bureau said that alongside regulators, it’s liaising with the industry to gauge their views about the budget plan proposals, and will consult them on specific enhancement proposals in due course.

Luring Business

The financial services sector is the backbone of Hong Kong’s economy, accounting for about 23% of gross domestic product in 2022. The asset management sector alone directly employs 54,000 people, according to a Financial Services Development Council report in March last year.

“Hong Kong cannot take its role as an asset management hub for granted,” according to a joint research report by KPMG and the Alternative Investment Management Association in November. “Hong Kong needs to take further steps to become a more attractive location of choice, including in the areas of tax and the overall regulatory environment.”

While most alternative asset managers are domiciled in offshore havens like the Cayman Islands, they often set up dozens if not hundreds of special purpose vehicles for specific investments. In Singapore, for example, such vehicles are often known as variable capital companies, a structure introduced in 2020. Almost 1,000 of such entities were incorporated or redomiciled in Singapore as of the end of 2022, according to research by HSBC Holdings Plc.

Singapore already has a broader scope for fund exemptions, meaning private credit funds can enjoy tax breaks on interest income.

“Singapore’s success in growing the sector is a good demonstration of how targeted incentives with clear conditions can be effective in attracting funds and the entire ecosystem,” the AIMA report said.

The report added that despite Hong Kong issuing rules for carried-interest exemptions, most fund managers haven’t been able to utilize the concession due to stricter requirements, such as the necessity for the fund to be certified by the city’s monetary authority.

Hong Kong’s tax exemption regime for funds is also self-assessed. That can create confusion over whether it applies to all or part of a fund’s investments. This uncertainty, which doesn’t exist in other jurisdictions, often means that managers in Hong Kong don’t explicitly rely on the exemption but continue to operate the fund under the “offshore” model.