Hong Kong’s Inland Revenue Department (IRD) has issued a new Interpretation and Practice Note No. 51 on the extension of the profits tax exemption for offshore funds to include offshore private equity funds.
Under a legislative amendment to Hong Kong’s tax code, which was promulgated in July last year, a profits tax exemption was extended to transactions conducted by offshore private equity funds in respect of their investment in eligible overseas private companies.
Most private equity funds are structured as limited partnerships. A private equity fund is regarded as a non-resident person if the central management and control of the limited partnership is exercised outside Hong Kong. However, that the general partner resides in Hong Kong does not necessarily lead to the conclusion that the central management and control of a private equity fund is located in Hong Kong. The residence of the private equity fund is the place where management and control is exercised by the general partner, although its actual business operations may take place elsewhere.
To prevent abuse by local companies by simply converting their taxable profits to non-taxable income via an offshore fund structure, an eligible fund portfolio company should be an overseas incorporated private company, and it must not hold any Hong Kong properties or carry out any business in Hong Kong.
Moreover, the existing deeming provisions, which provide that a resident person holding a beneficial interest of 30 percent or more in a tax-exempt private equity fund will be deemed to have derived assessable profits in respect of profits earned by the fund in Hong Kong, will equally apply to offshore private equity funds.
It is expected that, due to the tax exemption, more offshore private equity fund managers will set up or expand their business in Hong Kong due to the change, thereby generating more demand, for example, for local asset management and investment and advisory services.
The IRD has also issued a revised Interpretation and Practice Note No. 43, which adds guidance on the profits tax exemption for offshore private equity funds to the previous explanations regarding the offshore fund tax break.