Podcast

Carried interest: The latest tax developments in key Asian jurisdictions

05 May 2021

In this episode, IQ-EQ’s Jimmy Leong chats to Teo Wee Hwee, Tax Partner and Head of Real Estate & Asset Management at KPMG in Singapore. Together they discuss the taxation of carried interest, a hot topic for GPs and key factor in determining the attractiveness of a location for alternative investment managers. 

Asian investment hubs understand the importance of this aspect; for instance, Singapore offers a special rate on fund managers’ performance fees and Hong Kong has recently issued a proposal to provide a tax concession for carried interest distributed in respect of private equity transactions. 

Wee Hwee has practised tax for over 23 years and has extensive experience in structuring single country and multi-jurisdictional funds with an Asian focus. He has expertise in fund formations and is familiar with fund platforms in Singapore, Luxembourg, Cayman Islands and Labuan among others, as well as tax efficient divestment planning opportunities for funds with multiple exit strategies. He is also an expert in structuring carried interest from both a corporate and personal tax perspective.

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Transcript

Spoken content

Jimmy Leong: 0:05 

 Welcome to the IQ-EQ Podcast: The Alternative Series. I am Jimmy Leong, Chief Commercial Officer, Asia, and I’m your host for today. 

I am pleased to welcome our very special guest today, Mr Teo Wee Hwee, who is a Tax Partner, and Head of Real Estate & Asset Management at KPMG in Singapore. 

Wee Hwee has practised tax for over 23 years, and he has extensive experience in structuring single country and multi-jurisdictional funds with an Asian focus. He has expertise in fund formations and is also familiar with fund platforms in Singapore, Luxembourg, Cayman Islands, Labuan, among others, as well as tax efficient divestment planning opportunities for funds with multiple exit strategies. He is also an expert in structuring carried interest from both a corporate and personal tax perspective which will be our topic for today.

The taxation of carried interest is a key factor in determining the attractiveness of location for alternative investment managers. Asian investment hubs understand the importance of this key factor, for instance Singapore offers a special rate on fund managers’ performance fees and Hong Kong has also recently issued a proposal to provide a tax concession for carried interest distributed in respect of private equity transactions. Wee Hwee will help us to shed some light on this key topic for GPs. 

So, let’s get started. Hi Wee Hwee, thank you for joining us today. The first question I have for you today is around the Financial Sector Incentive Scheme in Singapore. Can you share with us the key features of the Singapore Financial Sector Incentive Scheme for Fund Management (FSI-FM), and could you also share your insights into the Singapore tax concession on carried interest, as an example of a very successful tax incentive regime that has been put in place for a while now. So possibly something that Hong Kong could draw lessons from.

Teo Wee Hwee: 2:11

Sure, thanks Jimmy. I would say that there are a few key features of the FSI-FM incentive, to start with first on the current prevailing tax rate in Singapore is at 17%. The main benefit of this incentive is that it helps to bring down the corporate tax rate from 17% to 10%. So, for a fund management company set up in Singapore and in terms of any qualifying income that they receive, it will be taxed at a reduced rate at 10%. To qualify for this incentive, there are basically two main conditions that you need to meet in order to be eligible for the application. First you must have an asset management of at least 250 million in terms of Singapore dollars, and you need to have at least three investment professionals. If you meet these two conditions, then you are eligible to contact MAS to request for them to send you an application form to apply for this incentive. As part of the application process, you need to complete the form and you need to also provide a business projection or financial projection to the MAS. In terms of the approval criteria, what they do mainly look at is whether you are committed to increase your head counts in terms of investment professionals. So, if you start with three, probably they will be looking at you increasing by at least two within a period of three years. Now this incentive is granted for below 10 or 5 years after which you will have to renew it. So, these are really the key features of the FSI-FM. 

In terms of Singapore tax concessions for carried interest, I would say the closest that we have is really the FSI-FM but unfortunately the FSI-FM, unlike the Hong Kong tax concession, it only applies to the fund management companies. It does not apply to employees of the fund management company, and unlike the Hong Kong version which allows you to be exempted from tax on the carried interest, this only provides for a concession of 10% rather than exemption under the Hong Kong law. 

Having said that, in practice a lot of our clients, they actually structure the carried interest in the form of a special return or special dividend or special partnership interest and a lot of time this is not subjected to tax under Singapore law if you were to take a certain position.

Jimmy Leong: 5:07

I see. Okay. I know you cannot touch on this briefly, you know. So, if we take a deeper dive into each jurisdiction, so what are the main differences between the current tax incentive regime in place in Singapore for carried interest, you mentioned that briefly, vs the recent Hong Kong proposal other than what you have mentioned earlier? Are there main differences that we should be aware of?

Teo Wee Hwee: 5:36 

Actually no. The main difference really as I have enunciated is 0 vs 10% and that the concession only applies to the fund management company but not its employees. 

Jimmy Leong: 5:49 

Understood. You know, that is very useful. Perhaps, my other question is, apart from private equity funds, are there any other fund structures that are eligible for tax concessions that’s being proposed on carried interest in Hong Kong, for example, close-ended, other open-ended funds or hedge funds? I think also the audience is also very interested. I’ve been asked this question a few times as well, and would love to hear from you as an expert.

Teo Wee Hwee: 6:22

Well, in principle the tax concessions apply to all private equity funds subject to meeting the relevant conditions. It doesn’t really matter whether the fund is open-ended or close-ended, although in practice as we’re all aware, most private equity funds invest in private equity rather than real estate and infrastructure. They tend to be close-ended in nature in Asia, but to answer your question it does not matter, it should not matter in principle, whether they’re close-ended or open-ended. 

Now in terms of the types of funds and specifically in terms of the asset classes that the funds invest in, at the moment, the tax concession only applies to private equity, so it is kind of limited in that sense. So, it therefore does not apply to hedge funds because the tax concession is drafted in such a way that the carried interest has to be paid out of unlisted shares, except for private equity funds that exit by an IPO. So, for hedge funds, they invest predominantly in listed stocks and bonds. So, unfortunately, for whatever strange reason, the tax concession does not cover hedge funds. 

For real estate funds, it’s a grey area. I think we can take a position that real estate funds should be covered, but actually it also depends on the specific structure that is used by the real estate fund and the divestment strategy. So, for instance, if the fund were to invest in real estate and they don’t use shares or companies to hold real estate but they use a trust instead, then trust is not exactly a qualifying investment so to speak for the purpose of the carried interest concession, or if the divestment is via a sale of the property itself, then again, because real estate, immovable property is not a qualifying investment in a sense for the tax concession, there are some grey areas as to whether in such situations the carried interest would qualify for the tax concession. 

Jimmy Leong: 8:53

That is very useful, thanks Wee Hwee. Could you also tell us about the main conditions of use, advantages and benefits of the proposed tax concessions that fund managers need to be aware of?

Teo Wee Hwee: 9:08 

There are a few conditions that need to be met. So, for instance, that’s what we call the substantial activities requirements. So, for instance the fund manager in Hong Kong must have an average of two or more employees each year, and the average operating expenditure incurred in Hong Kong, you know, should be at least, I’d say, Hong Kong 2 million dollars per annum. So, these are the key activity requirements that need to be met. From an administrative and procedural perspective, the fund would need to apply to the Hong Kong Monetary Authority for certification on whether the investments and local subsidiary requirements are to be met. And in the year in which the eligible carried interest distributions are made, external auditors will need to be engaged to verify that substantial activities requirements are met. So, these are really the key conditions from both technical and practical perspective. 

Jimmy Leong: 10:21

So, on conditions, what are the conditions applicable to the carry recipient in order to be able to avail themselves of the proposed tax concessions? 

Teo Wee Hwee: 10:33 

So, the carry recipient in this case would include individuals as well as the fund management companies. For the fund management companies, the main condition is that they need to be licensed by the Hong Kong Monetary Authority or it has to be an authorised financial institution. If the carry recipient is an individual, then they also must be employees of either the licensed financial company or the authorised financial institution. 

What’s important to note is that whether it’s a company or the individual, they must be providing investment matching services or arranging sub services to be carried out in Hong Kong to what we call a validated fund which is a qualified investment fund defined under the Hong Kong Income Tax Act. What this means for fund management companies that have chosen not to be licensed, they may need to be licensed in order to qualify for this concession.

In the case of individuals who are the carry recipients, it also raises a question as to those who are providing middle and back-office function. They are not exactly providing investment management services. Would they also qualify for this carried interest concession? I think if you read the legislation literally, they probably don’t qualify. So, I think those are the things that Hong Kong tax authorities need to look at to see how they can fine tune their rules, so that it is more applicable to a wider group of people.

Jimmy Leong: 12:23

Okay. So, perhaps on a very broader level, what are some of the other measures that you are aware of that have actually been put in place by Hong Kong to increase the attractiveness of that jurisdiction, particularly for private equity funds and operations?

Teo Wee Hwee: 12:42

There are probably a lot more that the Hong Kong Monetary Authority is trying to do behind the scenes, but as far as I’m aware, the main measure I think they have put in place quite recently is to introduce subsidies for anybody who wants to set up a Hong Kong fund vehicle, so it could be an open-ended investment company structure in Hong Kong, it could be the recently announced and implemented Hong Kong limited partnership. The Hong Kong government actually provides subsidies in terms of the setting up cost which is pretty generous. That, I view, is quite an important measure that they are putting to make Hong Kong more attractive as a fund domicile.

Jimmy Leong: 13:26 

That’s great. Wee Hwee, on behalf of IQ-EQ, thank you for joining us today and a very big thank you for sharing with us your valuable insights and experience. Thank you. 

Teo Wee Hwee: 13:40

You are most welcome Jimmy and thank you very much for inviting me as well.

Jimmy Leong: 13:45

Thank you.