Hong Kong Legislative Council has on 9 July 2020 passed the new legislation which introduced the Hong Kong limited partnership fund (LPF) structure, making available a new Hong Kong domiciled fund type for alternative investment funds, in particular private equity funds which are typically structured as limited partnerships.
With effect from 31 August 2020, the LPF structure may be established pursuant to the new Hong Kong Limited Partnership Fund Ordinance (LPFO). Application may be made to the Hong Kong Registrar of Companies to establish the LPF subject to the applicable requirements under the LPFO, identifying the proposed address, place of business and investment scope, the proposed general partner and proposed investment manager, as well as a proposed “Responsible Person”, which must be an authorised institution, licensed corporation, accounting person or legal professional, with responsibility to carry out anti-money laundering/counter-terrorist financing functions for the LPF. The application to register an LPF must be submitted on behalf of the fund by a registered Hong Kong law firm or a solicitor in Hong Kong admitted to practise Hong Kong law. The LPF will be registered if the Registrar of Companies is satisfied the application contains the necessary documents and information and the requisite application fee is paid.
As the LPF is not a separate legal person, the general partner of the LPF exercises authority and acts on behalf of the LPF. The general partner has ultimate responsibility for the management and control of the LPF and has unlimited liability for all the debts and obligations of the LPF, whereas if an authorised representative has been appointed by the general partner, the general partner and the authorised representative are jointly and severally liable and share ultimate responsibility for the LPF. A limited partner has the benefit of limited liability under the LPF, and is not liable for debts and obligations of the LPF beyond the amount of the limited partner’s agreed contribution, but this is provided the limited partner does not take part in the management of the fund. The LPFO specifically outlines certain activities or conduct that a limited partner may engage in that will not be regarded as taking part in the management of the fund, such as involving decisions around actual or potential conflict of interest, although those activities are not intended to be exhaustive circumstances through the exercise of which a limited partner may not be regarded as taking part in the management of the fund.
Licensing Requirements
Notably, unlike the Hong Kong open-ended fund company structure, the LPF is not subject to prior approval or (direct) regulation by the Securities & Futures Commission (SFC), Hong Kong’s primary regulatory body for the securities and futures market. The LPF must have a general partner and an investment manager that meet the respective requirements, as well as a proposed “Responsible Person” as noted above. The investment manager must be a Hong Kong resident over the age of 18 years, a Hong Kong company or a non-Hong Kong company registered with the Hong Kong Companies Registry, whereas the general partner may be one of those categories of persons, or, notably, may be a domestic or foreign limited partnership. Where the general partner is a domestic or foreign limited partnership, the LPF must have an authorised representative that is a Hong Kong resident who is at least 18 years old, a Hong Kong company or a registered non-Hong Kong company. There is also the requirement that an independent auditor be appointed to audit the financial statements of the LPF annually.
The conduct of business in regulated activities relating to securities and futures market is subject to potential licensing requirements by the SFC under the Hong Kong Securities & Futures Ordinance (SFO). In January 2020, the SFC issued a Circular to stamp out previous doubts as to the applicability of licensing requirements to private equity fund managers, noting it will consider the composition of the investment portfolio, which may trigger licensing requirements if the underlying specific purpose vehicles or underlying investments of the private equity fund under management fall within the definition of “securities”.
Where a person or entity deals in, advises on or manages a portfolio of “private equity” or “venture capital”, depending on whether the portfolio involves securities (the definition of which excludes shares or debentures of a company that is a private company within the meaning of section 11 of the Companies Ordinance), there may be potential licensing requirement. In cases where the general partner, the manager or the adviser of the LPF conducts business in Hong Kong and deals in, advises on or manages shares or debentures of private offshore companies that fall outside the definition of a “private company” under the Companies Ordinance, it is likely that the firm in question will be required to be licensed, unless any relevant exemption applies.
It should also be noted that persons engaged in the business of offering an LPF in Hong Kong may be required to be licensed by the SFC to carry on the Type 1 regulated activity of dealing in securities, unless any relevant exemption applies. Hong Kong managers licensed by the SFC to conduct Type 9 regulated activity of asset management may rely on an exemption to market its fund as being incidental to its conduct of asset management business.
Favourable Tax Framework
Hong Kong managers are not restricted under any local requirements to form or establish Hong Kong-domiciled investment funds, and the SFO does not differentiate between local funds or offshore funds in the conduct of regulated activities of licensed persons or offers of securities. It has been common for Hong Kong managers to establish private equity funds in the form of limited partnership funds in offshore jurisdictions such as the Cayman Islands, considered to be favourable from tax perspectives in a flexible regime.
As of 1 April 2019, Hong Kong has a new profits tax exemption regime for investment funds, regardless of the location of central management and control, their structure, size or investment objectives, to enjoy tax exemption for transactions in specified assets subject to meeting certain conditions. A fund may enjoy the tax exemption in connection with its investment in both overseas and local private companies. The said profits tax exemption requires that qualifying transactions for the tax exemption are carried out through or arranged by a “specified person”, meaning a corporation licensed or registered for carrying out specified regulated activity under the SFO and which would include Hong Kong licensed managers. Hence, since April 2019 the new profits tax exemption provides a more favourable and attractive tax framework for private equity funds to be established or managed in Hong Kong.
Another key issue is the tax treatment on performance fees or carried interest from the LPF and also the remuneration of fund executives, which may become subject to Hong Kong profits tax or salaries tax. The Hong Kong Inland Revenue Department (IRD) has in the past reiterated that funds operating in Hong Kong should ensure that true arm’s length fees are paid to the Hong Kong manager and/or advisor for the risks and functions performed. Furthermore, the IRD noted that any performance fee or carried interest arrangement would be closely examined by the IRD if it considers that the Hong Kong investment manager or advisor is not adequately remunerated for its level of services, after considering the functions, assets and risks attributable to the operations in Hong Kong, and that general anti-avoidance provisions may be applied if the distributions received are not genuine investment returns.
However, with the LPF structure available from 31 August 2020, Hong Kong is looking at introducing tax concessions for carried interest for private equity funds that operate in Hong Kong, the details of which are to be further issued. The industry anticipates that there would be tax concessions for carried interest of private equity fund managers to further encourage private equity fund operators to establish Hong Kong domiciled LPFs and to operate in Hong Kong.
We welcome the introduction and availability of the Hong Kong LPF to offer an additional structuring choice to sponsors and managers of private equity funds, which would enhance Hong Kong’s position as an asset management centre in private equity funds and investments, further developing Hong Kong’s dynamic fund management industry.
For further information regarding the set up of a Hong Kong limited partnership fund structure which can be established from 31 August 2020, and related licensing or tax considerations for private equity funds, please contact Vivien Teu, Managing Partner (Email: vivien.teu@vteu.co), Sarah He, Associate (Email: sarah.he@vteu.co) or any lawyer who is your usual contact at our firm.
