Hong Kong has long been established as a hub for Private Equity (PE) Funds in Asia. The number of PE firms in Hong Kong has increased by more than 30% in the last 5 years and there is considerable inbound and outbound investment activity with Mainland China.
Until recently, firms typically domiciled their funds in established jurisdictions, such as the Cayman Islands, as Hong Kong lacked legislation facilitating the set up and administration of PE Funds in particular. In response to this, the Hong Kong Legislative Council passed the Limited Partnership Fund Bill in July. With effect from 31 August 2020, funds can be set up as limited partnerships under the Limited Partnership Fund Ordinance, bringing Hong Kong on par with the traditional fund jurisdictions.
The new legislation is quite attractive to the PE Funds industry as existing structures available in Hong Kong do not lend themselves to PE Funds, where flexibility is of great importance. This has been addressed in the legislation. Limited Partnership Agreements will enjoy full contractual freedom, including the lifecycle of the fund and dissolution. Limited Partners will also be able to withdraw their investment from capital and enjoy greater privacy than under the current regime.
Every Limited Partnership Fund is comprised of a General Partner (GP), Limited Partners (LP), an Investment Manager and a Responsible Officer. It does not have a separate legal entity. Generally, PE funds are set up with connected entities serving as both GP and the initial LPs until external investors enter the fund. Under the new legislation, these investors must gain entry into the fund within the first 2 years of establishment.
The GP has overall responsibility for the fund and assumes liability for all debts and obligations of the fund. This individual is responsible for ensuring compliance with all legal requirements under the law (including appointment of the Investment Manager and Responsible Person) and bears ultimate responsibility for the management and control of the fund.
The scope of who can be a GP is very wide - it includes adults aged 18 years and older, and local / foreign registered companies as well as other limited partnership funds and non-Hong Kong limited partnerships without a legal personality. Where the GP does not have a legal personality (i.e. the GP is another limited partnership fund or a non-Hong Kong limited partnership that does not have a legal personality), the GP must appoint an Authorised Representative. The Authorised Representative must be a Hong Kong resident aged 18 and older, a Hong Kong company, or a registered non-Hong Kong company.
The GP is responsible for appointing an Investment Manager who oversees the day to day investment activities of the fund. The Investment manager can be a Hong Kong company, a registered non-Hong Kong company or a Hong Kong resident aged 18 or above. Notably, the General Partner can act as Investment Manager – in effect, this means that the fund does not need to appoint an external Investment Manager, such as a licensed corporation.
The Investment Manager need not be licensed unless the activities carried out are licensed activities as specified by the Securities and Futures Ordinance.
Limited Partners (LP) have the right to enjoy the profits of the fund. Their limited liability for the fund means they are not responsible for the fund’s debts and obligations. Equally, LPs generally do not manage or control the fund’s assets. If they do, they risk losing their limited liability and become responsible for the debt. However, under the new legislation there are extensive safe harbour provisions that allow the LPs to exercise some influence over the assets without losing their limited liability status. For example, serving on a board or discussing transactions of the fund with the GP, Investment Manager or others will not interfere with their position as LP. The safe harbour provisions set the Hong Kong regime apart from the established jurisdictions as they allow the LPs considerable powers.
While the particulars of the GP, Investment Manager and Authorised Representative (where applicable) will be publicly available, the particulars of the LPs will remain confidential, ensuring adequate privacy for investors.
The GP must appoint an authorised institution, a licensed corporation, an accounting or legal professional to act as Responsible Person (RP) of the fund. The RP is responsible for ensuring the fund complies with the provisions set out in the Anti-Money Laundering and Counter Terrorist Financing Ordinance.
Limited Partnership Agreement (LPA)
The funds enjoy complete contractual freedom when it comes to the LPA, including investment strategy, life of the fund and dissolution mechanisms. This enables the partners to tailor their agreement to the fund objectives. This is a major advantage compared to the existing Limited Partnership regime, which does not allow for simple dissolution of the partnership.
All in all, set-up and administration requirements of the new HK funds will be simpler and less costly than similar vehicles in established fund jurisdictions.
Existing profits tax exemptions for funds which meet the conditions set out in section 20AM of Hong Kong’s Inland Revenue Ordinance will apply to the new Limited Partnership Funds;, there will be no separate provisions. The existing exemption is likely to apply to most funds set up under the new legislation, though careful tax planning will ensure that the conditions set out under the Inland Revenue Ordinance are met.
While Hong Kong has comprehensive double taxation agreements, in practice it is often difficult and time-consuming to fulfil the conditions set out by the various jurisdictions. As such, adequate tax planning should be conducted to avoid unpleasant surprises during tax season. The double taxation agreements with Mainland China and India are especially interesting, since considerable inward and outward investment is routed through Hong Kong.
In early August 2020, the Inland Revenue Department further announced its plans to overhaul its treatment of Carried Interest (Carry). While the details of the proposed legislation are not yet available, it is clear that there is a view to provide certain tax concessions on Carry, further increasing Hong Kong’s attractiveness to the industry.
Offshore jurisdictions such as the Cayman Islands have recently introduced legislation addressing some of the international pressure to address Base Erosion and Profit Shifting. While it is too early to tell what the impact on the funds industry will be, investors may prefer to domicile their funds outside of offshore jurisdictions.
Hong Kong is not only one of the biggest hubs for Private Equity Funds, but also a popular jurisdiction for IPOs, which remain a common exit strategy for PE funds. The ability to keep a fund’s domicile, management and exit in one jurisdiction removes regulatory barriers and reduces paperwork, making for a more streamlined experience.
Limited Partnerships are a welcome addition to the existing options available. With more regulations facilitating the business landscape in both Hong Kong and Singapore, the region is becoming a more competitive option.
Equiom has a global network of trusted advisors who can assist businesses looking for alternative structuring options and cross-border solutions.
For further information on this topic please contact Berrin Oenguen.
This article has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The article cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Equiom to discuss these matters in the context of your particular circumstance. Equiom Group, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it.