Hedge fund tax break grips Hong Kong as banks fear exodus

Echo Wong, Eunice Xu, Bei Hu & Denise Wee / Bloomberg

Aug 18

The local government, eager to fend off competition from cities like Singapore and Dubai, has sent a sweeping new tax bill to lawmakers.(Aug 18): Hong Kong's move to cut taxes for hedge funds has set ...

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The most eye-catching part: a broad expansion of tax exemptions on so-called carried interest - a share of investment profits that can mean big bucks for star fund managers.\nThe bill is still making its way through Hong Kong's legislature but it has already set off a spree of lobbying, guessing games and old-fashioned gossip in the city's financial sector. Trading firms pushed to be included, before a hasty statement from the government appeared to brush them off. Family office managers are trying to figure out whether they qualify. Some small hedge funds are considering rewriting contracts to give even administrative staff a tax-free bonus, said a person familiar with the matter.\nThe fanfare that followed the proposal underscores how much is at stake as Hong Kong rewrites its tax rules for funds. But it also points to potential ripple effects in the city, where asset and wealth managers oversee about US$5.4 trillion ($6.9 trillion) of assets and the financial sector represents around a quarter of economic activity.\n\"There's definitely a lot of excitement and we've had a lot more requests for proposals to get licences in Hong Kong,\" said Gaven Cheong, a partner at law firm Charles Russell Speechlys. Fund managers from the Middle East, Greater China, and other parts of Asia and family offices from mainland China and Europe are among those who have asked him about setting up licensed entities and funds in Hong Kong in recent weeks, he said.\nThe move represents a challenge to Singapore and Dubai, both of which have made efforts to attract asset managers in recent years. Singapore mulled its own tax cuts for hedge funds and other asset managers following talks with the industry this year. Many fund managers are now waiting to see how the final rules look in both cities before making any major moves, said a tax consultant.\nThe Hong Kong bill contained broad proposals, including an expansion of the sort of investments funds can make at preferential tax rates, a more explicit treatment of special-purpose entities and a new reporting mechanism for some funds. But it was the tax exemption on carried interest - and the potential payday for lucky employees - that has drawn the most interest.\nBloomberg talked to more than a dozen tax consultants, lawyers and other industry experts about the buzz the proposal has generated across the city, and the plans already being put in place to make the most of the new rules.\nFunds scramble\nThe language of the tax bill, sent to the Legislative Council in June, was clear about its intention. The government wrote that it was \"committed to reinforcing our competitiveness as the prime asset and wealth management center in the region.\" Less clear was exactly who will benefit.\nCarried interest has for decades been used by private equity firms to give bumper payments to executives at the same time they share profits with outside investors. Even before the new tax bill, some private equity funds enjoyed a tax exemption on these payments.\nWhen Hong Kong announced plans this year to extend the tax relief beyond private equity, traders and investors across the city rushed to figure out if they would be included.\n\"When the rules first came out, my WhatsApps and emails were lighting up hot with people wanting to ask questions, understand more around the rules, and whether or not they could potentially qualify,\" said James Badenach, the Asia-Pacific head of Alvarez & Marsal Tax. \"That has continued.\"\nHedge fund managers appear to be the obvious target of the new legislation, which tax experts say will also include credit funds and venture capital. But carried interest in the traditional sense isn't nearly as common at hedge funds, which have more commonly paid an annual performance fee - a related concept but one which doesn't require managers to exit big investments to earn big bonuses.\n\nThe bill is still making its way through Hong Kong's legislature.\n\nThe bill is still making its way through Hong Kong's legislature.\nThe apparent broadening of the concept of carried interest to hedge funds' performance fees fueled the sense among other firms that they might be able to qualify for the tax break too, perhaps by restructuring how they book profits. \n\"It's pretty hard to draw a line right now,\" said Roy Phan, a tax partner at Deloitte. \"The market, including funds and family offices, is actively exploring structures to tap into the tax exemption.\"\nProprietary trading firms were also eager to be included, and had lobbied the government via industry bodies and accounting firms, according to a person familiar. But after a Financial Times (FT) article claimed Hong Kong was considering amending the tax bill to include these firms, the city's financial services and treasury bureau issued a swift response: Prop trading firms, it said, would not qualify.\n\"To qualify, carried interest has to be a genuine performancebased share of profits from managing thirdparty money, not a routine payout from the firm's own trading desk,\" said Rocky Tung, an executive director at the Financial Services Development Council, a government-funded advisory body.\nBankers had complained about unfairness following the FT report, said people familiar with the matter.\nThat sense of unfairness may extend beyond the financial industry, with other taxpayers asking why highly paid fund managers are getting an exemption on some of their tax obligations, said Kelvin Lam, a senior China economist at Pantheon Macroeconomics. \n\"If the tax breaks do not lead to a meaningful increase in funds setting up or expanding their operations in Hong Kong, then the indirect benefits to ordinary workers will naturally be much smaller,\" he said.\nPushing boundaries\nFirms across the city have started to examine how they pay their staff. In an extreme example, a small fund is considering calling its receptionist an investor relations official to ensure she can enjoy a tax-free bonus, said a tax adviser familiar with the matter. \nOthers are rethinking how they pay executives who don't manage money, such as chief financial officers or those running operations, the person said. The ambiguity over which employees could enjoy the tax exemption is likely to encourage some firms to game the rules, but experts said the spirit of the tax bill is clear.\n\"At the end of the day, the concession is aimed at investment professionals that are managing and making the investment decisions, raising capital, doing all the things around the fund itself,\" said Badenach at Alvarez & Marsal Tax. \"It's a stretch to try and push that beyond those investment professionals.\"\n\"Whilst the tea lady may perform a very important role in an organization, it would be difficult to argue that she's in fact an investment professional,\" he added.\nWhether the carried interest exemption applies to single-family offices that manage the wealth of one family - or whether it is relevant at all - depends partly on how those businesses are structured and operated, said Willa Chan, the founding principal of Hong Kong law firm Willa Legal. \nSome of these businesses rely on licensing exemptions and are not licensed by the Securities and Futures Commission, which may make it structurally more difficult for them to qualify, she said.\nMost multi-family offices in Hong Kong should be able to qualify for the exemption, although they will need to meet certain conditions, said Chan.\nBank exodus \nThe new rules also risk creating tensions within the city's investment banks. Firms like Goldman Sachs Group Inc, JPMorgan Chase & Co and Morgan Stanley collectively have thousands of staff in Hong Kong, where they have prop trading desks and asset management arms alongside their other businesses.\nTax experts think it's clear the exemption will apply to these asset management units - since they pass the key rubric, managing outside capital - but those on banks' prop trading desks may be left out. That is likely to ruffle feathers in an industry where bankers jealously eye each other's bonus packages.\nSome banks are worried that their prop traders will now have more incentive to move to the buyside, said people familiar with the matter. That will exacerbate the pressure they're under from the rise of giant pod shops in Asia, which are already tapping banks for talent.\n\"For a successful bank trader with a portable track record, moving to a fund was already financially attractive; the tax treatment could make that decision considerably easier,\" said Loretta Chan, a co-head of global banking and markets at Wellesley Partners, a headhunter. \"Banks may find themselves having to work much harder to retain their strongest risk-takers.\"\nMillennium Management recently hired former investment banker Thomas de Garidel to become its Asia co-chief executive officer alongside Julia Raiskin. The move means the multistrategy firm will have two former bank executives - from UBS Group AG and Citigroup Inc, respectively - as its bosses in the region.\nThe tax exemption may also prompt lawyers to take in-house jobs at funds since it would effectively give them a salary bump, said one of the people.\nThe end result looks set to be a boon to headhunters and tax advisers, as white-collar workers eye new jobs and a raft of overseas firms become increasingly tempted by Hong Kong.\n\"We are seeing firms around the world, including in the Middle East, explore establishing or expanding a Hong Kong presence,\" said Kher Sheng Lee, a co-head of Asia Pacific at the Alternative Investment Management Association. \"It is not just managers. The same questions are coming from the brokers and advisers around them. That breadth of interest tells its own story.\"\nUploaded by Tham Yek Lee","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":false,"editions":null,"column":"","sentiment":"-1","news_tag":"","news_rank":0,"isVideo":false,"video":null,"symbols":[],"gpt_button":0,"need_auth":false,"need_login_tip":false,"code":"91000000","status":"200"}}}