Barely a week after Hong Kong announced plans in mid-August for a broader – and more straightforward – zero tax regime for carried interest, Singapore confirmed it would follow suit. Failure to do so would risk a brain drain, according to industry participants.

“We expected them to do something to protect their base. I know of fund managers who are transferring teams to Hong Kong because they’ve got no choice; employees want to benefit from the incentive,” said Darren Bowdern, a partner in KPMG’s Hong Kong tax practice. “If managers don’t let them move, they could go somewhere else.”

Hong Kong sought to reassure the private equity industry that it wouldn’t tax carried interest in 2021, but the process was so burdensome most GPs didn’t bother applying.

The most recent legislation, introduced in June, sweeps away much of the bureaucracy as part of a package of measures intended to make it easier for managers to operate in the territory without fear of tax leakage. In addition, the regime was expanded to include hedge fund performance fees.

Singapore’s longstanding lack of clarity on carried interest, described by some as “don’t ask, don’t tell,” and its policy of taxing hedge fund performance fees immediately became a competitive disadvantage.

The Alternative Investment Management Association (AIMA) laid this out in a letter to the Monetary Authority of Singapore (MAS) in July, noting that Hong Kong had widened the effective tax gap and global managers were increasingly moving headcount from Singapore to Hong Kong. Tax breaks for performance-related compensation were among several recommendations.

It’s possible fears of a hedge fund exodus are what forced Singapore’s hand. Shawn Tan, a counsel responsible for investment funds at Reed Smith in Singapore, observed that most enquiries have come from investment professionals on the hedge fund side who are highly mobile and intrigued by the prospect of swapping Singapore’s 24% levy on performance fees for zero in Hong Kong.

“Private equity professionals tend to be quite geographically bound. A firm might follow a pan-Asia strategy, but the team in Singapore is doing different things to the team in Hong Kong,” Tan said. “For hedge fund guys, especially those in the quant space, it doesn’t really matter where you are based.”

Others offer a more nuanced interpretation. Private equity firms with global and regional footprints have tended to maintain a presence in both jurisdictions, but for a period there was a tendency to downgrade Hong Kong operations in favour of Singapore. With Hong Kong moving to plug holes in its tax system, recent conversations have focused on moves in the opposite direction.

While tit-for-tat announcements play up the notion of a zero-sum game, it has never been that straightforward – nor is tax the sole consideration behind choice of location. What has changed is that after years of trailing in Singapore’s wake on tax certainty, Hong Kong has taken the initiative.

“It remains to be seen how Singapore responds [on carried interest], there’s no detail yet,” KPMG’s Bowdern added. “But they have to match what we are doing.”

Broader scope

Until Singapore explains how its zero-tax regime will function, which won’t happen until the 2027 budget, private equity firms are reluctant to comment publicly. Hong Kong, on the other hand, has flagged its intention to enhance preferential tax regimes for funds in the last three budget statements. In February, the financial secretary announced that an amendment to existing legislation was imminent.

What emerged addresses much of what industry participants have been lobbying on for years. “The way the legislative process works in Hong Kong, it’s not as top-down as it would be in Singapore. This law has been around since 2006 and there have been various iterations,” said Samantha Tan, co-chair of Hong Kong Venture Capital and Private Equity Association’s (HKVCA) technical committee.

The bill serves two main purposes: expanding the scope of the unified fund exemption (UFE), intended to allow managers to conduct more activity in Hong Kong without fear of one investment making an entire fund liable for local taxation; and updating the carried interest provision, which ensures Hong Kong residents providing investment management services aren’t taxed on their share of the profits.

Tan identified including funds-of-one to an expanded list of fund types – endowments and pension funds also feature – that qualify for UFE as one of HKVCA’s key objectives. While some conditions are attached, it represents a much-needed shift. At a time when fundraising is tough and some LPs are looking for bespoke terms, requiring funds to have at least five investors is commercially unhelpful.

Moreover, raising money from Hong Kong-based LPs will potentially become easier with the relaxation of anti-round tripping measures that mean anyone holding more than 30% interest in a fund could be taxed on locally sourced gains. Multiple investors will now be carved out.

The scope of investments that qualify for UFE – as well as fund types – has been expanded. Debt instruments are a notable addition, which is expected to spur private credit investors. The legislation also widens the exemption to capture more special purpose vehicle and co-investment level activities.

There has been a tightening of reporting and substance requirements attached to UFE, with qualification contingent on managers having two full-time employees in Hong Kong and incurring at least HKD 2m (USD 255,000) in annual local operating expenditure. But it might be a small price to pay.

“There was a lot of concern among tax advisors as to whether the previous exemption really worked or they were comfortable signing off on it,” said James Ford, an investment funds partner at Ashurst.

“This meant the option of bringing funds onshore by way of a LPF [locally domiciled limited partnership] or directly managing a Cayman fund from Hong Kong instead of using an onshore advisor-offshore decision maker structure wasn’t available. It should be now.”

Carrying on

The carried interest provision introduced in 2021 was supposed to reassure an industry shaken by an earlier Inland Revenue Department (IRD) decree that such payments should be taxed onshore as income rather than going untaxed as a capital gain. The 0% levy promise worked in theory but not in practice.

First, managers were required to submit substantial fund information to the Hong Kong Monetary Authority (HKMA) for pre-approval. Second, rather than being transferred to the receiver from an offshore entity, payments had to be routed through a Hong Kong vehicle. Third, gaps in UFE coverage meant not all investment gains qualified. Take-up in the investor community was limited.

“Global firms with most of their people in London or New York were never going to register with HKMA or restructure their carried interest programmes for a handful of individuals in Hong Kong,” said Nicolas Malkin, a partner in Deloitte’s international tax practice in Hong Kong. “The new approach is more user friendly. It’s more in the Hong Kong DNA in terms of being pragmatic and entrepreneurial.”

The revised version is set to fit within global carried interest plans without amendment. It exempts all carried interest, regardless of whether underlying investments qualify for UFE; and it exempts employees who have a contractual right to carried interest, not just those – typically more senior investment professionals – who have committed capital to the fund in question.

There is an eligibility caveat. The bill emphasises genuine participation and genuine performance: employees must have formal documentation setting out their carried interest participation rights and payments must be linked to economic upside rather than fixed or guaranteed returns. It is also suggested IRD might look at whether job descriptions are exaggerated for the sake of tax benefits.

The extent to which IRD scrutinises eligibility will become apparent only once the legislation is passed and gets implemented. This is why HKVCA’s Tan believes global firms are more likely to hold back, with some eschewing UFE entirely and continuing to use the onshore advisor-offshore decision maker model.

“For pan-Asian managers where the founders sit in Hong Kong, it’s a big deal. For global managers, it’s more a case of wait-and-see. They need to look at how it works in practice. There will still be tax reporting and so you are potentially opening yourself up to tax audit,” she said.

One area of focus for IRD is expected to be understanding how firms distinguish carried interest from management fees, and who receives payments for what activity. Another will involve reconciling the headline annual carried interest payments disclosed by managers with what is declared by individuals.

Adam Williams, a managing director for APAC private capital and asset management tax at Alvarez & Marsal, predicts a flurry of queries on reconciliation. However, the process, referred to as track and trace, doesn’t cause him undue concern.

“If USD 1,000 of exempt carried interest has been paid to 10 employees, they may want to know where it came from and ensure the fund didn’t make USD 1,000 in profit and pay out USD 2,000 in exempt carried interest,” Williams said. “Beyond that, I wouldn’t expect significant auditing of the rules; they are reasonable and flexible. The IRD just wants to ensure compliance.”

Mindset shift

Equilibrium will come slowly. Deloitte’s Malkin suggested it could take years for these systems to bed in. On fund level tax leakage if not carried interest, Singapore has been there before, and there is an enduring value to its track record of providing regulatory certainty.

For example, last month MAS issued a circular refining qualification criteria for exemption schemes that apply to private equity. These included requiring managers reach a minimum assets under management (AUM) threshold on application for the schemes rather than maintaining it on an annual basis.

“There had been feedback on certain elements of the tax exemption. If you are at the end of fund life and selling down assets, it doesn’t make sense that you must maintain a certain level of AUM,” said Reed Smith’s Tan. “These are tweaks around the fringes that make it more workable.”

While Singapore’s system is to some extent burdensome and costly, the private equity industry knows what to expect. Moreover, the August circular is emblematic of a regulator regarded as nimble, commercially minded, and responsive to industry input on policy matters. HKVCA’s Tan believes Hong Kong has ground to make up in this respect.

“Singapore has been running these systems for a long time, and it constantly refines them based on industry feedback,” she said. “There are substance and minimum spend requirements in Hong Kong’s draft legislation, but when are they going to test them? Some things still need to be thought through.”

Nevertheless, IRD-industry relations are apparently better than ever. Tax advisors previously railed at what they saw as a failure to appreciate the philosophical principles and structural nuances around carried interest in private equity. As a case in point, when IRD originally sought to reclassify payments as income, it was looking at perceived transfer pricing violations based on a hedge fund model.

Now, they claim that tax officials have a clearer understanding of how the industry works and a willingness to listen to concerns. Where there is scope for misbehaviour, the instinct is to find a solution, not bolt the door. For instance, concerns that banks might take advantage of UFE by moving loans into private credit funds have been addressed through anti-avoidance rules.

Asked about the possibility of a resurgence in problematic implementation, three tax advisors deemed it highly unlikely. IRD and the Financial Services and the Treasury Bureau (FSTB) are said to be discussing potential road shows in London and New York to encourage fund managers to come to Hong Kong – all in service of the government’s overarching objective to promote the local asset management industry.

“There has been a significant shift in mindset. There’s been strong engagement, a lot of collaboration and it’s clear that the IRD wants to get this right,” noted Williams of Alvarez & Marsal.

“Last time, when the bill came before Legco, it was difficult to make changes. This time there have been multiple stages of consultation. Advisors and associations have submitted many comments and suggestions, and the government took them on board and tweaked the draft.”

Luxury of choice

Not every item on private equity’s wish list for making Hong Kong more user friendly has been ticked off. Ashurst’s Ford points to a more streamlined local licensing process for private equity firms, which lies under the Securities and Futures Commission’s (SFC) purview, as an achievable goal.

Then there are issues beyond the reach of industry lobbyists. Artificial intelligence (AI) has climbed the agenda in recent months, given the likes of OpenAI and Anthropic do not make their large language models (LLMs) available to users based in Hong Kong.

AIMA observed in its letter to MAS – without referencing Hong Kong – that “Singapore’s open access to the strongest AI models, frontier and open-weight alike, wherever they are built, is a genuine differentiator whose value compounds as the field evolves.” It argued that the country should do more to facilitate the trial and deployment of AI-enabled research by global institutional investors.

It remains to be seen whether an inability to access these tools, which hinders collaboration by teams across different geographies, undermines Hong Kong’s status as a regional private equity hub. Firms might be sufficiently concerned in the context of broader China-related data security issues that they pull back. Equally, they may just find workarounds.

“We can’t control geopolitics and how it impacts Hong Kong,” said KPMG’s Bowdern. “We want to make sure our regime is best in class, regardless of the environment we are operating in, and we believe investor sentiment has shifted back in our favour from an investor viewpoint.”

In terms of Hong Kong versus Singapore, a level playing field on tax brings more optionality. With two readily accessible regimes, investment strategy and individual choice might be able to drive where private equity firms put their people, unencumbered by other considerations.

“It really depends on the location of the parent and their aims,” added Neil Synnott, regional chief commercial officer for APAC at IQ-EQ. “If you’re doing business in North Asia, it’s probably Hong Kong. If you’re doing business in Southeast Asia or ASEAN, it’s probably Singapore. If you want IPOs, it would be Hong Kong because that’s where the majority of the prime brokers are located.”

Meanwhile, Hong Kong and Singapore can both benefit from the trend towards onshoring within global fund management. As institutional investors prioritise transparency and tax benefits become more closely tied to economic substance, legal entities and personnel are gravitating towards regional hubs.

“There’s a tax exemption in Hong Kong and Singapore, but you need to have the people, the functions, and the decision-making happening in those jurisdictions,” said Deloitte’s Malkin.