Carried Interest Tax Hong Kong: Schedule 16D Guide

Hong Kong offers one of the most favourable carried interest tax regimes in the world: a flat 0% effective rate on eligible carry at both fund-entity level and individual employee level, codified in Schedule 16D of the Inland Revenue Ordinance (Cap. 112).

Carried interest is the performance-based share of profits received by private equity, venture capital and hedge fund managers in return for managing investor capital. It is the economic mechanism that aligns the interests of the fund manager with those of its limited partners, and it is the single largest source of remuneration for senior investment professionals in the industry.

This article explains what carried interest is, how it works mechanically within a private equity fund, how it is taxed in major jurisdictions, and the specific conditions under which fund managers and qualifying employees in Hong Kong can benefit from the concession.

Carried interest, often shortened to carry, is a contractual entitlement of a private equity fund’s general partner (or its principals) to a share of the profits generated by the fund’s investments, paid after the limited partners have received the return of their committed capital plus a preferred return. It is, in economic substance, a performance fee structured as a capital allocation, and it sits alongside the management fee in the standard ‘2 and 20’ model of fund economics.

Carried interest typically represents 20% of the fund’s profits above a hurdle rate, with the remaining 80% returned to the limited partners. It is a powerful alignment mechanism: the GP earns meaningful upside only if the fund delivers a return in excess of what the LPs would have earned passively.

The market standard for private equity funds is a 2% annual management fee on committed (and later on invested) capital, plus 20% carried interest on profits above a hurdle rate. Variations exist (some growth funds charge 1.5/15, some top-tier sponsors negotiate 2.5/25), but the 2 and 20 model remains the reference point.

The hurdle rate (or preferred return) is the minimum annual IRR the limited partners must receive on their capital before the GP begins to participate in the profits. Hurdles are typically set between 6% and 8%. A soft hurdle includes a catch-up provision once the hurdle is met (the GP receives 100% of profits between hurdle and full catch-up), while a hard hurdle applies to all profits above the hurdle without catch-up.

The waterfall is the contractual sequence by which distributions are paid out. Two main models dominate, with very different implications for the GP and the LPs.

Carried interest is usually allocated to GP principals subject to a vesting schedule, typically four to five years from the start of the fund’s investment period. A good leaver / bad leaver regime determines what happens to vested and unvested carry if a principal leaves the firm.

Where an American waterfall has allowed the GP to receive carry on early deals, a clawback obligation ensures that the GP returns excess distributions if later deals underperform and the LPs ultimately fail to receive their full preferred return. Clawbacks are usually backed by personal guarantees or escrow arrangements covering a defined percentage of carry.

Carried interest sits at the intersection of investment income and labour income, and jurisdictions take different positions on which characterisation prevails. The political debate is genuinely contested in most countries. The table below summarises the headline treatment in the four leading PE jurisdictions, with detail in the sections that follow.

Carried interest is generally taxed as long-term capital gains, at a federal rate of up to 20% (plus 3.8% net investment income tax in some cases), provided the underlying investment has been held for more than three years. This treatment has been politically controversial for over a decade. Several proposals to recharacterise carry as ordinary income (taxed at rates up to 37%) have been introduced in Congress but have not become law.

The UK regime has changed materially. From 6 April 2026, carried interest is taxed as trading income within the income tax framework, with income tax up to 45% and Class 4 National Insurance contributions. Where carried interest meets the qualifying conditions, a 72.5% multiplier applies to the taxable amount, giving an effective rate of approximately 34.075% for additional rate taxpayers. For the year from 6 April 2025 to 5 April 2026, carried interest that qualified for capital treatment was charged to capital gains tax at 32% (up from the prior 28%). The Disguised Investment Management Fees (DIMF) and Income-Based Carried Interest (IBCI) rules continue to apply alongside the new framework. This is a more onerous regime than the US or Hong Kong.

Singapore does not have a dedicated zero-rate carried interest concession comparable to Hong Kong’s Schedule 16D regime. The Singapore framework operates primarily at the fund level through the Section 13O and Section 13U fund tax exemption schemes (refreshed with effect from 1 January 2025), which exempt specified income from designated investments. Carry recipients are taxed under standard Singapore income tax principles, with employment-style remuneration taxed at progressive rates up to 24% and certain investment-style allocations potentially benefiting from the absence of a general capital gains tax. Singapore remains a direct competitor to Hong Kong as a fund management hub, but the structural treatment of carry is different.

Hong Kong introduced the Carried Interest Tax Concession in 2021, codified in Schedule 16D of the Inland Revenue Ordinance. The regime offers a 0% concessional rate of Profits Tax for the qualifying person and an effective 0% Salaries Tax outcome (via 100% deduction) for the qualifying employee. It is, on its face, one of the most attractive tax regimes for fund managers in the world, although the qualifying conditions are tightly drawn.

The concession is enacted in Schedule 16D of the Inland Revenue Ordinance, introduced by the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Ordinance 2021, which came into effect on 7 May 2021. The legislation applies to eligible carried interest received or accrued on or after 1 April 2020, giving the regime retrospective effect to its policy announcement date.

Eligible carried interest received by a qualifying person (typically the investment manager or a related entity acting as GP) is taxed at 0% for Profits Tax purposes, in place of the standard 16.5% rate. The 0% rate applies to the full amount of eligible carried interest, without any threshold or cap.

Eligible carried interest received by a qualifying employee is given a 100% deduction against the employee’s assessable income for Salaries Tax purposes. The mechanism is technically a deduction rather than an exclusion, but the effective rate on eligible carry is 0%. This is a significant benefit, given that Hong Kong Salaries Tax otherwise applies at progressive rates up to 17%.

The concession applies to eligible carried interest received or accrued on or after 1 April 2020. The retrospective application reflects the timeline between the policy announcement and the legislative enactment.

The concession was introduced as part of Hong Kong’s broader strategy to strengthen its position as an international asset management hub, in response to competition from Singapore and onshore Mainland Chinese centres. It complements the Limited Partnership Fund (LPF) regime introduced in 2020 and the unified fund exemption.

The carried interest concession is set for its most significant change since it was introduced. On 12 June 2026 the Government gazetted the Inland Revenue (Amendment) (Preferential Tax Regimes for Funds, Family-owned Investment Holding Vehicles and Carried Interest) Bill 2026. The Bill had its First Reading in the Legislative Council on 24 June 2026. Subject to enactment, the enhanced concession will take retrospective effect from 1 April 2025, that is, from the year of assessment 2025/26.

Until the Bill is enacted, the existing regime described above continues to apply in full. What follows is what the Bill proposes to change for carried interest.

Several substantive conditions would remain under the Bill. The carry must be genuine “eligible carried interest”: income derived from fund gains that are either exempt under the exemption regime or taxable within the Hong Kong tax net, so the concession stays tied to real investment performance rather than fixed or guaranteed returns. The right to participate must be clearly set out in the limited partnership agreement, the fund’s constitutional documents or the management agreement. Entitlement is assessed on the legal right to receive carried interest, not on the timing of distributions.

The concession is generous on its face but tightly drawn in detail. Each of the following conditions must be satisfied. Failure on any single condition disqualifies the relevant carry from the concession.

The recipient of the carried interest must be a qualifying person, defined under Schedule 16D as a corporation, partnership or trustee carrying on in Hong Kong a business of providing investment management services to a certified investment fund or a specified entity (the latter being limited to the Innovation and Technology Venture Fund Corporation).

An individual recipient must be a qualifying employee, defined under section 8 of Schedule 16D as an individual employed by a qualifying person (or its associated corporation or partnership) who provides investment management services in Hong Kong in relation to the certified investment fund. Employees performing non-investment functions (for example, HR or administrative roles) are not qualifying employees, even if they work for a qualifying person.

The investment fund must be a certified investment fund within the meaning of section 20AM of the IRO and certified by the Hong Kong Monetary Authority under the Guideline on Certification of Funds dated 16 July 2021. Note that in late 2024 the Financial Services and the Treasury Bureau consulted on removing the HKMA certification requirement to streamline implementation, and the regime is expected to evolve.

For non-SFC-licensed payers, the fund must be a qualified investment fund under the IRO, which generally requires a minimum of five investors at all times after the final closing, with the majority of committed capital from investors who are not associates of the originator, and rules on the distribution of net proceeds. The Hong Kong LPF regime is the most common Hong Kong fund vehicle used by sponsors seeking to qualify.

Eligible carried interest means a sum received by, or accrued to, a qualifying person or qualifying employee by way of a profit-related return subject to a hurdle rate, in respect of the fund’s profits from qualifying transactions. Qualifying transactions are limited to shares, stocks, debentures, loan stocks, funds, bonds or notes of private companies, or shares or comparable interests in special purpose entities holding such investments. Transactions incidental to qualifying transactions are permitted subject to a 5% threshold.

Carry can only be eligible if the underlying fund profits would themselves qualify for tax exemption under the Unified Fund Exemption regime. The concession sits on top of the existing fund tax exemption, not in place of it.

The qualifying person must carry out substantial activities in Hong Kong, with statutory minimum thresholds: at least two full-time qualifying employees performing investment management services in Hong Kong, and at least HK$2 million of operating expenditure incurred in Hong Kong for the provision of those services, in each year of assessment. Meeting these thresholds is necessary but not sufficient: the IRD also applies an adequacy test under section 5(3) of Schedule 16D, which is a substance-based assessment when the concession is claimed.

The investment manager or GP files an application with the Hong Kong Monetary Authority for certification of the investment fund. The application requires evidence of fund structure, fund manager identity, investment strategy, source of capital and the projected substance in Hong Kong.

Once certification is obtained, the qualifying person applies the concession in its annual Profits Tax return. Eligible carried interest is reported in a separate schedule, with supporting computation of the eligible amount.

A qualifying employee includes the relevant employment income in their annual Salaries Tax return, claiming the exclusion for eligible carried interest. Supporting documentation from the employer (confirming qualifying status) is required.

Robust documentation is essential. Required records include the fund’s certification by HKMA, the employee’s contract of employment and role description, evidence of substantial activities in Hong Kong, calculation of the eligible carried interest amount, and supporting waterfall computations. The IRD has been visibly active in audits of early-adopter funds.

Certification is typically applied for once at fund launch, with renewal or update where structural changes occur. The Salaries Tax and Profits Tax claims are made annually as part of the standard tax cycle.