Hong Kong’s Financial Services & the Treasury Bureau (FSTB) issued a consultation paper on 17 June setting out the government’s proposal to amend Hong Kong’s foreign source income exemption (FSIE) regime for passive income in order to address the concerns of the European Union (EU) about double non-taxation.
Last October, the EU added Hong Kong to its ‘grey list’ of non-cooperative jurisdictions for tax purposes following a review of the FSIE regime. It considered that the non-taxation of offshore passive income – such as interest and royalties – and the absence of any requirement for recipient companies to have substantial economic activities in Hong Kong might lead to situations of double non-taxation and exploitation of tax advantages by shell companies.
Hong Kong SAR agreed to amend the Inland Revenue Ordinance by the end of 2022 and bring the relevant tax arrangements into line with the international standards from 1 January 2023. The paper sets out the key features of the refined regime, which reflect the outcome of negotiations with the EU, as well as the proposed implementation arrangements.
Hong Kong will continue to adhere to the territorial source principle of taxation, but Hong Kong constituent entities of a multinational enterprise (MNE) group, wherever headquartered and irrespective of group asset size and revenue, will be subject to an amended FSIE regime in respect of in-scope offshore passive income received in Hong Kong. It will apply to the following types of passive income:
- Interest income;
- Income from qualifying intellectual property assets;
- Disposal gains from shares or equity interests.
This passive income will continue to be exempt from profits tax in Hong Kong under the FSIE regime if an entity satisfies the economic substance or nexus approach requirements. Pure equity holding companies will be subject to a reduced economic substance requirement.
To meet the economic substance requirement, a taxpayer will need to employ an adequate number of qualified employees and incur an adequate amount of operating expenditures in Hong Kong in relation to the relevant activities. Outsourcing of the relevant activities will be permitted provided that the taxpayer can demonstrate adequate monitoring of the outsourced activities and that the relevant activities are conducted in Hong Kong.
To meet the nexus approach requirement, only income from a qualifying IP asset can qualify for preferential tax treatment based on a nexus ratio that is defined as the qualifying expenditures as a proportion of the overall expenditures that have been incurred by the covered taxpayer to develop the IP asset.
In addition, participation exemption will be introduced for offshore dividends and disposal gains in relation to shares or equity interest so that the relevant income will continue to be tax-exempt in Hong Kong if the conditions for the participation exemption are satisfied, regardless of whether the economic substance requirement is met.
A unilateral tax credit will further be introduced such that overseas taxes paid in respect of in-scope offshore passive income received from jurisdictions that have not concluded double taxation agreements (DTAs) with Hong Kong will be creditable against the Hong Kong tax payable on the same income under the amended FSIE regime.
The Hong Kong government said it plans to introduce a legislative bill to implement the proposed amendments in the last quarter of 2022 and bring the amended FSIE regime into force from 1 January 2023.
To be updated upon further announcements by HK IRD