The Hong Kong Special Administrative Region government gazetted the Inland Revenue (Amendment) (Taxation on Foreign-sourced Disposal Gains) Bill 2023 on 13 October. It seeks to amend Hong Kong’s foreign-sourced income exemption (FSIE) regime in line with the latest requirements of the European Union’s Guidance on FSIE regimes.
The EU added Hong Kong to Annex II of its list on non-cooperative jurisdictions for tax purposes – the so-called ‘grey list’ – on 5 October 2021 because it considered aspects of Hong Kong’s territorial tax system might facilitate tax avoidance or other tax practices regarded as harmful. The EU’s deadline for listed jurisdictions to make the necessary changes was 31 December 2022.
In response to its inclusion, last December the HKSAR government enacted the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022 to put in place a new FSIE regime for foreign-sourced dividend, interest, intellectual property income and disposal gain in relation to shares or equity interests received in Hong Kong by multinational enterprise (MNE) entities.
The EU, however, had subsequently updated its Guidance on FSIE Regimes to explicitly require capital gains, as a general class of income covered by an FSIE regime, to also be subject to the economic substance requirement. It therefore requested Hong Kong to further amend its FSIE legislation by the end of 2023 and implement the refined regime with effect from January 2024. Hong Kong was kept on the EU grey list when it was reviewed in February, pending completion of the necessary legislative amendments.
Following extensive consultations with stakeholders, the new Inland Revenue (Amendment) Bill will expand the scope of assets in relation to foreign-sourced disposal gains to cover assets other than shares or equity interests. However, the refined FSIE regime will continue to cover only four types of foreign-sourced passive income received by MNE entities in Hong Kong, leaving foreign-sourced active income unaffected.
Under the refined FSIE regime, exemption and relief will continue to be provided to minimise the compliance burden of the affected MNE entities. Foreign-sourced non-intellectual property (IP) disposal gains will be exempt from tax if the MNE entity has adequate economic substance in Hong Kong. For foreign-sourced IP disposal gains, the extent of the tax exemption will be determined by the OECD’s nexus approach.
Foreign-sourced non-IP disposal gains derived from, or incidental to, the business of a trader or a regulated financial entity, or the profit-producing activities of a taxpayer benefitting from an existing preferential tax regime will fall outside the scope of the refined FSIE regime.
To ease the compliance burden of covered taxpayers and facilitate corporate restructuring, a new intra-group transfer relief applicable to disposal gains will be introduced through the Bill. Any tax charged on disposal gains will be deferred if the asset concerned is transferred between associated entities, subject to specific anti-abuse rules.
In addition, double taxation relief will continue to be available under the refined FSIE regime to mitigate possible double taxation. The HKSAR government will continue to provide a series of business-facilitating measures, including simplified reporting procedures, availability of advance rulings, administrative guidance and technical support from the Inland Revenue Department to facilitate tax compliance, with a view to reducing compliance burden, enhancing tax certainty and ensuring tax transparency.
“The legislative proposal will align our FSIE regime with the international tax standard of requiring a corporate taxpayer to have substantial economic substance in Hong Kong in enjoying tax exemption with regard to foreign-sourced disposal gains, and prevent shell companies from deriving tax benefits through ‘double non-taxation’ of foreign-sourced disposal gains,” said a government spokesman.
“After the proposed refinements are made to the FSIE regime, Hong Kong’s tax system will continue to maintain a competitive edge, and our territorial source principle of taxation will be upheld. The majority of taxpayers including individuals, standalone local companies and pure local groups will not be affected.”
The draft legislation was introduced into the Legislative Council for reading on 18 October and the refined FSIE regime is scheduled to come into force as from 1 January 2024.