Hong Kong proposes safe harbour rule for onshore equity disposal gains
Hong Kong’s Legislative Council Panel on Financial Affairs issued a consultation paper on 3 April for the proposed enhancement of tax certainty of onshore gains on disposal of equity interests. It proposes introducing a safe harbour rule under which such gains will be accepted as being non-taxable capital gains in Hong Kong.
Financial Secretary Paul Chan Mo-po announced, in his 2023-24 Budget speech in February, that the government intended putting forward an enhancement proposal to provide clearer guidelines. The legislative amendments are expected to be enacted later in 2023 with effect from 1 January 2024.
Currently, under the Inland Revenue Ordinance (Cap. 112), gains are not subject to profits tax if they are of capital nature. The Inland Revenue Department (IRD) adopts a ‘badges of trade’ approach, where considerations are given to the relevant facts and circumstances of the case, such as the frequency of similar trades, the holding period, the shareholding ratio, reasons for purchase or sale of the equity interests.
If the gains are determined to be capital in nature after the ‘badges of trade’ analysis, they are not subject to profits tax; if they are determined to be revenue in nature, they are subject to profits tax. Similarly, onshore losses on disposal of equity interests of capital nature are not tax deductible but onshore disposal losses of revenue nature are deductible.
To provide upfront certainty on onshore disposal gains without undertaking the ‘badges of trade’ analysis, the Panel has proposed a safe harbour rule under which an onshore gain on disposal of an equity interest will be deemed a non-taxable capital gain in Hong Kong if the investor entity has held at least 15% of the total equity interest in the investee entity for a continuous period of at least 24 months ending on the date immediately prior to the date of disposal of such interest.
There are certain exclusions for gains that are normally not considered to be capital in nature and for which the risk of abuse is relatively high. However, it is proposed that gains by excluded investor entities or in relation to excluded interests would continue to be examined by IRD using the ‘badges of trade’ approach under the existing arrangements.
Subject to the views collected in the consultation, the Panel plans to present an amendment Bill to LegCo in the second half of 2023, so that the scheme can be implemented with effect from 1 January 2024.