Hong Kong Enhancing Foreign-Sourced Income Exemption (FSIE) Regime

Updates Introduced to the Foreign-Sourced Income Exemption (FSIE) Regime in Hong Kong

Hong Kong is amending the foreign-sourced income exemption (FSIE) regime to address cross-border tax avoidance. This will position Hong Kong’s FSIE regime in line with international standards. The standards require corporate taxpayers to satisfy economic substance criteria in Hong Kong to enjoy tax exemption on foreign-sourced disposal gains. Moreover, such criteria will prevent shell companies from reaping tax benefits through double non-taxation of foreign-sourced disposal gains.

Once the proposed refinements to the FSIE regime are complete, Hong Kong’s tax system will maintain a competitive edge. The Hong Kong SAR government will also sustain its territorial source principle of taxation. With this in place, the government assures that most taxpayers will be unaffected.

 

Getting Out of EU’s Watchlist

In 2021, the European Union placed Hong Kong on the EU’s watchlist for tax cooperation. It has led the Hong Kong SAR Government to pass the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance in December 2022. The amendment includes creating a new FSIE regime for foreign-sourced dividend, interest, intellectual property-related and disposal gains related to shares or equity interests that multinational enterprises (MNE) entities in Hong Kong receive.

As a general income category covered by FSIE regimes, disposal gains should be subject to the economic substance requirement, according to the most recent requirement outlined in the EU’s Guidance on Foreign Source Income Exemption Regimes, as updated in December 2022. The latest amendment to the bill will bring Hong Kong’s tax system into compliance.

The EU has asked Hong Kong and other jurisdictions adopting FSIE changes to further update their FSIE laws by the end of 2023 and apply the improved regimes starting in January 2024.

Hong Kong is still on the EU’s monitoring list until the required legislative changes. After the legal changes are complete, the Hong Kong SAR Government will appeal to the EU to promptly take Hong Kong off the list.

The refined FSIE regime will cover only four categories of foreign-sourced passive income that MNE firms receive in Hong Kong, while foreign-sourced active income will remain untouched. The Hong Kong SAR Government will provide exemption and relief to affected MNE entities to minimise the compliance burden. If an MNE business has sufficient economic substance in Hong Kong, foreign-sourced non-intellectual property (IP) disposal profits will be tax-free.

 

What Falls Under the Scheme?

The government will utilise the Organisation for Economic Cooperation and Development’s nexus methodology to determine the degree of exemptions.

Foreign-sourced non-IP disposal profits from or incidental to a trader’s or a regulated financial entity’s activity or profit-producing activities of a taxpayer benefiting from an existing preferential tax scheme are excluded from the enhanced FSIE regime.

The bill would include a new intra-group transfer exemption applicable to disposal gains to reduce the regulatory burden on eligible taxpayers. Business assets transferred between related businesses can defer tax on disposal profits. However, it is subject to specific anti-abuse laws.

Nevertheless, double taxation relief will be available under the revised FSIE framework to offset potential double taxation.

The Hong Kong SAR Government will also maintain several business-friendly measures. This includes simplified reporting procedures, the availability of advance rulings, administrative guidance, etc. There will also be technical support from the Inland Revenue Department, to ease tax compliance, reduce compliance burdens, and ensure tax transparency.

 

Business Compliance and Clarity with 3E Accounting

With concerns about being inclusive of global tax cooperation, Hong Kong’s SAR Government is adamant about ensuring multinational enterprises doing business in Hong Kong comply with the worldwide law yet can continue their business as usual. If you are concerned about whether your business is affected by the latest amendment, contact us, and we will provide an extensive explanation to put you and your business at ease.