Understanding the new Foreign-Sourced Income Exemption in Hong Kong

Hong Kong new Foreign Source Income Exemption

According to the existing territorial source principle of taxation, the incomes sourced from Hong Kong is subject to the local profits tax. While the offshore passive incomes such as dividends, disposal gains in relation to shares or equity interest, interest income, income from intellectual properties (IP) are exempted from profits tax. The new Foreign-Sourced Income Exemption in Hong Kong will impact groups’ and MNCs’ foreign income taxation.

Amendment of Hong Kong’s Foreign Source Income Exemption (FSIE)

The Hong Kong SAR Government has recently published a proposal to amend the Inland Revenue Ordinance (IRO) to renew Hong Kong’s Foreign Source Income Exemption (FSIE) for passive income. The proposal is raised to address concerns expressed by the European Union (EU) over the potential risk of double non taxation arising from tax exemption for offshore passive income in Hong Kong.

Under the proposals, in-scope offshore passive income received in Hong Kong by a covered taxpayer will be deemed to be source from Hong Kong and chargeable to profit tax, unless the prescribed requirements are met. The reform has been in discussion in the past few months and is now close to be implemented.

Four types of offshore passive income are deeded in-scope, namely:

  1. interest,
  2. Intellectual Property (IP) income,
  3. dividends and
  4. disposal gains in relations to shares or equity interest.

Change of foreign-sourced income exemption

The profit tax exemption or preferential treatment will only continue to apply if the requirements the following requirement are met:

As a reminder, you can read more about the economic substance and nexus approach on our initial article of the FSIE reform.

If foreign income tax is paid on in-scope offshore passive income that is chargeable to profit tax under the FSIE regime. Then, a tax credit will be offered by Hong Kong even if there is no applicable double taxation agreement.

The proposals have it passed by the end of 2022, bringing the FSIE rules into force from 1 January 2023.

Entities in scope for the change of FSIE

The rules will only affect large global multinational enterprises (MNEs) with total revenue exceeding EUR 750 million and groups. Hong Kong small and medium-sized enterprises (SMEs) are also included if they are operating companies with parent or subsidiary entities located in another jurisdiction (including offshore jurisdictions like the British Virgin Islands).

Reviewing company positioning and tax structuring in Hong Kong

Taxpayers should need to assess any potential effect of the FSIE rules for their group. This includes whether they can satisfy the conditions of the economic substance requirement, the nexus approach, or participation exemption. This is to verify that their in-scope offshore passive income would remain exempt from profits tax. Additionally reviewing adjacent matters is advisable:

  • related compliance requirements;
  • consider whether any restructuring is available to mitigate any potential additional tax exposure;
  • revisit their Hong Kong profits tax positions and
  • consider if any changes to their holding structures or operating models are desirable.

MyBusiness in Asia can help you assess the impact of the new Foreign Sourced Income Exemption changes and consequently adjust the company’s policies.

Taxpayers also are in scope of the OECD’s Pillar Two proposal. They may need to consider the interaction between the refined FSIE regime and the Global Anti-Base Erosion model rules.

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