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November 21, 2022

Hong Kong introduces bill to refine its foreign source income exemption regime

  • The Hong Kong Government introduced a bill on the proposed refinement of the foreign source income exemption (FSIE) regime (the Bill) which is expected to be effective from 1 January 2023.

  • This Alert highlights the key features of the Bill, with specific reference to the administrative guidance published by the Hong Kong Tax Authority regarding the FSIE regime.

  • Multinational enterprises (MNEs) should review their Hong Kong holding, financing and intellectual property (IP) structures to assess the tax implications.

Executive summary

The Hong Kong Government introduced the Inland Revenue (Amendment) (Taxation on Specified Foreign-Sourced Income) Bill 2022 on 2 November 2022 and subsequently submitted committee stage amendments on 10 November 2022 in response to the European Union’s latest comments to the FSIE regime (collectively the Bill). The Hong Kong Inland Revenue Department (IRD) also published on its website administrative guidance with “Frequently Asked Questions” and “Illustrative Examples” to assist taxpayers to better understand the proposed refined FSIE regime.

As outlined in our earlier Global Tax Alert,there are proposed amendments to the tax exemption of certain foreign-sourced passive income which will be subject to additional economic substance, participation and nexus requirements. The provisions in the Bill are substantially consistent with the proposed framework in the original consultation but indeed with several positive enhancements. The Bill is currently under review by the Hong Kong Legislative Council and is expected to take effect from 1 January 2023, however with no grandfathering provision.

This Alert summarizes the key provisions of the Bill.

Detailed discussion

Scope of the regime

Under the refined FSIE regime, specified foreign-sourced income (i.e., interest, dividends, income from the use of IP and disposal gain on equity interest) will be deemed to be sourced from Hong Kong and chargeable to profits tax if the following conditions are met:

  • The income is received in Hong Kong by an MNE entity carrying on a trade, profession or business in Hong Kong irrespective of its revenue or asset size.

  • The recipient entity fails to meet the additional requirements, as prescribed and discussed below.

The deeming provision will also apply to foreign-sourced disposal gain on equity interest even it is capital in nature.

There are certain exclusions for income derived by a regulated financial entity and those benefitting from preferential tax regimes or specific tax exemption regimes. A foreign permanent establishment of a Hong Kong resident person will not be subject to the refined FSIE regime.

The Bill has adopted the definition of the corresponding term as elaborated in Singapore law in determining whether income is “received in Hong Kong” and hence subject to the refined FSIE regime. As per the definition, a sum will be regarded as “received in Hong Kong” if the sum meets one of the following conditions:

  • Remitted to, or is transmitted or brought into, Hong Kong
  • Used to satisfy any debt incurred in respect of a trade, profession or business carried on in Hong Kong
  • Used to buy movable property, and the property is brought into Hong Kong

While the IRD has provided two illustrative examples in its administrative guidance, it is still unclear to what extent a covered taxpayer needs to track the income flow and how the deemed receipt of income in Hong Kong will be applied.

Exceptions from the deeming provision

The specified foreign-sourced income will not be deemed taxable if the MNE entity meets the economic substance requirement (for non-IP income) or participation exemption (for dividend and equity disposal gain) or complies with the nexus requirement (for IP income).

The economic substance requirements for non-IP income requires the entity to have adequate employees and to incur adequate operating expense for carrying out the specific economic activities in Hong Kong, such activities include making necessary strategic decisions and managing and assuming principal risks in respect of the assets. The IRD has indicated that a tax residency certificate of Hong Kong for tax treaty purposes in itself cannot be used to demonstrate the satisfaction of the economic substance requirements under the refined FSIE regime. Meanwhile, pure equity-holding companies will be subject to a reduced substance test.

Outsourcing of the relevant activities will be permitted provided that the taxpayer is able to demonstrate adequate monitoring of the outsourced activities and that the relevant activities are conducted in Hong Kong, to fulfil the economic substance requirements.

As an alternative to satisfy the economic substance requirements, an MNE entity can also rely on the new participation exemption for foreign-sourced dividends or equity disposal gains provided the following conditions are met:

  • The MNE entity is a Hong Kong resident person (or has a permanent establishment in Hong Kong to which the income is attributable).
  • The MNE entity has continuously held not less than 5% of equity interests in the investee entity concerned for a period of not less than 12 months immediately before the income accrues.

It is important to note that the participation exemption is subject to specific anti-abuse rules, including a “subject to tax” condition of at least 15%.

Regarding foreign-sourced IP income, the nexus requirement will be applied to determine the extent of the tax exemption. It is modelled on the nexus approach adopted by the Organisation for Economic Co-operation and Development as a minimum standard under Base Erosion and Profit Shifting (BEPS) Action 5. Under the nexus requirement, only IP income from a qualifying IP asset (i.e., patent and software copyright) will be exempt from profits tax based on a nexus ratio in proportion to the qualifying research and development expenditure. Marketing-related IP assets henceforth will not qualify for tax exemption and will be taxed on a remittance basis.

Other provisions

To alleviate taxpayers from possible double taxation, the Bill grants a unilateral tax credit on overseas taxes paid in non-treaty jurisdictions in respect of the relevant specified foreign-sourced income now deemed taxable under the refined FSIE regime. For dividends received from treaty or non-treaty jurisdictions, a tax credit will be allowed in respect of both the foreign taxes paid on the dividend and the underlying profits out of which the dividend is paid. Key to note that a look-through approach will be adopted subject to prescribed conditions.

There are also several additional provisions included in the Bill to address treatment of losses and operating expenditures regarding specified foreign-sourced income, as well as the compliance obligation to be fulfilled by the taxpayers.


For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, Hong Kong

Ernst & Young LLP (United States), Hong Kong Tax Desk, New York

Ernst & Young LLP (United States), Asia Pacific Business Group, New York

Ernst & Young LLP (United States), Asia Pacific Business Group, Chicago



  1. See EY Global Tax Alert, Hong Kong proposes to refine its foreign source income exemption regime for certain passive income, dated 30 June 2022.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.


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