Sign up for tax alert emails    GTNU homepage    Tax newsroom    Email document    Print document    Download document

December 16, 2022
2022-6232

Hong Kong passes bill on refined foreign-sourced income exemption regime

  • The bill on the refinement of the foreign source income exemption (FSIE) regime (the Bill) was passed in its current form on 14 December 2022 and will be effective from 1 January 2023.

  • The Hong Kong Government has further clarified certain provisions during the legislative process, including the determination of income qualifying as “received in Hong Kong,” qualification of a “pure equity-holding entity,” and applicable tax rate for the “subject to tax” test.

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

Executive summary

On 14 December 2022, the Inland Revenue (Amendment) (Taxation on Specified Foreign-Sourced Income) Bill 2022 (the Bill) passed its third reading and is expected to formally become law by 23 December 2022. The Bill introduced amendments to the tax exemption of certain foreign-sourced passive income which will apply to income accrued and received in Hong Kong on or after 1 January 2023.

The Bill has been passed in the current form and the key provisions were outlined in our earlier Global Tax Alert.1 This Alert summarizes the key clarifications made by the Hong Kong Government on certain provisions during the legislative scrutiny of the Bill.

Detailed discussion

Under the refined FSIE regime, specified foreign-sourced income (i.e., dividends, interest, income from the use of IP and disposal gain on equity interest) received in Hong Kong will be deemed as sourced from Hong Kong and chargeable to profits tax unless the additional economic substance, participation, or nexus requirements (as applicable) are met. During the legislative review of the Bill, the Hong Kong Government clarified the following issues raised on certain provisions:

  • The refined FSIE regime will apply to an MNE entity carrying on a trade, profession, or business in Hong Kong. For this purpose, “MNE entity” includes a trustee acting for a trust arrangement, however it is not intended to include general independent service providers.
  • While “dividend” and “interest” are not specifically defined in the legislation, the income characterization should be determined by all the facts and circumstances relating to the transaction.
  • In determining whether a specified foreign-sourced income constitutes “received in Hong Kong” and therefore subject to the refined FSIE regime, the Hong Kong Tax Authority indicated that the income will not be regarded as “received in Hong Kong” if the unremitted income is used to pay dividends into a shareholder’s offshore bank account without being remitted back to Hong Kong.
  • A pure equity-holding entity (PEHE) will be subjected to a reduced economic substance test. While a PEHE should only hold equity interests in other entities, it is allowed to borrow money to finance its equity investment and earn incidental income, however it should not lend monies or participate in a group cash pooling arrangement.
  • The participation exemption requirement includes a “subject to tax” condition of at least 15%. In determining the applicable rate for the test, the “headline tax rate” approach will be adopted. However, if the income concerned is taxable under a special lower rate tax regime which is not a tax incentive for carrying out substantive activities in the jurisdiction concerned, it will then refer to the highest stipulated tax rate under the special tax regime.
  • A bilateral or unilateral tax credit can be claimed on overseas taxes paid in respect of the relevant specified foreign-sourced income now deemed taxable under the refined FSIE regime. Consistent with the current tax credit system, tax credits will be computed on an “income-by-income” basis.

It is expected that a Departmental Interpretation and Practice Note and further administrative guidance will be issued to provide more explanation and examples.

_________________________________________

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

_________________________________________

Endnotes

  1. See EY Global Tax Alert, Hong Kong introduces bill to refine its foreign source income exemption regime, dated 21 November 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.

 

Copyright © 2024, Ernst & Young LLP.

 

All rights reserved. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP.

 

Any U.S. tax advice contained herein was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

 

"EY" refers to the global organisation, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

 

Privacy  |  Cookies  |  BCR  |  Legal  |  Global Code of Conduct Opt out of all email from EY Global Limited.

 


Cookie Settings

This site uses cookies to provide you with a personalized browsing experience and allows us to understand more about you. More information on the cookies we use can be found here. By clicking 'Yes, I accept' you agree and consent to our use of cookies. More information on what these cookies are and how we use them, including how you can manage them, is outlined in our Privacy Notice. Please note that your decision to decline the use of cookies is limited to this site only, and not in relation to other EY sites or ey.com. Please refer to the privacy notice/policy on these sites for more information.


Yes, I accept         Find out more