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December 16, 2022

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



  1. See EY Global Tax Alert, Hong Kong introduces bill to refine its foreign source income exemption regime, dated 21 November 2022.

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