FOREIGN-SOURCED INCOME EXEMPTION REGIME INTRODUCED IN HONG KONG
A new amendment bill approved by the Hong Kong government to introduce a new foreign-sourced income exemption (FSIE) regime has come into force. The FSIE Regime, which came into effect on 1 January 2023, puts in place an economic substance requirement and nexus requirement for certain specified foreign-sourced income of MNE entities.
Under the existing territorial taxation principle in Hong Kong, income sourced outside Hong Kong is not subject to tax, even upon receipt/remittance in Hong Kong. The new FSIE regime will co-exist with the current territorial source-based taxation in Hong Kong.
The FSIE Regime applies to MNE entities (i.e. entities that are part of an MNE Group). In short, an MNE Group is a Group that includes two or more entities that are located or established in different countries, thus, a wide definition is applicable to MNE entities.
What are the requirements under the new FSIE Regime?
Certain specified foreign-sourced passive income (Interest, Dividends, Capital gain on disposal of equity interest and Intellectual property (IP) income) of such MNE entities would now be subject to tax in Hong Kong, unless at least one of the following additional criteria is met:
✔ Economic Substance Requirements
For foreign-sourced interest, dividend or capital gain, the MNE entity is required to meet the following substance criteria (cumulatively);
- Have adequate number of qualified employees in Hong Kong; and
- Have adequate amount of operating expenditure in Hong Kong; and
- Strategic decisions making and risk management of its assets shall take place from within Hong Kong.
Pure equity holding MNE entities that only hold equity interests in other entities and earn dividends or capital gains are subject to reduced substance requirements as follows:
- Comply with all statutory registrations and filings required under applicable laws; and
- Holding and managing its equity participations in other entities shall take place from within Hong Kong; and
- Have adequate employees and premises in Hong Kong.
✔ Participation Exemption for dividend and capital gains
Certain qualifying MNE entities (that hold at least 5% equity in the underlying entity for more than 12 months) may also apply for participation exemption in lieu of economic substance requirements subject to certain conditions. If applicable, the qualifying foreign-sourced dividend income and capital gains from disposal of equity interest may continue to be exempt from taxation in HK.
✔ Nexus Requirement for IP Income
Only certain portion of the income from a qualifying IP asset will be eligible for the exemption determined based on a nexus ratio in line with OECD’s nexus approach.
What are the tax consequences and reporting obligations?
If the above requirements are not satisfied when such foreign-sourced income accrues to the MNE entity (i.e. year of accrual), the relevant income will be deemed subject to tax in the year when the income is received in Hong Kong (i.e. year of receipt).
Tax credits for taxes paid outside Hong Kong in respect of the specified foreign-sourced income will be allowed against the taxes payable in Hong Kong.
Hong Kong entities will be required to report the specified foreign-sourced income in their Tax Returns along with the information on economic substance and the nexus requirement.
How can Amicorp Group help?
Amicorp has a wide pool of experienced professional with in-depth knowledge on substance requirements across the globe. Our broad service offerings can enhance the governance and help you stay compliant with the new economic substance requirements with respect to the new law. Some of the services that we can assist with include the following:
- Impact assessment of the new foreign-sourced income exemption regime on your structure
- Review and optimize existing tax/legal structures
- Directorships and corporate secretarial support
- Holding and managing in Hong Kong the equity participations in overseas investee entities
- Provide other services in relation to carrying out of specified economic activities in Hong Kong
- Accounting and reporting assistances to meet regulatory requirements
- Tax reporting and compliance services
If you would like to know more about the new regime or to discuss how Amicorp can help, please contact the team here.