29 December 2023 - The latest development in Hong Kong’s move towards expanding its Foreign-Sourced Income Exemption (FSIE) regime saw the gazettal of the Inland Revenue (Amendment) (Taxation on Foreign-sourced Disposal Gains) Bill 2023 (the Bill) on 13 October, and its introduction into the Legislative Council on 18 October for review and approval.
Further to our update in the summer, this article summarizes the expanded scope for the disposal gains income category; the new intra-group transfer relief; and exception requirement, all of which are detailed in the draft legislation and will impact multinational enterprise (MNE) entities operating in the region.
It is anticipated that the refined FSIE regime will take effect from 1 January 2024. Once the legislative process concludes, the Hong Kong Inland Revenue Department is expected to issue administrative guidelines to provide further clarification on how the regime will apply in practice.
Expanded scope for covered disposal gains income
The refined FSIE regime will continue to cover four types of foreign-sourced passive income: interest, dividends, equity interest disposal gains and income from use of intellectual properties (IP).
Importantly, the Bill captures a significant change from the current FSIE regime by expanding the scope of covered income from disposal gains deriving from only equity interests to include foreign-sourced gains or profits resulting from the sale of all types of property. However, keeping in line with the EU’s non-exhaustive approach, the Bill does not set out a definitive list of covered assets.
Under the refined FSIE regime, there are four categories of disposal gains which covers all assets:
It should be noted that there is an exclusion for traders (defined as any entity that sells, or offers to sell, property in the entity’s ordinary course of business). Specified foreign-sourced income does not include any non-IP disposal gains that accrues to an entity that is a trader, and is derived from or is incidental to its business as a trader.
Intra-group transfer relief
With a view to alleviate the compliance burden placed on covered taxpayers, a new intra-group transfer relief for disposal gains has also been introduced in the Bill. This means that under the refined FSIE regime, any tax charged on disposal gains will be deferred if being transferred between associated companies, but only if the following conditions are met:
- The selling entity receives in Hong Kong any specified foreign-sourced income (subject income) which is a disposal gain;
- The sale from which the gain is derived (subject sale) is an intra-group transfer;
- The property to which the subject sale relates (subject property) is acquired by an entity (acquiring entity); and
- Both the selling entity and the acquiring entity are, at the time of the subject sale, chargeable to profits tax.
If MNE entities meet the exception requirements set out below for particular types of incomes they will not be chargeable to profits tax:
Despite the expanded scope of disposal gains, MNE entities who are able to meet the economic substance requirement set out in Hong Kong’s existing FSIE regime should not be impacted by the incoming changes. This a message that has been emphasized by the Hong Kong government itself.
With this being said, the refinements to the FSIE regime are expected to take effect imminently. It is therefore now a good time for MNE entities to conduct full internal reviews to ensure the relevant documentation fulfilling economic substance requirements is being properly maintained; this includes satisfying annual Board meeting requirements and maintaining a clear record of minutes.
As experts in entity life cycle management, Citco Corporate Solutions companies pragmatically support Family Offices, Corporate and Fund clients in both Hong Kong and around the world. We will continue to closely monitor this development and can assist multinationals to perform their review ensuring the relevant documentation fulfilling economic substance requirements is in place.