Hong Kong: Refined FSIE Takes Effect

published on 7 February 2023 | reading time approx. 2 Minutes

The Amendment Bill for refinement of Hong Kong foreign-sourced income exemption ("FSIE") has been gazetted and the refined FSIE regime became effective on 1 January 2023. Comparing to the draft version, the major differences in the final version are summarized as follows:

Taxpayer

The final version explicitly excludes certain entities from the FSIE regime that foreign-sourced dividends, equity disposal gains and interest income derived by regulated financial entity, ship-owner that has derived any exempt sums under the tax regime for ship-owner business and entity which its assessable profits are chargeable to tax under a preferential tax regime from or incidental to their profit-producing activities will not be subject to the FSIE regime.

Clarification on "Received in Hong Kong"

As expected, the final version specified that foreign income will be deemed to be received in Hong Kong if it is

• remitted to, or is transmitted or brought into, Hong Kong;
• used to satisfy any debt incurred in respect of a business carried on in Hong Kong; or
• used to buy movable property, and the property is brought into Hong Kong.

Participation Exemption for Dividends and Equity Disposal Gains

The preconditions for exempting offshore dividends and disposal gains from profit tax are modified as follows:

• The investor company is a Hong Kong-resident or a non-Hong Kong resident with a permanent establishment in Hong Kong.
• The investor company holds at least 5 percent of the equity interest in the investee company for a period of not less than 12 months immediately before the foreign-sourced dividends or disposal gains accrue to the investor company.

Switch-over Rule

Regarding the anti-abuse rules applicable to participation exemption, following contents are newly added to the switch-over rule:

• However, if the dividends or disposal gains are subject to lower tax rate under special tax regime without substantive activities requirement, the applicable rate would be the highest tax rate under that special tax regime.
• In the case of dividends, a "look-through approach" of up to five tiers of holding structure will be adopted to ascertain the aggregate amount of the underlying profits of the investee companies that are subject to foreign tax at rate of at least 15 percent is equal to or greater than the amount of dividends received investor company.

Nexus Approach Requirement for IP Income

Copyrighted software is newly added to the scope of qualifying IP assets, and to define the qualifying expenditures, the R&D activities undertaken by the taxpayer outside Hong Kong is also included in the final version.

Treatment of Loss

The final version introduced the treatment of the loss sustained from sales of equity interest and qualifying IP income:

• Loss sustained from disposal of equity interests can be used to set-off against assessable profits derived from in-scope foreign source income in the year of assessment that the sale proceeds are received in Hong Kong. Any unused loss can be carried forward. However, it is subject to the condition that the MNE entity had derived a gain from sale of equity interests and that gain would have been chargeable to profits tax under the proposed FSIE regime.
• Qualifying portion of loss sustained from qualifying IP income received will not be ring-fenced and can be used to set-off against the assessable profits of the MNE entity. Any unused loss can be carried forward.

Example to the Tax Consequence under New FSIE

If a Shanghai WFOE, which is 100 percent owned via HK Holding without business substance, distributes dividends to Hong Kong and then passes the dividends on to Germany, the tax consequences for a) to a GmbH b) to a GmbH & Co. KG are as follows: