The Government published legislative bill on the proposed refined foreign source income exemption regime (FSIE regime) on 28 October 2022. The Inland Revenue Department also has updated the administrative guidance on November 11, 2022. Subject to the passage of the Bill by the Legislative Council, the proposed refined FSIE regime will take effect from 1 January 2023.
Covered taxpayers
Covered income
Specified foreign-sourced income covered by the FSIE regime includes:
Note:
Meaning of “received in Hong Kong”
A specified foreign-sourced income is deemed as received in Hong Kong when:
Exceptions
Specified foreign-sourced income received in Hong Kong will not be chargeable if the MNE entity meets the exception requirements specifically for the particular types of incomes as follows:
Exceptions |
Specified foreign-sourced income |
|||
Interest |
Dividend |
Disposal gains |
IP income |
|
Economic substance requirement |
✓ |
✓ |
✓ |
|
Participation requirement |
|
✓ |
✓ |
|
Nexus requirement |
|
|
✓ |
Exception 1 : Economic substance requirement – for interest, dividend and disposal gains |
|
Pure equity-holding entity |
Non-pure equity-holding entity |
Definition |
An MNE entity which only: · holds equity interests in other entities; and · earns dividends, disposal gains; and income incidental to the acquisition, holding or sale of such equity interests |
An MNE entity that is not a pure equity-holding entity |
Economic substance requirement |
· satisfy every applicable registration and filing requirements under the laws in Hong Kong; and · have adequate human resources and premises for carrying out the specified economic activities in Hong Kong |
· employ adequate number of employees with necessary qualifications to carry out the specified economic activities in Hong Kong; and · incur adequate amount of operating expenditure for carrying out the specified economic activities in Hong Kong |
Specified economic activities* |
Holding and managing its equity participations in other entities
|
Making necessary strategic decisions in respect of any assets the entity acquires, holds or disposes of; and managing and bearing principal risks in respect of such assets |
* |
An MNE entity is allowed to outsource some or all of its specified economic activities provided that it is able to demonstrate adequate monitoring of the outsourced activities and that the outsourced activities are conducted in Hong Kong subject to certain requirements. |
Exception 2 :Participation requirement – for dividend and disposal gains |
It provides an alternative to the economic substance requirement to facilitate an MNE entity which receives foreign-sourced dividend or disposal gain in Hong Kong to claim tax exemption.
Conditions apply
Anti-abuse rules
Following anti-abuse rules are in place to disallow the participation exemption:
Switch-over rule (Subject to tax condition) |
(a) investee’s underlying profits and/or underlying dividends are subject to tax in a foreign jurisdiction at an applicable tax rate equal to or higher than 15%, with a ‘look-through’ approach for investee’s profits (in the case of dividends) where foreign tax paid on dividends and underlying profits by a chain of a maximum of five tiers of investee entities (including the immediate investee) will also be taken into account; and (b) the aggregate amount of underlying profits out of which the dividends are paid and subject to tax at 15% or above must be equal to or larger than the amount of the subject dividends. |
Anti-hybrid mismatch rule |
For dividend, the participation exemption will not apply to the extent that the dividend is allowable for deduction when computing the amount of tax of the investee entity. |
Main purpose rule |
Participation exemption will not apply if the Commissioner is of the opinion that main purpose, or one of the main purposes, of entering into an arrangement is to obtain a tax benefit in relation to a liability to pay profits tax. |
Exception 3 : Nexus requirement – for IP income |
The tax exemption under the nexus requirement is only applicable to qualifying IP income, which means income derived from the use of, or a right to use, “qualifying intellectual property” (i.e. patent or copyright subsisting in software), but not other IP assets such as marketing-related IP assets (e.g. trademarks and copyrights).
For the purpose of computing the R&D fraction (nexus ratio), an uplift of maximum of 30% of the qualifying R&D expenditure (QE) is allowed if non-qualifying expenditure (NE) has also been incurred, but the amount after the uplift (i.e. the numerator) is capped at the total amount of qualifying R&D expenditure and non-qualifying expenditure incurred (i.e. the denominator).
R&D expenditures (including capital expenditure) are classified as follows:
R&D expenditures |
QE* |
NE* |
For an R&D activity carried out |
||
· by the MNE entity |
✓ |
|
· by a non-associated person |
✓ |
|
· by an associated person that is a HK resident person |
||
– in Hong Kong |
✓ |
|
– outside Hong Kong |
✓ |
|
· by an associated person that is a non-HK resident person |
✓ |
* |
QE does not include interest payments; payments for any land or buildings, or for any alteration, addition or extension to any building and acquisition of intellectual property. NE does not include interest payments and payments for any land or buildings, or for any alteration, addition or extension to any building and acquisition of intellectual property. |
Only certain portion of the qualifying IP income will be exempt from profits tax.
Double Taxation Relief
Foreign tax paid by a Hong Kong resident person
Any foreign tax paid by a MNE entity who is a Hong Kong resident person on the specified foreign-sourced income that is chargeable to profits tax under the refined FSIE regime will be eligible for tax credit against the profits tax payable on the same income, either as bilateral tax credit under a CDTA or as unilateral tax credit under the refined FSIE regime.
For dividend, tax credits will be allowed in respect of not only the foreign tax paid on the dividend, but also the foreign tax paid on the investee entity’s underlying profits out of which the dividend is paid, provided that the MNE entity has held at least 10% equity interests in the investee entity when the dividend is distributed.
Foreign tax paid by a non-Hong Kong resident person
Where the MNE entity is not a Hong Kong resident person, the foreign tax paid on the specified foreign-sourced income which is chargeable to profits tax in Hong Kong may be allowed as deduction under section 16(1)(ca) of the IRO.
Taxpayers’ obligations
An MNE entity deriving chargeable specified foreign-sourced income must:
For more information, please contact Ms. Amie Cheung at amie@beas.com.hk