Refinement to Hong Kong’s overseas supply earnings exemption regime for passive earnings

In October 2021, the European Union (“EU”) positioned Hong Kong (“HK”) on its “watchlist” of non-cooperative jurisdictions for tax functions (“EU Record”) over potential dangerous tax practices arising from the standard exemption from tax granted to offshore passive earnings, notably the place fee or recipient firms usually are not required to reveal a considerable financial presence in HK. The EU expressed its issues over the doable exploitation of such preparations by HK shell firms, which frequently resulted in an erosion to the tax base of its constituent member states.

In response to the issues raised by the EU, the HKSAR authorities moved shortly to gazette the Inland Income (Modification) (Taxation on Specified Overseas-sourced Revenue) Invoice 2022 (the “Invoice” or “FSIE Regime”) on 28 October 2022. [1] After the gazette of the Invoice and subsequent dialogue with the EU, the HKSAR authorities has proposed two amendments [2] in November 2022 to the Invoice within the Committee Stage Amendments (“CSAs”), particularly: (1) eradicating the exclusion of sure entities from the FSIE Regime; and (2) exempting the desired overseas sourced earnings (see definition beneath) derived from or incidental to the revenue producing actions as required below the preferential tax regimes. The Invoice targets Multinational Enterprises (“MNE”) with the intention of stopping tax constructions that permit for the double non-taxation of offshore passive earnings, and introduces substance-based situations that should be glad for sure overseas sourced earnings to proceed having fun with tax exemption in HK.

Following the passage of the Invoice by the Legislative Council on 14 December 2022, the brand new FSIE regime for passive earnings will likely be efficient from 1 January 2023. Each proposed amendments within the CSAs have been taken under consideration within the Invoice handed by the Legislative Council.

How does the refined FSIE Regime influence your organization/ funding portfolios?

Beneath the FSIE Regime, entities inside an MNE group that carries on a commerce or enterprise in HK can be coated as an in-scope entity. An MNE group refers to a bunch with at the least one of many entities or everlasting institution throughout the group that isn’t positioned throughout the identical jurisdiction of the final word father or mother firm (“UPE”) of the group, the place UPE means an entity who owns a controlling curiosity in one other entity. On this regard, pure home teams (i.e., all entities throughout the group are HK tax residents) or an HK firm holding a minor non-controlling curiosity in overseas entities usually are not in-scope entities.

What’s “in-scope earnings” below the refined FSIE Regime?

The FSIE Regime targets “specified foreign-sourced earnings” (i.e., passive earnings together with curiosity, dividend, disposal positive aspects and earnings from mental property), which below the brand new guidelines will now be deemed HK sourced earnings and topic to HK Income Tax at 16.5% whether it is obtained in HK. “Acquired in HK” is outlined as follows:

i. remitted to/ transmitted/ introduced into HK;

ii. used to fulfill any debt incurred in respect of a commerce, career or enterprise carried on in HK; or

iii. used to purchase movable property and the property is introduced into HK.

For personal fairness funds and their SPVs who’re deriving assessable earnings which are exempt from tax below the present exemption regimes, the desired foreign-sourced earnings could also be excluded from the FSIE Regime to the extent the earnings is derived from or incidental to the manufacturing of such assessable earnings.

Is any reduction/ exemption accessible below the FSIE Regime if the earnings is deemed as sourced in HK?

To ensure that an in-scope firm to proceed adopting the offshore non-taxable remedy on specified foreign-sourced earnings, it will must fulfill the newly launched situations related to the characterisation of that earnings:-

What if the situations of the above reduction/ exemption requirement can’t be met?

Double taxation reduction needs to be accessible for in-scope entities who’ve paid tax on the desired foreign-sourced earnings the place the tax paid is substantial of the identical nature as earnings tax in a overseas jurisdiction exterior of HK, no matter whether or not that overseas jurisdiction has entered right into a complete double taxation association (“CDTA”) with HK or not. A tax credit score might be granted both as a bilateral tax credit score below a CDTA or as a unilateral tax credit score for HK tax residents who obtain earnings from a non-CDTA jurisdiction.

Abstract of FSIE regime

Comparability of FSIE regimes in Hong Kong, Singapore and Malaysia

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Though tax exemption wouldn’t be accessible below the FSIE regime if the related situations usually are not glad, there should still be avenues to pursue a non-taxable declare and/or obtain tax neutrality on sure forms of earnings in sure instances.

For example, even within the absence of the FSIE regime, we might count on positive aspects arising from the disposal of investments which were held for long-term funding functions to be non-taxablein HK, Singapore and Malaysia on the idea that these jurisdictions don’t impose tax on capital positive aspects. In Singapore, a secure harbour rule can be accessible whereby disposal positive aspects (no matter whether or not income or capital in nature) are exempted if sure situations are met.

For foreign-sourced curiosity earnings and IP earnings, though not particularly coated below the respective FSIE regimes in Singapore or Malaysia, it might be doable to maintain such earnings offshore such that they might not be topic to tax in Singapore and Malaysia. In Singapore, a decreased tax price for qualifying IP earnings could also be accessible below the IP Improvement Incentive for IP earnings that’s obtained in Singapore.

For HK, to the extent that the MNE entities foresee the related exemption situations usually are not glad, it might even be doable to deal with the foreign-sourced passive earnings as offshore sourced and never topic to tax in HK by (1) maintaining the earnings exterior of HK; (2) not utilizing the earnings to fulfill any debt in relation to their profit-generating actions; and never utilizing the earnings to purchase any movable property in HK.

How can we assist?

When you’ve got any questions on the refined FSIE Regime; and/or want any help in ascertaining your place within the refined FSIE Regime; please be happy to contact us and we might be glad to debate and supply additional help.

[1] The FSIE invoice might be accessed by way of this hyperlink:

[2] The proposed amendments might be accessed by way of this hyperlink:

[3] On 30 December 2022, the Malaysia Inland Income Board introduced financial substance necessities with respect to tax exemption on overseas sourced dividend earnings. Beneath the brand new financial substance necessities, resident firms, resident LLPs and resident people in relation to a partnership enterprise in Malaysia might want to make use of a enough variety of certified employees and incur enough working bills for the needs of finishing up sure financial actions in Malaysia. The willpower of the minimal threshold values (e.g., what constitutes “enough”) will likely be primarily based on the precise info of every case given the extent of operations required range from trade to trade.