The Hong Kong Special Administrative Region Government said today it will propose an amendment bill to refine Hong Kong's foreign-sourced income exemption (FSIE) regime by expanding the scope of its coverage. In relation to foreign-sourced disposal gains, the expanded regime would cover assets other than shares or equity interests.

The Inland Revenue (Amendment) (Taxation on Foreign-sourced Disposal Gains) Bill 2023 will be gazetted on October 13 and introduced into the Legislative Council on October 18.

The Hong Kong SAR Government stressed that, as a staunch supporter of international tax co-operation, Hong Kong has been working closely with the European Union (EU) and other international organisations in countering cross-border tax avoidance.

The proposed legislation will align Hong Kong’s FSIE regime with the international standard by requiring corporate taxpayers to have adequate economic substance in Hong Kong to enjoy tax exemption with regard to foreign-sourced disposal gains, and prevent shell companies from deriving tax benefits through double non-taxation of foreign-sourced disposal gains.

The Hong Kong SAR Government said that after the proposed refinements are made to the FSIE regime, Hong Kong’s tax system will continue to maintain a competitive edge, and that its territorial source principle of taxation will be upheld. It added that the majority of taxpayers will not be affected.

In response to the EU's inclusion of Hong Kong on its watchlist on tax co-operation in 2021, the Hong Kong SAR Government enacted the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022 last December to establish a new FSIE regime for foreign-sourced dividend, interest, intellectual property-related and disposal gains in relation to shares or equity interests received in Hong Kong by multinational enterprise (MNE) entities.

Through the proposed bill, Hong Kong’s tax regime will be brought into line with the latest requirement outlined in the EU’s Guidance on Foreign Source Income Exemption Regimes, as updated in December 2022, that disposal gains, as a general class of income covered by FSIE regimes, should be subject to the economic substance requirement.

Hong Kong and other jurisdictions enacting ongoing FSIE reforms have been requested by the EU to further amend their FSIE legislation by the end of 2023 and implement the refined regimes with effect from January 2024.

Hong Kong is being kept on the EU watchlist pending completion of the necessary legislative amendments. The Hong Kong SAR Government will request that the EU swiftly remove Hong Kong from the watchlist upon completion of the legislative amendments.

The refined FSIE regime will continue to cover only four types of foreign-sourced passive income received by MNE entities in Hong Kong, leaving foreign-sourced active income unaffected.

Under the refined regime, exemption and relief will continue to be provided to minimise the compliance burden on affected MNE entities. Foreign-sourced non-intellectual property (IP) disposal gains will be exempt from tax if an MNE entity has adequate economic substance in Hong Kong.

For foreign-sourced IP disposal gains, the extent of tax exemptions will be determined by the nexus approach promulgated by the Organisation for Economic Co-operation & Development.

Foreign-sourced non-IP disposal gains derived from, or incidental to, the business of a trader or a regulated financial entity, or the profit-producing activities of a taxpayer benefitting from an existing preferential tax regime, will fall outside the scope of the refined FSIE regime.

To ease the compliance burden on covered taxpayers and facilitate corporate restructuring, a new intra-group transfer relief applicable to disposal gains will be introduced through the bill.

Any tax charged on disposal gains will be deferred if the asset concerned is transferred between associated entities, subject to specific anti-abuse rules.

In addition, double taxation relief will continue to be available under the refined FSIE regime to mitigate possible double taxation.

The Hong Kong SAR Government will maintain a variety of business-facilitating measures, including simplified reporting procedures, availability of advance rulings, administrative guidance and technical support from the Inland Revenue Department to facilitate tax compliance, with a view to reducing compliance burdens while enhancing tax certainty and ensuring tax transparency.