Latest Consultation by the Hong Kong Government on Proposed Refinements to the Foreign-sourced Income Exemption Regime
Shortly after the introduction of the new Foreign-sourced Income Exemption (FSIE) regime in Hong Kong in December 2022 with a view to removing the city from the watchlist of non-cooperative jurisdictions for tax purposes of the European Union (the EU), the Hong Kong government is tasked again to make further amendments to this new FSIE regime by the end of 2023 for operation from January 2024 in order to bring it in line with the updated FSIE Guidance (Updated FSIE Guidance) promulgated by the EU in December 2022, failing of which will leave Hong Kong falling into the blacklist of the EU and facing tax-related defensive measures imposed by the EU member states.
In response, the Hong Kong government has recently published a consultation paper (Consultation Paper) on the proposed refinements to the existing FSIE regime on three major aspects, namely the widening scope of foreign-sourced disposal gains, the proposed introduction of transitional computation of disposal gains or losses and some other new exemption and relief to minimise compliance burden of affected multinational enterprise (MNE) entities.
Expanded definition of disposal gains
In view of the Updated FSIE Guidance and the EU’s stipulation that all disposal gains are to be covered under the FSIE regime regardless of whether the assets are financial or non-financial in nature, the Hong Kong government initially proposed to expand the definition of the existing in-scope disposal gains in relation to shares or equity interests to cover also gains arising from the disposal of a definite and exhaustive list of assets, including (1) debt instruments, (2) movable properties, (3) immovable properties, (4) intellectual properties and (5) foreign currencies. Nonetheless, it is disclosed in the Consultation Paper that the EU has clearly pointed to a non-exhaustive list approach in order to ensure consistent treatments across all assets, risks and jurisdictions.
In light of the above, subject to further negotiations with the EU, it is expected the definition of disposal gains in the refined FSIE regime would be expanded in a non-exhaustive manner. As to whether the five types of assets listed above or any other additional types of assets would be eventually cited as examples in the amendment bill should the non-exhaustive approach be adopted, it would depend on the input from stakeholders during the consultation period and subsequent discussions with the EU.
Transitional computation of disposal gains or losses
Taking note of the public’s opinion that the new FSIE regime may potentially be inequitable to existing asset holders in the absence of any transitional protection arrangement, the Hong Kong government, in an effort to avoid any retrospective effect of the regime, has been actively discussing with the EU the possibility of introducing a rebasing arrangement such that the cost of the assets can be “rebased” to those as at the effective date of the refined FSIE regime when calculating the taxable amount of disposal gains. However, the EU has raised concerns over its grandfathering effect and unprecedented nature.
As such, the Hong Kong government invited views on the proposed rebasing arrangement. In case the rebasing arrangement is eventually rejected by the EU, the Hong Kong government will endeavor to explore alternative options with the EU, such as a taper relief mechanism for the reduction of the taxable amount depending on the duration of how long the assets have been held for by a company.
Proposed new exemption and relief
While the existing economic substance requirement, nexus approach, and participation exemption would continue to apply accordingly to exclude different types of disposal gains from the scope of the FSIE regime if relevant conditions are satisfied, the Consultation Paper has revealed two additional proposed new exemption and relief under the refined FSIE regime to ease the compliance burden of covered taxpayers:
- Carve-out of disposal gains for traders: Under this proposed exemption, foreign-sourced disposal gains derived from sale of asset by an MNE entity that is a trader of an asset as part of its substantial business activities income in Hong Kong would be carved out from the refined FSIE regime.
- Intra-group transfer relief: While there was previously no guidance by the Hong Kong government on whether the usual intra-group transfer relief would fall under the scope of the new FSIE regime, it is most welcomed that the Consultation Paper has finally touched upon the potential applicability of intra-group transfer relief on any tax charged on foreign-sourced disposal gains where the asset concerned is transferred between associated companies. Different from the usual threshold of 90% required under the Stamp Duty Ordinance, it is proposed that the transferor and transferee companies are considered “associated” as long as either one of them is the beneficial owner of not less than 75% of the issued share capital of the other, or a third company is the beneficial owner of not less than 75% of the issued share capital of each of them. Having said that, it is expected that the relief would be eventually subject to anti-avoidance measures, such as limitation to its applicability to only where both the transferor and transferee are chargeable to profits tax in Hong Kong.
Other issues covered
In addition, the Consultation Paper also discussed other issues, including, amongst other things, the concerns of the Hong Kong government over the differential timeline adopted by the EU between jurisdictions with ongoing FSIE reforms (including Hong Kong) and other jurisdictions which are further assessed to be non-compliant with the Updated FSIE Guidance. While the former is required to complete the reforms by the end of 2023, the latter is allowed a buffer until 30 June 2024 to make amendments.
The way forward
As of the date of this alert, the new FSIE regime has already been in operation in Hong Kong for about half a year. We trust that taxpayers are gradually getting more familiar with the new FSIE regime when working with their tax advisors for tax planning. In light of the expanded scope of the refined FSIE regime, we strongly advise companies to consult their tax advisors and plan ahead of disposals of all types of assets, regardless of their financial or non-financial nature. Meanwhile, the consultation period has been closed on 6 June 2023 and taxpayers are encouraged to keep abreast of the draft bill which is expected to be introduced in October 2023. We will keep you posted on the latest development of the refined FSIE regime.
While the refined FSIE regime appears to be one challenge after another on companies claiming offshore profits in respect of their disposal gains, it is anticipated that the refinements will mainly affect shell companies and companies which possess considerable economic substance and participation within the jurisdiction will remain tax-exempt under the refined FSIE regime. Companies may also be eligible for tax credits under double tax relief and take advantages of the business facilitating measures, such as advance ruling. We trust that the refined FSIE regime will continue to contribute to the tax competitiveness and business friendliness of the city.