Hong Kong to refine new foreign-sourced income exemption (FSIE) regime

The Hong Kong government said, on 15 February 2023, it would continue to refine its new foreign-sourced income exemption (FSIE) regime, which came into effect on 1 January, in respect of foreign-sourced disposal gains in relation to assets other than shares or equity interests.

The move comes in response to last December’s update by the European Union to its Guidance on FSIE Regimes, which explicitly requires capital gains, as a general class of income covered by an FSIE regime, to be subject to the economic substance requirement.

The EU said jurisdictions with ongoing FSIE reforms, such as Hong Kong, would be kept on its watchlist until necessary legislative amendments had been made to account for the treatment of foreign-sourced capital gains by the end of this year, for implementation with effect from January next year.

The EU added Hong Kong to Annex II of its list on non-cooperative jurisdictions for tax purposes – the so-called ‘grey list’ – on 5 October 2021 because it considered aspects of Hong Kong’s territorial tax system might facilitate tax avoidance or other tax practices regarded as harmful. The EU’s deadline for listed jurisdictions to make the necessary changes was 31 December 2022.

In response to its inclusion, the HKSAR government enacted the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022 last December to put in place a new FSIE regime for foreign-sourced dividend, interest, intellectual property income and disposal gain in relation to shares or equity interests received in Hong Kong.

However, the EU periodically issues or updates its guidance on different aspects of tax issues. The HKSAR government said it had already communicated with the EU to ascertain the specific requirements entailed by the Updated Guidance and explore options to refine the FSIE regime in respect of the treatment of foreign-sourced capital gains.

“The government will conduct a consultation exercise to seek stakeholders’ comments on the proposed refinements to the FSIE regime. We will request the EU to swiftly remove Hong Kong from the watchlist after making the necessary legislative amendments,” said a HKSAR government spokesman.

“In formulating the refined FSIE regime, Hong Kong will observe several key principles, i.e., the territorial source principle of taxation will be maintained, while due regard will be given to Hong Kong’s tax competitiveness and minimisation of the compliance burden.

“Under the to-be-formulated refined regime, foreign-sourced capital gains in relation to assets, regardless of their financial or non-financial nature, received by MNE entities in Hong Kong will remain exempt from tax provided that the economic substance requirement is complied with. Individuals, standalone local companies and purely local groups will not be affected,” the spokesman added.