Hong Kong's participation exemption for foreign-sourced disposal gains and dividends hinges on satisfying the "subject to tax" condition — and as these cases illustrate, qualifying tax paid in a third jurisdiction or at the level of an underlying subsidiary can be sufficient to meet the threshold.
The Hong Kong Inland Revenue Department has released additional and updated FAQs on the Foreign-Source Income Exemption (FSIE) regime.
The FSIE regime, effective from 1 January 2023, provides tax exemptions for specified foreign-sourced passive income received in Hong Kong by in-scope multinational enterprise entities, subject to conditions such as economic substance requirements. The updated FAQs aim to further clarify the application of these exemption rules.
32. Q: Company HK’s disposal of equity interests in Company X located in Jurisdiction X results in an indirect transfer of Subsidiary Y, a foreign subsidiary indirectly held by Company HK in Jurisdiction Y. Company HK is subject to indirect transfer tax (which is a corporate income tax imposed on a withholding basis) at the tax rate of 10% on the disposal gain in Jurisdiction Y. If the statutory corporate income tax rate in Jurisdiction Y is 25%, can the “subject to tax” condition be regarded as satisfied?
A: If the specified foreign-sourced income is a gain derived from the disposal of equity interests in an investee entity, the participation exemption only applies if the disposal gain is subject to a qualifying similar tax in a territory outside Hong Kong (foreign jurisdiction). The foreign jurisdiction may not necessarily be the jurisdiction in which the investee entity is located.
If the gain from the disposal of the equity interests in Company X is subject to corporate income tax in Jurisdiction Y on the indirect transfer of Subsidiary Y, such tax would be taken into account in determining whether the “subject to tax” condition is satisfied in respect of the equity interest disposal gain. As the headline tax rate in Jurisdiction Y is higher than the reference rate of 15%, the “subject to tax” condition would be regarded as satisfied.
35. Q: Company HK, a Hong Kong tax resident, holds 100% equity interest in Company X, located in Jurisdiction X. Company HK received a dividend of $76 from Company X. The dividend was not subject to any withholding tax in Jurisdiction X.
The underlying profits of the dividend distributed by Company X consisted wholly of dividends received from its subsidiary, Company Y, which is located in Jurisdiction Y. The dividend distributed by Company Y to Company X was $80 and was subject to a 5% withholding tax in Jurisdiction Y. The corporate tax rate of Jurisdiction Y is 20%. Can the “subject to tax” condition be regarded as satisfied?
A: As the underlying profits (i.e. the dividend of $80 distributed by Company Y to Company X) of the dividend income was subject to a qualifying similar tax in Jurisdiction Y and the amount of the underlying profits is equal to or larger than that of the dividend income of Company HK, Company HK can be regarded as satisfied the “subject to tax” condition under the participation requirement.
