Hong Kong: IRD issues new FAQs on foreign income exemption rules

The FAQs provide detailed clarifications on the FSIE regime, covering definitions of covered income, economic substance, and participation requirements.

The Hong Kong Inland Revenue Department (IRD) has released new FAQs on 24 July 2025, regarding the Foreign-Source Income Exemption (FSIE) regime, effective from 1 January 2023.

This regime permits tax exemptions for specified foreign-sourced passive income received in Hong Kong by qualifying multinational enterprise (MNE) entities. To qualify, entities must meet specific exemption conditions, including demonstrating economic substance.

The following four additional FAQs are:

5. Q: According to Hong Kong Accounting Standard (HKAS) 28, an investment in an associate shall be accounted for using the equity method. Under the method, the investment in an associate is initially recognised at cost and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition. Is a share of profit from overseas associate recognised in a taxpayer’s income statement regarded as dividend income for the purposes of the FSIE regime? (New)

A: Under the equity method of accounting, an adjustment to the carrying amount of an associate arising from the share of profit or loss represents a change in value of the investor’s proportionate interest in the associate. As the adjustment merely increases or decreases the carrying value of the investor’s investment in the associate, it is not a distribution of profits from the associate to the investor and thus would not be regarded as a dividend. Instead, at the time when the associate distributes part of its profits to its investors, the amount of profits so distributed would be regarded as dividend for the purposes of the FSIE regime.

8. Q: Under section 15H of the IRO, a “disposal gain” means any gain or profit derived from the sale of property. If the disposal gain is sourced outside Hong Kong and falls within the FSIE regime, it will be regarded as not arising from the sale of capital assets by virtue of section 15I(1)(b) of the IRO. In this regards, will expenses in relation to the disposal of the property be deductible, notwithstanding that they are of capital nature? (New)

A: Section 15Q of the IRO provides that an outgoing or expense incurred in the production of specified foreign-sourced income that is chargeable to profits tax under section 15I(1) may be deducted in accordance with Division 4 of Part 4 (Profits Tax) of the IRO. In case the disposal gain is chargeable to profits tax under the FSIE regime, outgoings and expenses incurred in the production of the disposal gain will be deductible pursuant to section 15Q of the IRO. Generally, the amount of disposal gain on the property is the disposal proceeds in excess of the acquisition cost of the property and direct expenses in relation to the purchase and sale of the property (e.g. legal cost, stamp duty). Outgoings and expenses that are of capital nature (e.g. capital expenditure on the provision of machinery or plant) will not be deductible under section 17(1)(c).

9. Q: Under section 15H(1) of the IRO, a “disposal gain” means any gain or profit derived from the sale of property, whereas “sale”, in relation to any property, means a transfer of the property (other than a transfer effected by extinguishing the property) for valuable consideration. Will (i) redemption of bonds; and (ii) conversion of convertible bonds into equity interest be regarded as “sale”? (New)

A: Redemption of bonds is a process by which a bond issuer repays the principal amount of money borrowed to the bond holder upon maturity. It does not constitute a sale as defined under section 15H(1) of IRO. Thus, a gain or profit, if any, derived from the redemption of bonds will not be regarded as a disposal gain under the FSIE regime. However, in case of a zero rated bond, which was issued to the bond holder at a discount, the difference between the discounted price of the acquisition of the bond and the face value received by the bond holder upon redemption could be regarded as interest being a reward to the bond holder for the use of money borrowed. The interest derived therefrom would fall within the scope of the FSIE regime.

Conversion of convertible bonds into equity interest will not be regarded as a sale provided that no transfer of asset by the taxpayer is involved. If the equity interest is subsequently sold, the purchase cost of the original asset (i.e. the bond) will be taken into account in ascertaining the disposal gain on the equity interest.

13, Q: A taxpayer has its parent company in Hong Kong (“the Parent Company”) and a wholly owned subsidiary outside Hong Kong (“the Subsidiary”). The Subsidiary transferred its shares in an investee entity (“the Investee Entity”), which was incorporated outside Hong Kong, to the taxpayer as in-kind dividend and the taxpayer in turn distributes the in-kind dividend (i.e. shares in the Investee Entity) to the Parent Company. The Investee Entity does not have any business operation, establishment or staff in Hong Kong, and its central management and control is exercised outside Hong Kong. Will the in-kind dividend distributed by the Subsidiary to the taxpayer be regarded as received in Hong Kong? (New)

A: The Investee Entity is an oversea company as it was incorporated outside Hong Kong, it has no business operation, establishment or staff in Hong Kong. Also, its central management and control is exercised outside Hong Kong. Under such circumstances, the Investee Entity’s shares distributed by the Subsidiary to the taxpayer, in general, would not be regarded as kept in Hong Kong. Thus, such offshore dividends received by the taxpayer would not be regarded as received in Hong Kong under the FSIE regime. The dividend would not be treated as used to satisfy a debt incurred in respect of a trade or business carried on in Hong Kong.

Earlier, the Hong Kong IRD issued guidance on various facets of the foreign-sourced income exemption (FSIE) regime on 5 July 2024. The guidance includes FAQs that clarify multiple aspects of the FSIE regime, including definitions for covered income, economic substance, and participation requirements.