Hong Kong’s Inland Revenue Department (IRD) issued guidance on various facets of the foreign-sourced income exemption (FSIE) regime, on 5 July 2024, clarifying definitions for covered income, economic substance requirements, and participation requirements.
IRD has also updated its webpage on the FSIE regime with the “frequently asked questions” (FAQs) and illustrative examples section.
FSIE Regime – Frequently Asked Questions
Territorial Source Principle of Taxation (Updated)
Q: What is the tax treatment for losses sustained from the sale of equity interests outside Hong Kong?
A: In the case where a covered taxpayer sustains a loss from the sale of equity interests outside Hong Kong (“equity interest disposal loss”), the “equity interest disposal loss” can be used to set off against the taxpayer’s assessable profits derived from specified foreign-sourced income that is chargeable to profits tax under the FSIE regime in the year of assessment during the basis period of which the sale proceeds are received in Hong Kong if the taxpayer fails to meet the economic substance requirement and the conditions for participation exemption. Any amount of loss not so set off can be carried forward and set off against the taxpayer’s assessable profits derived from specified foreign-sourced income in subsequent years of assessment.
Economic Substance Requirement (Updated)
Q: If a company has already received a certificate of resident status (“COR”), can the COR serve as a proof that there is sufficient economic substance?
A: A COR is a document issued by the Hong Kong competent authority to a Hong Kong resident person who requires proof of resident status for the purpose of claiming tax benefits under a Comprehensive Double Taxation Agreement (“CDTA”). Therefore, it only serves as a proof that the entity is a Hong Kong tax resident for the purposes of the CDTA. Since an entity’s tax resident status and its compliance with the “economic substance requirement” under the FSIE regime are considered in different contexts, COR cannot be used to demonstrate sufficient economic substance for the purposes of the FSIE regime.
FSIE Regime – Illustrative Examples
Covered Taxpayers
Example 1 – Whether an entity is an MNE entity
Company-HK, a company incorporated in Hong Kong, carried on a business in Hong Kong. It was a member of Group-HK which has operations in various jurisdictions in Asia and Europe. It held 100% of the ownership interest in Subsidiary-F, which is a resident of Jurisdiction F. It received dividends from Subsidiary-F in Hong Kong.
As Company-HK was an entity included in an MNE group, it was an MNE entity. The dividends from Subsidiary-F were specified foreign-sourced income received in Hong Kong. Under the foreign-sourced income exemption (“FSIE”) regime, such dividends could be exempt from profits tax provided that the economic substance requirement was met or the participation exemption applied.
Covered Income
Example 5 – Accrual and receipt of specified foreign-sourced income
Company-HK was an MNE entity carrying on a business in Hong Kong. Its wholly-owned subsidiary in Jurisdiction F, Subsidiary-F, declared dividends of F$1 million for each of the years ended 30 June 2022 and 30 June 2023 in November 2022 and December 2023 respectively. The 2022 and 2023 dividends were received in Hong Kong in February 2023 and March 2024 respectively.
For foreign-sourced dividends, the FSIE regime only applies in relation to those accrued and received as from 1 January 2023. Thus, the regime would not affect the 2022 dividend which accrued before 1 January 2023. It would only apply to the 2023 dividend which accrued and was received after 1 January 2023.
