Let’s admit it, Hong Kong is one of the best jurisdictions in Asia as a regional headquarter; however, due to the low tax regime, Hong Kong’s reputation has always been questioned.
To be an attractive financial hub, it is time that the Hong Kong tax system adapts to OECD norms regarding the taxation of passive income.
Last October, Hong Kong was added to the European Union’s “grey list”, as a non-cooperative jurisdiction for tax purposes due to the lack of taxation of foreign passive income.
Reacting to this, the Hong Kong government decided to implement the ‘Foreign Sourced Income Exemption’ regime (FSIE) for passive income from January 1st 2023
Now, let’s explain who will be affected and how things will change:
There are four types of passive income to consider: dividends, interest, royalties, and capital gains. When those are received in Hong Kong, they will be taxed at the standard 16.5% rate if the receiver Hong Kong company is part of a MNE (Multinational Enterprise).
But no worries! The following will be exempt from the new regime:
- Individual taxpayers
- Standalone local companies with no operations outside Hong Kong
Additionally, there will be 3 additional types of exemptions:
1. Economic Substance Exemption
Interest, dividends and capital gains will still be exempted from Hong Kong Profits Tax if the receiving company can show economic substance in Hong Kong.
What is economic substance?
- Having an office
- An adequate number of qualified employees
- Having substantial operations
- In case of lack of the above, companies can still show that strategic decisions and management are taken in Hong Kong
Each situation will need to be assessed on a case-by-case basis with a substantial activities test.
2. Participation Exemption
Despite the economic substance requirements, the offshore dividends and capital gains shall be exempted from Hong Kong Profits Tax, if:
a. The investor is a Hong Kong resident or with a permanent establishment in Hong Kong;
b. The investor holds at least 5% of the shares or equity interest in the investees from which it derives passive income; and
c. No more than 50% of the income derived by these investees is passive income.
3. Nexus Exemption
Some exemptions will be granted for offshore passive income as long as the underlying IP assets are patents or functionally equivalent to patents. Contrariwise, marketing-related IP assets, such as trademarks and copyrights, will not be entitled to Profits Tax exemption.