2023 could represent a watershed for Hong Kong’s corporate taxation. The Inland Revenue Amendment Bill 2022 (about Taxation on Specified Foreign-sourced Income), gazetted on 28 October 2002, is now under scrutiny by the Legislative Council of Hong Kong and is expected to come into force in 2023, affecting both companies and trusts.
For the first time in his history, foreign sourced income will be taxable in HK when received locally by certain companies or business entities, irrespective of where that income was generated. A totally new approach that will change the way multinational groups and companies do business in Hong Kong.
The draft legislation amendment was set in response to the European Union’s concerns over potential “double non-taxation” arising from Hong Kong’s foreign source income exemption (FSIE) regime for certain passive income.
To avoid being blacklisted by the EU as a non-co-operative jurisdiction for tax purposes, Hong Kong publicly committed in October 2021 to amending its tax law by the end of 2022 with the aim to implement the new FSIE regime in January 2023.
Hong Kong reaffirmed that the city will continue to adhere to the territorial source principle of taxation with respect to both passive and active income. At the same time, local government has indicated that the proposed legislative amendments will merely target corporations with no substantial economic activity in Hong Kong that make use of passive income to evade taxes.
The new FSIE regime in respect of in-scope offshore passive income received in Hong Kong will apply to: interest, income from intellectual property, royalties, dividends and disposal gains in relation to shares or equity interest.
If enacted, the amendments will tax constituent entities of multinational enterprise groups (MNEs) on their foreign-sourced passive income received in Hong Kong, wherever headquartered and irrespective of group asset size and revenue. Conversely standalone entities and local corporate groups where all group entities are located or established in Hong Kong would not be affected.
As a result, if a trust holds a private investment holding company carrying on trade or business in Hong Kong – and the trust and the investment holding company are established in different jurisdictions – the structure will be treated as a multinational enterprise.
Thereby, any offshore-sourced gain of the investment holding company which is received in HK would be subject at first sight to a profit tax under the new regime.
Entities satisfying the economic substance or nexus approach requirements will be exempt. The economic substance tests will look at whether the company employs an adequate number of qualified employees and incurs sufficient operating expenditures in HK for its specific economic activities. The HK Inland Revenue Department will provide legally binding opinions free of charge on whether the economic substance requirement is met.
Through the Bill, Hong Kong’s tax regime «will be refined and strengthened to better combat cross-border tax avoidance arising from double non-taxation» said the Inland Revenue Department in its explanatory note, also underling that a package of measures will be put in place «to minimise the tax compliance burden for corporations, mitigate possible double taxation, enhance tax certainty and maintain Hong Kong’s tax competitiveness».