Are you eligible for the Foreign-Sourced Income Exemption regime?
Hong Kong has introduced the Foreign-Sourced Income Exemption (FSIE) regime, a tax law aimed to combat cross-border tax evasion.
Effective from January 2023, the FSIE regime provides relief to taxpayers who generate income outside of Hong Kong while exempting multinational enterprises (MNEs) from paying taxes on certain types of offshore income: interest, dividends, disposal gains from the sale of equity interests in entities, and intellectual property (IP) income.
In Hong Kong, received income is considered to be foreign-sourced when any of these conditions are met:
- The income is remitted, transmitted or brought into Hong Kong
- The money is used to satisfy any debt incurred in carrying out a profession, trade, or business in Hong Kong
- Where the income is used to purchase movable property, and the property is subsequently brought into Hong Kong, the income is regarded as being received at the time when the property crosses Hong Kong’s borders
There are three main requirements that companies must satisfy in order to claim tax benefits under the Hong Kong regime:
1. The economic substance requirements
This ensures companies are conducting genuine operations and activities in Hong Kong. To meet this condition, the MNE must adhere to the following guidelines:
- The company must have adequate operating expenditure in Hong Kong
- The company must have a sufficient number of qualified employees based in Hong Kong, who are responsible for carrying out the business activities of the company
- The company’s activities that are essential to its core business must have taken place in Hong Kong. These activities are known as Core Income Generating Activities (CIGA)
- Depending on the nature of CIGA, a company may be considered a pure equity holding or non-pure equity holding. In the case of a pure equity holding, the substance requirements are less
2. The participation exemption
Under this regime, companies can still be granted tax exemption even if the economic substance requirements are not met, but the following conditions must be satisfied:
- The entity must be a person who is a Hong Kong resident or have a permanent establishment in Hong Kong
- The MNE entity must have continuously held more than 5% of equity interests in the relevant investee entity for a minimum period of 12 months, before the accrual of foreign-sourced dividends or disposal gains
- The foreign income that MNEs receive in the form of dividends, disposal gains, or underlying profits, must have been subjected to tax in the foreign jurisdiction, and the headline tax rate of that foreign jurisdiction must be at least 15%
- The participation requirement is subject to additional anti-abuse measures
3. Nexus Requirements
In relation to foreign-sourced IP income, only income derived from a qualifying IP asset can be eligible for preferential tax treatment, which is calculated based on a nexus ratio. Qualifying IP includes:
- A patent granted under the Patents Ordinance (Cap. 514)
- A patent application made under Cap. 514
- A copyright subsisting in software under the Copyright Ordinance (Cap. 528)
- Any of the above intellectual properties granted, made, or subsisting under the law of any place outside Hong Kong
The FSIE regime can be a complex and challenging area for businesses to navigate and therefore it is vital that companies seek the appropriate guidance to ensure they are compliant.
Outsourcing substance is permitted in Hong Kong, but there are a few conditions, which our expert team can assist with and guide you through the process. Contact our Hong Kong team for more information about the FSIE, establishing substance or any of the above topics.
