Hong Kong tax update on foreign-sourced income | Dentons

On 28 October 2022, Hong Kong launched into the Legislative Council for assessment the proposed Inland Revenue (Amendment) Taxation of Specified Foreign-sourced Income Bill 2022 (the Foreign-sourced Income Amendment Bill), which is able to render sure specified classes of foreign-sourced income topic to Hong Kong income tax legal responsibility. When handed, the Foreign-sourced Income Amendment Bill will result in probably the most important modifications to Hong Kong’s long-standing territorial supply foundation of taxation, doubtlessly making use of tax on income acquired in Hong Kong with the said goal of addressing “double non-taxation”.

Background

Hong Kong’s current territorial foundation of taxation imposes income tax on assessable income or income arising in or derived from Hong Kong by individuals carrying on a commerce, career or enterprise in Hong Kong, until particularly exempted from tax beneath the Inland Revenue Ordinance (IRO). Under such territorial foundation of taxation, the chargeability to tax is set on the supply of income versus the residence standing. As such, an individual could also be liable to tax in Hong Kong in respect of assessable income that are attributable to a commerce or enterprise carried on in Hong Kong and which have a Hong Kong supply. Whether a commerce or enterprise is carried on in Hong Kong and whether or not income are sourced in or derived from Hong Kong is a query of reality and topic to software of regulation and rules for which case regulation supplies some steerage. The Hong Kong Inland Revenue Department (IRD) has clarified that the idea of carrying on enterprise in Hong Kong is usually broader than the definition of everlasting institution within the IRO and in double tax agreements concluded by Hong Kong. Conversely, at current, tax is just not levied primarily based on remittance or receipt in Hong Kong, subsequently foreign-sourced income falls exterior the cost to tax in Hong Kong.

In October 2021, the European Union (EU) included Hong Kong in its watchlist for tax cooperation, because the EU is worried that companies with no substantial financial exercise in Hong Kong are usually not topic to tax in respect of sure offshore passive income (equivalent to curiosity and royalties), therefore resulting in circumstances of “double non-taxation”. In response, the Hong Kong authorities has emphasised its help for worldwide tax cooperation and combatting cross-border tax evasion, with the intention to amend the IRO by the tip of 2022 and implement related measures in 2023, with a view to having Hong Kong faraway from the EU watchlist. Hong Kong has expressed the intention to proceed its territorial supply precept of taxation as a easy and low-tax regime with a view to sustaining the competitiveness of Hong Kong’s enterprise setting, whereas proposed legislative amendments will specifically goal companies with no substantial financial exercise in Hong Kong that make use of passive income to evade tax cross-border.

Proposed modifications

The Foreign-sourced Income Amendment Bill is anticipated to use from 1 January 2023, topic to legislative course of, amending the IRO to treat sure foreign-sourced income as arising in or derived from Hong Kong and thus chargeable to income tax, topic nonetheless to prescribed exceptions and to aid towards double taxation in respect of sure foreign-sourced income. “Received in Hong Kong” is proposed to cowl or deem as acquired in Hong Kong: (a) sums remitted to or transmitted or introduced into Hong Kong; (b) sums used to fulfill any debt incurred in respect of a commerce, career or enterprise carried on in Hong Kong; or (c) sums used to purchase movable property and the property is introduced into Hong Kong.

Foreign-sourced income within the nature of curiosity, dividend, disposal achieve from sale of fairness curiosity in an entity or specified “mental property income” shall be caught beneath present proposed modifications. Remarkably, specified foreign-sourced income is to be considered not arising from the sale of capital belongings even when it so arises, making use of income tax on what might in any other case be a achieve capital in nature.

Under the Foreign-sourced Income Amendment Bill, “MNE entity” is outlined as an individual that’s, or acts for, an MNE group or an entity included in an MNE group, and isn’t an excluded entity; “entity” refers to a authorized particular person (apart from a pure particular person), or an association that prepares separate monetary accounts, equivalent to a partnership and a belief; and “MNE group” means a gaggle that features at the least one entity or everlasting institution that’s not situated or established within the jurisdiction of the last word dad or mum entity of the group. “Group” is outlined to imply: (a) a group of entities which can be associated by means of possession or management such that the belongings, liabilities, income, bills and money flows of these entities: (i) are required beneath relevant accounting rules to be included within the consolidated monetary statements of the last word dad or mum entity of the gathering; or (ii) are excluded from the consolidated monetary statements of the last word dad or mum entity solely on measurement or materiality grounds or on the grounds that the entities are held on the market (i.e. as would in any other case be included); or (b) a stand-alone MNE entity.

A “stand-alone MNE entity” is one situated in a single jurisdiction and has a number of everlasting institutions in different jurisdictions, and isn’t a part of a “group”. While that’s easy, the complexity lies the place “MNE entity” and “MNE group” as outlined would cowl a gaggle or assortment of entities, together with any partnership or belief constructions inside such group, which may be topic to potential chargeability to Hong Kong income tax on foreign-sourced income if acquired by an individual carrying on commerce, career or enterprise in Hong Kong and which is an entity throughout the group or performing for the group.

Entities or teams having presence or actions in Hong Kong ought to think about whether or not there could also be potential chargeability to income tax going ahead, by means of a gaggle entity carrying on a commerce or enterprise in Hong Kong and receiving or deemed as receiving specified foreign-sourced income in Hong Kong. An MNE entity that may turn out to be chargeable to income tax in respect of any specified foreign-sourced income beneath the brand new guidelines should notify the Commissioner of Inland Revenue in writing of its chargeability inside 4 months after the tip of the idea interval of the 12 months of evaluation throughout which the income is acquired in Hong Kong.

The Foreign-sourced Income Amendment Bill proposes to use the definition of “everlasting institution” in Hong Kong in line with Schedule 17G of the IRO and “Hong Kong resident particular person” beneath part 50AAC(1) of the IRO, as are related for figuring out legal responsibility for property tax, salaries tax or income tax in Hong Kong within the context of double taxation preparations and switch pricing guidelines. The proposed new provisions beneath the Foreign-sourced Income Amendment Bill will must be thought-about along with these current provisions.

Regulated monetary entities and excluded entities

Having stated that, it could be welcomed by monetary establishments and monetary intermediaries in Hong Kong that the proposed modifications won’t have an effect on the income of regulated monetary entities carrying on commerce or enterprise in Hong Kong and receiving foreign-sourced income in Hong Kong – an insurer authorised beneath the Insurance Ordinance, an authorised establishment beneath the Banking Ordinance, or an entity licensed beneath the Securities & Futures Ordinance to hold on any regulated exercise are all proposed to be out of scope and needn’t be involved with chargeability on foreign-sourced income.

The Foreign-sourced Income Amendment Bill additionally proposes to exclude a authorities funding entity, an insurance coverage funding entity, worldwide organisation, a pension fund entity or pension providers entity, a non-profit entity or a non-profit organisation, an funding fund that’s an final dad or mum entity, or an actual property funding automobile that’s an final dad or mum entity (the entire above as outlined in every case) from turning into topic to Hong Kong income tax on foreign-sourced income acquired in Hong Kong.

In this context, we additional define the important thing proposed exclusions, in addition to the exceptions primarily based on financial substance requirement the place the foreign-sourced income is curiosity, dividend or disposal achieve, or the participation requirement the place the foreign-sourced income is a dividend or disposal achieve. It is exterior the supposed scope of this update to cowl the potential therapy of mental property income and the associated exception beneath the Foreign-sourced Income Amendment Bill – if of curiosity, please contact the creator to debate the subject individually.

The following key classes of funding constructions are exclusions proposed to not be topic to income tax cost on foreign-sourced income beneath the Foreign-sourced Income Amendment Bill:

Government funding entity

A governmental entity having the principal function of fulfilling a authorities operate or managing or investing authorities belongings by means of the making and holding of investments, asset administration and funding actions associated to the federal government belongings and which doesn’t carry on a commerce or enterprise apart from such funding enterprise, amongst different standards;

Insurance funding entity

An insurance coverage funding entity which could be the equal of an funding fund or an actual property funding automobile, established in relation to liabilities beneath an insurance coverage or annuity contract, and is wholly owned by an entity which is a regulated insurance coverage firm in its native jurisdiction;

Investment fund or actual property funding automobile

An funding fund or an actual property funding automobile which is an final dad or mum entity, the place “funding fund” is outlined to cowl fund entities exempted from income tax beneath sure current provisions of the IRO, an authorised retail fund beneath the Securities & Futures Ordinance or a bona fide broadly held funding scheme in a suitable regulatory regime, and likewise, extra broadly, entities that meet designated components of being an funding fund construction or actual property funding automobile, respectively;
Given that the exclusion solely applies to an funding fund or actual property funding automobile which is an final dad or mum entity, it needs to be famous this refers to a stand-alone MNE entity or an entity that owns immediately or not directly a controlling curiosity in some other entity and isn’t owned with a controlling curiosity immediately or not directly by one other entity – constructions having underlying funding holding corporations or buying and selling entities needs to be reviewed for potential tax legal responsibility beneath the proposed new guidelines;

Pension fund entity or pension fund providers entity

A pension fund entity that meets the prescribed definition as a pooled fund established and operated solely or virtually solely to manage or present retirement advantages and ancillary or incidental advantages which is regulated or protected in its jurisdiction, or a pension providers entity established and operated solely or virtually solely to take a position funds for the pension fund entity or perform actions ancillary to the regulated actions of a pension fund entity of the group;

Non-profit organisation

a non-profit organisation which refers to an entity established and operated in its jurisdiction of residence solely for non-profit function or as a non-profit entity (the latter referring to organisations equivalent to chamber of commerce, trade organisation, social welfare organisation, labour organisation, skilled organisation) the place its income from its unique non-profit function or as a non-profit entity is considerably exempt from income tax in its jurisdiction of residence, and such entity has no shareholders or members having proprietary curiosity in its income or belongings or any personal particular person or non-charitable entity which can obtain distributions or good thing about the entity’s income of belongings apart from on a restricted and restricted foundation as stipulated within the provisions.

These exclusions are according to the federal government’s intention to retain Hong Kong’s attractiveness as a enterprise setting, together with its function as a aggressive asset administration centre and funding hub, whereas the proposed modifications shall goal companies with no substantial financial exercise in Hong Kong that make use of passive income to evade tax cross-border. If an MNE entity is a pure fairness holding entity, exception from income tax applies if it meets minimal specified financial substance necessities and, within the opinion of the Commissioner of Inland Revenue, has satisfactory human sources and premises for finishing up its related financial actions in Hong Kong. Otherwise, an MNE entity might want to have such variety of workers in Hong Kong with the mandatory {qualifications} to hold out specified financial actions and such whole working expenditure incurred in Hong Kong for finishing up specified financial actions, in every case as thought-about satisfactory within the Commissioner’s opinion. “Specified financial actions” refers back to the making of strategic selections in respect of the acquisition, holding or disposal of belongings of the entity, managing and bearing principal dangers in respect of such belongings.

Separately, an MNE entity might qualify for participation exception if it’s a Hong Kong resident particular person or a non-Hong Kong resident particular person with everlasting institution in Hong Kong and meets the required participation requirement of getting constantly held not lower than 5% fairness curiosity within the investee entity for a interval of not lower than 12 months instantly earlier than accrual of the dividend income or disposal achieve, offered the investee entity is topic to a minimal reference tax price of 15% and likewise topic to different anti-abuse provisions.

In view of Hong Kong’s place as a monetary centre for asset administration, funding funds and wealth administration hubs, by means of which funding entities could also be generally established or operated, participating within the conduct of funding actions, funding entities or constructions (together with partnership or belief) receiving foreign-sourced income in Hong Kong ought to think about the relevance and potential implications of the proposed modifications, to adjust to extra chargeability to tax on foreign-sourced income or whether or not tax mitigation measures can be found.

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