In temporary
The Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022 (Amendment Ordinance) has come into operation on 1 January 2023 to place in place a new taxation regime for foreign sourced passive income (FSIE Regime) in Hong Kong.
The Amendment Ordinance is considerably the identical because the invoice proposed by the Government, as amended by the Committee Stage Amendments, the important thing options of which had been mentioned in our Client Alert issued in November 2022. In this alert, we define some clarifications made by the Government in the course of the legislative course of and up to date updates on the executive steerage issued by the Inland Revenue Department (IRD) in respect of the operation of the new regime.
Clarifications made by the Government
Covered income
The FSIE Regime applies to 4 varieties of specified foreign sourced income, specifically, curiosity, dividend, disposal achieve and mental property income, which can be obtained in Hong Kong.
During the legislative course of, options had been made to the Government by stakeholders to outline the phrases ‘dividend’ and ‘curiosity’ within the laws to offer extra certainty on the scope of lined income underneath the FSIE Regime. Whilst the 2 phrases stay undefined within the Amendment Ordinance, the Government has acknowledged that, usually,
Dividend refers to a cost of a part of the income for a interval in respect of a share in an organization and doesn’t embrace distributions from a partnership, unit belief or different non-corporate entities and revenue distributions from a department
Interest is payable for using cash and is within the nature of compensation for the deprivation of such use.
In relation to features on disposal of fairness pursuits, regardless of there being no grandfathering association within the Amendment Ordinance, the Government has acknowledged that it’ll make clear with the European Union (EU) on the potential for permitting the rebasing of the worth of fairness pursuits to their honest worth as of 31 December 2022 for the aim of calculating the quantity of disposal features chargeable underneath the FSIE Regime to cut back impression to current holding buildings. If the rebasing strategy is agreeable to the EU, unrealised honest worth achieve gathered earlier than 1 January 2023 might be carved out from the applying of the new regime. The IRD will clarify the place in additional steerage or departmental interpretation and observe notes as soon as it has ascertained the appropriate observe with the EU.
On a associated word, the Government has indicated that it’ll look into measures to reinforce tax certainty in respect of onshore disposal of fairness pursuits and ensuing features, noting that taxpayers could also be prompted by the FSIE Regime to contemplate bringing such transactions onshore. It stays to be seen whether or not the Government will take into account adopting a bright-line take a look at just like that adopted by Singapore whereby features derived from disposal of bizarre shares (whether or not onshore or offshore) are handled as capital in nature, topic to the satisfaction of sure situations.
In respect of the idea of ‘obtained in Hong Kong’, the IRD has just lately offered extra examples for example when a foreign sourced income is taken into account ‘obtained in Hong Kong’ or in any other case. To recap, a foreign sourced income which isn’t thought-about as ‘obtained in Hong Kong’ falls exterior the scope of, and therefore shouldn’t be chargeable underneath, the FSIE Regime, and a sum is to be considered ‘obtained in Hong Kong’ if (i) it’s remitted to, or is transferred or introduced into Hong Kong; (ii) it’s used to fulfill any debt incurred in respect of a enterprise carried on in Hong Kong; or (iii) it’s used to purchase movable property, and the property is introduced into Hong Kong.
In one instance offered by the IRD, a taxpayer entity retains its foreign sourced dividend in its offshore checking account and later makes use of the fund for cost of dividend immediately into an offshore checking account of its shareholder. In such case, the dividend won’t be considered obtained in Hong Kong underneath the FSIE Regime, because the foreign sourced dividend is saved exterior Hong Kong and used to pay dividend into the shareholder’s offshore checking account with out being remitted to Hong Kong. The IRD has confirmed the dividend won’t be handled as used to fulfill a debt incurred in respect of a commerce or enterprise carried on in Hong Kong.
In one other instance, a taxpayer purchases uncooked supplies from an abroad provider for its enterprise carried on in Hong Kong and makes use of its foreign sourced curiosity income saved exterior Hong Kong to settle the quantity payable to the provider by an abroad checking account of the provider. In such case, the foreign sourced curiosity income might be regarded by the IRD as obtained in Hong Kong underneath the FSIE Regime, as they’re used to fulfill a commerce debt incurred in respect of the taxpayer’s enterprise carried on in Hong Kong. This is however that the provider is situated exterior Hong Kong and the debt is settled exterior Hong Kong.
Activities of pure fairness holding entities (PEHEs)
Foreign sourced curiosity, dividend or disposal achieve obtained in Hong Kong could also be exempt from tax underneath the FSIE regime if the financial substance requirement is met for the yr wherein the income accrues. The financial substance requirement can fluctuate relying on whether or not the entity is a PEHE.
Under the Amendment Ordinance, a PEHE is outlined as ‘an entity that solely holds fairness pursuits in different entities and solely earns dividends, disposal features, and income incidental to the acquisition, holding or sale of such fairness pursuits’ and the desired financial actions required of a PEHE to be carried out in Hong Kong to fulfil the financial substance requirement is ‘holding and managing fairness participations in different entities’.
The Government has clarified that borrowing cash for financing its fairness funding and incomes incidental income (e.g., alternate features) from such borrowing doesn’t disqualify an entity from being a PEHE. However, making interest-free loans to investee entities, lending surplus funds arising from foreign sourced dividends to a gaggle treasury firm or utilizing surplus funds to take part in a gaggle money pooling association to earn curiosity will disqualify it.
In its newest printed FAQs, the IRD has acknowledged that actions for holding and managing fairness participations usually embrace making selections on the holding and promoting of fairness pursuits, calculating dangers, and reviewing or revising financing association for buying the fairness pursuits.
Outsourcing preparations
Some or the entire specified financial actions that an entity is required to carry out in Hong Kong to fulfill the financial substance requirement could also be outsourced, contracted or delegated to 3rd events or group entities to carry out in Hong Kong. One of the important thing situations is that the outsourced actions should be adequately monitored and managed. For this objective, the Government has indicated that, it might be enough for a taxpayer to have an inside grasp service settlement or different correct documentation offered that the related particulars of the outsourcing association (e.g., the identities of the related events, the character of specified financial actions outsourced, the charges charged, the monitoring mechanism) are set out within the doc.
Application of the ‘topic to tax’ situation for participation requirement
To recap, the participation requirement supplies a substitute for the financial substance requirement to exempt foreign sourced dividend income and disposal features from taxation underneath the FSIE Regime. The participation exemption is topic to anti-abuse guidelines together with the ‘topic to tax’ situation, which requires the related income, income or associated downstream income to be topic to tax in a foreign jurisdiction at a fee of a minimum of 15%.
The Government has confirmed that, after vigorous alternate of views and having regard to practices in different jurisdictions, it has agreed with the EU that the ‘headline fee’ strategy, versus the ‘precise fee’ strategy, might be adopted for the aim of the ‘topic to tax’ situation. In different phrases, the relevant tax fee will usually seek advice from the headline fee (i.e., the best company tax fee) of the foreign jurisdiction, which needn’t be the precise fee imposed on the income or income involved.
However, if the income is taxed underneath a particular tax regime that’s separate from the principle tax regime of that jurisdiction, and the particular tax regime shouldn’t be a preferential tax regime for carrying on substantive actions, the ‘headline fee’ ought to be the best tax fee stipulated underneath the particular tax regime. If that ‘headline fee’ is decrease than 15%, then the ‘topic to tax’ situation wouldn’t be met.
The IRD has since up to date its steerage to mirror the above interpretation of the relevant fee. The IRD has additionally indicated that:
If the income or income involved is topic to withholding tax at a fee which is decrease than the headline company tax fee of the foreign jurisdiction (e.g., pursuant to a double taxation association), the relevant fee would be the headline company tax fee however the decrease tax fee utilized to that income or income; and
If the income or income involved is topic to tax at multiple fee (e.g., progressive tax charges) within the foreign jurisdiction, the relevant fee would be the highest tax fee utilized to that income or income.
Takeaways
As the FSIE regime has now come into operation, entities that are probably lined taxpayers ought to take speedy actions to evaluate whether or not they’re taxable, and in that case, the extent of their publicity to tax in Hong Kong underneath the new guidelines. Covered taxpayers should notify the IRD of its chargeability to tax underneath the FSIE regime inside 4 months of the top of the yr of evaluation throughout which the related income is obtained (except the IRD has issued a income tax return to the taxpayer) and retain enough enterprise information for a minimum of seven years from the date of the receipt of the related income.
Whilst plenty of welcome clarifications have been made by the Government and extra steerage has been offered by the IRD, the new guidelines stay complicated. The EU will maintain a gathering in February 2023 to determine whether or not the Amendment Ordinance has addressed the entire EU’s issues and whether or not Hong Kong might be relieved from being included within the checklist of non-cooperative jurisdictions for tax functions and faraway from the watchlist. Covered taxpayers ought to control these developments in addition to the IRD’s administrative steerage and the Departmental Interpretation and Practice Notes to be printed to evaluate any potential tax implications and search skilled recommendation as applicable.
Content is offered for instructional and informational functions solely and isn’t meant and shouldn’t be construed as authorized recommendation. This could qualify as “Attorney Advertising” requiring discover in some jurisdictions. Prior outcomes don’t assure related outcomes. For extra info, please go to: www.bakermckenzie.com/en/client-resource-disclaimer.
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