Changes proposed to foreign-source income exemption for passive income

The Hong Kong government recently wrapped up a public consultation on proposals to modify the offshore tax regime that applies to foreign dividends, interest, royalties and gains on the disposal of shares. The Financial Services and Treasury Bureau released a consultation paper on 4 July 2022 that set out proposals that would amend the foreign-source income exemption regime for passive income.

Hong Kong operates a territorial basis for taxing profits derived from a trade, profession or business carried on in Hong Kong, as a result of which profits derived from outside Hong Kong are not subject to tax.

The proposed changes are in response to the EU’s inclusion of Hong Kong on its grey list of noncooperative jurisdictions for tax purposes due to concerns that the foreign-source income exemption may give rise to double nontaxation, and hence, the regime is considered “harmful” by the EU. The EU grey list is used for jurisdictions that do not yet comply with all international tax standards but have committed to implementing tax good governance principles (for prior coverage, see the article in the November 2021 issue of Corporate Tax News). Hong Kong has committed to amend its rules by 31 December 2022.

The government has proposed that foreign-source passive income in the form of dividends, interest, IP income or gains from the disposal of shares would be deemed to be sourced from Hong Kong and chargeable to profits tax where the income is received in Hong Kong by a constituent entity of a multinational group, irrespective of where the entity is headquartered or its revenue or asset size, and the income recipient fails to meet an economic substance requirement or fails to comply with the “nexus” approach (for IP income). Other offshore passive income would continue to be exempt from tax in Hong Kong. Aside from these changes, Hong Kong will continue to operate its territorial tax system for trading profits and service income and to continue to apply its low rate of profits tax.

Draft legislation is expected to be presented to Hong Kong’s Legislative Council in October, with the enacted changes taking effect on 1 January 2023.

Agnes Cheung
agnescheung@bdo.com.hk

Abigail Li
abigailli@bdo.com.hk