Summary
The Hong Kong Inland Revenue Department (IRD) recently released further guidance on various aspects of the foreign-sourced income exemption (FSIE) regime, including the covered income, economic substance requirement and the participation requirement.
In this tax alert, we summarise the key points of the additional guidance and share our observations.
On 5 July 2024, the IRD updated the frequently asked questions 1(FAQs) and illustrative examples 2 on its webpage on the FSIE regime. In this round of updates, the IRD added 6 FAQs and 2 illustrative examples which are marked as NEW on the webpage.
The new FAQs on the FSIE regime
We summarise in the table below the topics and issues covered by the newly added FAQs.
FAQ |
Topic |
The IRD’s views / guidance |
---|---|---|
9 |
Covered income |
For unremitted specified foreign-sourced income (FSI) used to purchase an overseas movable or immovable property which is subsequently disposed of:
|
KPMG observations This treatment is similar to that adopted by Singapore for its FSIE regime, as reflected in the explanatory notes on the standard template for foreign income tracking schedule issued by the Inland Revenue Authority of Singapore3 for tax filing purposes. |
||
25 |
Economic substance (ES) requirement |
|
26 |
An MNE entity which had held both debts and equity interests during part of the basis period of a YOA is not a pure equity holding entity in that YOA even if the MNE entity disposed of all the debts before the end of that YOA. |
|
KPMG observations MNE entities should be mindful of the relevant YOA in which the ES requirement needs to be met - i.e. the YOA in which the specified FSI is accrued despite the taxing point is when the income is received in Hong Kong. |
||
28 |
Participation requirement |
|
29 |
If no tax is charged by a foreign jurisdiction on the equity disposal gains due to the tax exemption under the participation exemption regime in that jurisdiction, the “subject to tax” condition will not be regarded as met. |
|
30 |
Example: Foreign-sourced dividends of $100 are distributed from the underlying profits that are composed of (i) $80 of which the “subject to tax” condition is met and (ii) $20 tax-exempt income of which the “subject to tax” condition is not met. The “subject to tax” condition is not met with respect to the whole $100 of foreign-sourced dividends. No apportionment approach can be adopted to treat the subject-to-tax condition as being met in respect of the $80 dividends. |
|
KPMG observations
|
The new illustrative examples on the FSIE regime
The 2 newly added illustrated examples are Examples 33 and 38. Example 33 demonstrates the computation of the nexus fraction when there is an intra-group transfer of the qualifying intellectual property and a claim on the intra-group transfer relief under the FSIE regime has been made. Example 38 demonstrates the application of the “subject to tax” condition under the participation requirement when an intra-group transfer of equity interests is involved and for the subsequent disposal of the equity interests outside of the group, the MNE entity derives an accounting loss but a disposal gain for FSIE purpose because of an adjustment made to its acquisition cost due to a claim on the intra-group transfer relief made by the group company selling the equity interests to it.
KPMG Observations
The updated FAQs and illustrative examples on the FSIE regime provide further guidance on how the IRD administers the regime in practice. In addition to this guidance, the IRD may issue a Departmental Interpretation and Practice Note on the FSIE regime at a later stage.
Business groups in Hong Kong should take note of the further guidance issued by the IRD on the FSIE regime, revisit the Hong Kong and overseas tax positions of their specified FSI and consider whether any actions are required to optimise the overall tax outcome.
1 Please refer to https://www.ird.gov.hk/eng/faq/fsie.htm
2 Please refer to https://www.ird.gov.hk/eng/tax/fsie_example.htm#a04
3 For more details, please refer to https://www.iras.gov.sg/media/docs/default-source/uploadedfiles/pdf/explanatory-notes-(final)(v2).pdf?sfvrsn=9554a8d2_13
4 Based on the current wording of section 15N(2) of the IRO, the amount, or the aggregate amount, of the underlying profits or related downstream income of the profits meeting the "subject to tax" condition has to be equal to or larger than the amount of the foreign-sourced dividends.
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