Hong Kong: Latest proposals on tax certainty scheme for onshore equity disposal gains and expanded FSIE regime

The Inland Revenue Department (IRD) recently conducted two engagement sessions with stakeholders to provide an update on the proposed (1) tax certainty scheme for onshore gains from disposal of equity interests, and (2) expanded foreign-sourced income exemption (FSIE) regime to cover foreign-sourced gains from disposal of assets.   

The Hong Kong government earlier this year issued the following two consultation papers to seek input from stakeholders: 

• Consultation paper on enhancing tax certainty of onshore gains on disposal of equity interests (March 2023)
• Consultation paper on refinements to Hong Kong’s foreign-sourced income exemption regime for foreign-sourced disposal gains (April 2023)

The first consultation paper concerns a tax certainty scheme on the non-taxation of onshore equity disposal gains (i.e., tax certainty scheme) that includes a bright-line test requiring an ownership percentage of at least 15% and a holding period of at least 24 months before disposal. For more details about the government’s initial proposal on this scheme, read TaxNewsFlash.

The second consultation paper is about expanding the scope of the existing FSIE regime to cover foreign-sourced gains from disposal of assets (other than equity interests) to align with the latest guidance on FSIE regimes issued by the European Union (EU). For more details about the government’s initial proposal on this scheme, read TaxNewsFlash.

The main changes and clarifications of the proposed tax certainty scheme as compared to the one set out in the consultation paper issued in March 2023 are: 

• Definition of equity interest: In addition to being interest that carries rights to profits, capital or reserves, the interest must be accounted for as equity in the books of the investee entity.
• The 15% ownership threshold can be counted on a group basis—i.e., equity interest held by the investor entity and its closely related entities (i.e., determined based on the “control test”) can be aggregated for meeting the 15% threshold. 
• Disposal in tranches is allowed but subject to a 24-month restriction—e.g., if the investor entity had held 15% of Co A shares for 24 months and then disposed the shares in three tranches (i.e., 5% for each tranche), provided that the second and third disposals were made within 24 months from the first disposal, the tax certainty scheme can still apply to the second and third disposals even though the holding percentage is less than 15% prior to these disposals. 
• Trading stock is not to be counted for determining whether the 15% ownership threshold is met.  
• Equity interests that have previously been regarded as trading stock for tax purposes in accordance with the “badges of trade” analysis would not be eligible for the scheme. Example:

An investor entity acquired and held 200 shares in an investee entity in 2023. It disposed of 150 shares held by it in 2023 and has agreed with the IRD that the 150 shares disposed are considered trading stock and the onshore gains from the disposal are revenue in nature and taxable. Assuming the investor entity disposes of the remaining 50 shares in early 2024 and acquires another 100 shares in late 2024. It would appear that the 50 shares disposed of in early 2024 would be regarded as “being previously regarded as trading stock for tax purpose” whereas the 100 shares newly acquired in late 2024 would not be regarded as such.

• The tax certainty scheme would be applicable to cases involving a change of intention from trading stock to a capital asset provided that the following two conditions are met: 
  • The market value of the interest as at the date of change has been brought into accounts for profits tax purpose (e.g., under section 15BA of the Inland Revenue Ordinance) 
  • The 15% ownership threshold and the 24-month holding period requirements are met after the date of change of intention
• The following two enhancements would be made in relation to the exclusion from the scheme of non-listed investee entities engaging in property development:
  • Immovable property will be defined to exclude “infrastructure”
  • Meaning of property development will exclude renovation or refurbishment of a building with a view to maintaining the commercial value of a building
• The exclusion from the scheme of non-listed investee entities engaging in property holding would also be enhanced by carving out the immovable property held for carrying on its own trade or business (including business of letting immovable property) when determining whether the investee entity is a “property-rich” entity (i.e., whether the value of immovable property held by the investee entity exceeds 50% of the value of the entity’s total assets).
• When determining the 50% threshold, an approach similar to the one under the existing unified fund exemption regime would be adopted—i.e., both direct and indirect holding of immovable property (via another entity) will be taken into account. 
• An investee entity would only be subject to the exclusion and the applicable rules of either “property development” or “property holding” activities but not both at the same time. 
• The tax certainty scheme only applies to disposal of equity interest but not other types of assets. 

The main changes and clarifications of the proposed expanded FSIE regime as compared to the one set out in the consultation paper issued in April 2023 are:

• The carve-out for disposal gains of traders would apply to both disposal gains on equity interests and other types of assets but not intellectual property (IP) assets (when the nexus requirement applies) once the expanded FSIE regime becomes effective (i.e., from 1 January 2024 onwards).  
•  A trader refers to a person who sells, or offers to sell, property in its ordinary course of trade.
• The proposals for (1) rebasing the cost of the asset disposed, (2) a taper relief and (3) other measures of reducing the tax liabilities on the disposal gains have been rejected by the EU. 
• Intra-group relief:
  • The IRD will consider accepting other means of fulfilling the 75% threshold for association in addition to by means of issued share capital.
  • The relief will be revoked if these two conditions are not met: (1) both the transferor and the transferee are within the charge to Hong Kong profits tax for six years after the transfer, and (2) the transferor and the transferee remain associated for two years after the transfer. 

The government plans to introduce the tax bills on the two regimes to the Legislative Council in October 2023, with an aim to enact the bills by the end of this year and for the two regimes to take effect from 1 January 2024. 
 

For more information contact a KPMG tax professional:

David Ling | davidxling@kpmg.com