Hong Kong: Draft legislation on expansion of FSIE regime to asset disposal gains; updated guidance on FSIE regime

Draft legislation to expand the existing foreign-sourced income exemption (FSIE) regime to cover gains from disposal of assets was published in the official gazette on 13 October 2023, and on the same day, the Inland Revenue Department (IRD) updated its guidance on the FSIE regime.

The existing FSIE regime in Hong Kong that became effective 1 January 2023 covers interest, dividends, equity interest disposal gains and income from use of intellectual property (IP).

As a result of the EU updating its guidance on FSIE regimes in late 2022 and explicitly requiring such regimes to cover gains from disposal of all types of assets, the government launched a stakeholder consultation in April 2023 regarding the necessary changes to the existing FSIE regime to include other asset disposal gains in addition to equity interest disposal gains. Read TaxNewsFlash

Following the consultation, draft legislation setting out the detailed amendments to the Inland Revenue Ordinance (IRO) for implementing the expanded FSIE regime was published in the official gazette on 13 October 2023. If enacted into law, the expanded FSIE regime would be effective from 1 January 2024.

The key amendments to the existing FSIE regime proposed in the draft legislation include:

• Expanded scope of covered income would include foreign-sourced gains from disposal of all types of assets (i.e., movable property and immovable property).
  • The draft legislation does not set out a definitive list of covered assets as the EU has indicated that a non-exhaustive approach must be adopted.
  • No definition of “immovable property” or “movable property” is included in the IRO but based on the Legislative Council Brief on the bill, reference can be made to the definition of these two items in the Interpretation and General Clauses Ordinance. 
• Full amount of disposal gains or losses computed based on historic acquisition costs of the disposed assets would be within the scope of the expanded FSIE regime.  
• Foreign-sourced non-IP disposal gains which are derived from, or incidental to, an entity’s business as a trader would be carved out from the scope of the FSIE regime.
  • A trader is defined as an entity that sells, or offers to sell, property in the entity’s ordinary course of business.
  • Unlike the proposal in the April consultation, such active business income of traders would be excluded without the condition that the disposal gains form part of the income derived from substantial business activities in Hong Kong.
• An intra-group transfer relief would be introduced under which taxation of all foreign-sourced disposal gains (including equity interest disposal gains) received in Hong Kong from a sale of an asset within a group would be deferred until the time when the asset leaves the group, so long as the selling entity and the acquiring entity are at the time of the sale both chargeable to Hong Kong profits tax and associated with each other.
  • Two entities would be considered “associated” for this purpose if one entity has at least 75% of direct or indirect beneficial interest of the other entity or is directly or indirectly entitled to exercise or control the exercising of at least 75% of the voting rights of the other entity, or a third entity has at least 75% of direct or indirect beneficial interest of each of the two entities or is directly or indirectly entitled to exercise or control the exercising of at least 75% of the voting rights of each of them.
• As a transitional measure and before the enactment of the bill, taxpayers can either apply for a separate Commissioner’s opinion on their compliance with the economic substance (ES) requirement in respect of foreign-sourced gains from disposal of the proposed added assets by completing Form IR1297C or if the taxpayer has already obtained a favorable Commissioner’s Opinion on compliance with the ES requirement under the FSIE regime before, it can apply (subject to certain conditions) for expanding the scope of the opinion obtained to cover the disposal gains from the added assets by completing Form IR1297D.
  • Upon passage of the bill and the coming into operation of the Amendment Ordinance, the above transitional measure would cease to apply and advance ruling can be applied in respect of compliance of the ES requirement.
  • Further information on advance ruling / expanding the scope of the advance ruling obtained before will be provided by the IRD upon the enactment of the Amendment Ordinance.

Other existing features of the FSIE regime remain unchanged, including: (1) only consolidated entities within a multinational enterprise (MNE) group as defined will be covered taxpayers, (2) the income exclusion approach for regulated financial entities and taxpayers benefitting from certain preferential tax regimes in Hong Kong, (3) ES requirement, (4) the participation requirement and (5) the nexus approach for IP income.

For more information contact a KPMG tax professional:

David Ling | davidxling@kpmg.com