Hong Kong: Draft legislation to clarify non-taxation of onshore gains from disposal of equity interests

Draft legislation to clarify the non-taxation of onshore equity disposal gains was published in the official gazette on 20 October 2023, and on the same day, the Inland Revenue Department (IRD) published related guidance, “frequently asked questions” (FAQs), and illustrative examples on its website. 

The government on 23 March 2023 launched a consultation on a proposal to clarify the non-taxation of onshore gains from the disposal of equity interests in Hong Kong in response to concerns about the revised foreign-sourced income exemption (FSIE) regime that became effective on 1 January 2023. Read TaxNewsFlash

Under the proposal, a bright-line safe harbor would be introduced for treating certain onshore equity disposal gains as capital in nature and non-taxable, without the need to conduct the “badges of trade” analysis. For investment funds, an additional alternative option for enjoying non-taxation of their onshore equity disposal gains is the tax exemption under the unified fund exemption regime, provided that the specified conditions under the regime are met.

Following the consultation, draft legislation setting out the detailed amendments was published in the official gazette on 20 October 2023. If enacted into law, the amendments would apply to qualified onshore equity disposal gains (1) from disposals occurring on or after 1 January 2024, and (2) accrued in the basis period for the year of assessment (YOA) 2023/24 or any subsequent YOAs.

• An eligible investor entity or an eligible investee entity must be a legal person (other than a natural person) or an arrangement that prepares separate financial accounts such as a partnership, a trust, and a fund. Certain entities are excluded from being an eligible investor entity or investee entity. For example, insurers generally are not eligible investor entities, other than entities (e.g., subsidiaries of insurers) that are not chargeable to profits tax in accordance with the special tax regime for insurance businesses.
• Eligible equity interest refers to an interest that (1) carries rights to the profits, capital, or reserves of the investee entity, and (2) is accounted for as equity in the books of the investee entity under applicable accounting principles. 
  • However, eligible equity interests do not include equity interests that are “regarded as trading stock.” Equity interests are regarded as trading stock if any (1) unrealized fair value gain/loss, or (2) provision for diminution in value of such interests has been brought into account for tax purposes for a YOA.
  • Eligible equity interests also does not include non-listed equity interests in certain investee entities engaged in property trading, property development and property holding.
• Onshore gains derived from disposal of equity interests in an investee entity by an investor entity would be regarded as capital in nature and non-taxable without the need to conduct the “badges of trade” analysis if the investor entity has held at least 15% of the equity interests in the investee entity throughout a continuous period of 24 months immediately before the date of disposal of such interests.
  • For purposes of the 15% ownership threshold, the amount of equity interests held can be measured on a group basis (among “closely related” entities (i.e., one entity has more than 50% of direct or indirect beneficial interest of the other entity or is directly or indirectly entitled to exercise, or control the exercising of, more than 50% of the voting rights of the other entity, or a third entity has more than 50% 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, more than 50% of the voting rights of each of them).
  • An exception to the equity holding conditions also applies when equity interests are disposed of in tranches, that is, when the investor entity’s equity holding in the investee entity falls below 15% after one or more earlier disposal(s).
• An investor entity must elect in writing to apply the rules by providing the requisite information in its profits tax return for the YOA in which the disposal occurs.

The draft legislation introduced helpful changes from the March consultation proposal, including the ability to measure the 15% ownership threshold on a group basis and the exception when equity interests are disposed of in tranches.
 

For more information contact a KPMG tax professional:

David Ling | davidxling@kpmg.com