Hong Kong: Tax authority’s views on various issues relating to profits tax, including FSIE regime

The minutes of the 2023 annual meeting between the Hong Kong Institute of Certified Public Accountants (HKICPA) and the Inland Revenue Department (IRD) were recently published. The minutes summarize the IRD’s views on various issues related to profits tax (including the foreign-sourced income exemption (FSIE) regime) and salaries tax that were discussed during the meeting. 

With respect to the profits tax, the IRD expressed views regarding:

• Whether the “provision of credit” test or the operation test must be applied to determine the source of interest income
  • The operation test must apply when the loan is not a “simple loan of money.”
  • In general, the IRD would only accept mere lending of its own surplus funds by a company (which is not carrying on a business of a financial institution, money lending or intra-group financing) as a “simple loan of money.”
  • The fact that a loan is one-off does not necessarily mean it is a “simple loan of money” or that the operation test could not be applied.
  • When a one-off loan involves borrowing and on-lending of funds, it would be surprising to solely consider the place of lending, to the exclusion of the place of borrowing, in determining the source of the interest income.
• Clarifications on practical application of the FSIE regime, including the economic substance requirement, the subject to tax condition, and the interpretation of “received / deemed received in Hong Kong”
• Taxation of electronic commerce (e-commerce) business models
  • The IRD indicated that the location of the server is not the sole determining factor for the locality of the profits of e-commerce businesses and the proper approach is to focus on (1) the core operations that have affected the e-commerce transactions to earn profits and (2) the place where those core operations have been carried out. If all the core operations and support activities of a platform-based operator are performed in Hong Kong, the e-commerce profits should be fully chargeable to Hong Kong profits tax even though the server is located outside Hong Kong.
  • The IRD considered that the core operations of e-commerce business models may include (1) user network promotion (e.g., developing network relationships between suppliers and consumers or viewers and advertisers) and customer contract management, (2) provision of services associated with establishing, maintaining and terminating links between users and (3) network infrastructure operations associated with maintaining and running a physical and information infrastructure. 
  • The IRD also mentioned it would consider updating DIPN 39 on taxation of e-commerce after any implementation of Pillar One in Hong Kong.
• Tax treatment of founder/promoter shares of special purpose acquisition companies (SPACs)
  • The IRD indicated that the tax treatment of founder/promoter shares of SPACs would depend on the circumstances under which the shares were granted, in particular the terms and conditions governing the grant and the obligations performed by the founders/promoters. If the shares are regarded as a capital investment, any gains arising from the shares would be capital in nature and non-taxable. If the shares are regarded as payments for services rendered by the sponsors/promoters, the relevant gains would be regarded as service income for salaries tax or profits tax purposes (depending on whether the remuneration was derived from an employment or a business). 
• Dividends or profits distributions received from a tax-exempt fund
  • The IRD confirmed that dividends or profits distribution from a tax-exempt fund under the unified fund exemption regime would be regarded as tax-exempt income in the hands of the recipients.
• Tax deduction of lease reinstatement costs
  • The IRD reiterated that it does not intend to provide a concessionary deduction of lease reinstatement costs given that they are capital in nature.

For more information contact a KPMG tax professional:

David Ling | davidxling@kpmg.com