Under FSIE, is your investment income still tax-free in Hong Kong?
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August 2025 | ONC Lawyers
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Introduction
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The Hong Kong Inland Revenue Department (“IRD”) has continued to refine its administration of the Foreign-Sourced Income Exemption (“FSIE”) regime, most recently issuing new Frequently Asked Questions (“FAQs”) on 24 July 2025. These clarifications are highly relevant for multinational enterprise (“MNE”) groups, as they directly influence the tax treatment of dividends, disposal gains, bond transactions, and in-kind dividends.
The FSIE framework, however, has been evolving since its implementation in 2023 to align with international tax standards, particularly the European Union’s (“EU”) requirements on economic substance and the OECD’s BEPS 2.0 initiative. Refinements effective 1 January 2024 further expanded the scope of covered income to include non-equity disposal gains, tightening compliance requirements for corporate taxpayers.
This article consolidates insights from the IRD’s July 2025 FAQs and earlier IRD guidance, offering a holistic perspective on the FSIE regime’s development, clarifications, and implications.
1. Background to the FSIE Regime in Hong Kong
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Hong Kong’s tax system is traditionally territorial, taxing only income arising in or derived from Hong Kong. To address international pressure and safeguard its competitiveness, Hong Kong introduced the FSIE regime to tax foreign-sourced passive income received in Hong Kong, unless exemption conditions are met.
The original regime applied to four categories of income:
• Interest.
• Dividends
• Disposal gains from the sale of equity interests
• Intellectual property (IP) income
Following refinements in 2024, the scope was extended to include non-equity disposal gains, reflecting international expectations of
fairness and anti-abuse. The framework now sits at the heart of Hong Kong’s corporate tax system, balancing its low-tax positioning
with global compliance standards.
2. Key Clarifications from the IRD (July 2025 FAQs and Earlier Guidance)
2.1 Share of Profits from Overseas Associates Is Not a Dividend.
IRD’s Position: Profits recorded under the equity method (HKAS 28) are not treated as dividends for FSIE purposes. Only actual distributions count as dividends.
Implication: Companies must carefully track actual cash or in-kind distributions, not accounting entries, to determine FSIE exposure.
2.2 Deductibility of Expenses Relating to Disposal Gains
IRD’s Position: Expenses directly linked to generating disposal gains (e.g., legal fees, brokerage, stamp duty) are deductible, while capital expenditures remain non-deductible.
Implication: Businesses must maintain detailed documentation to distinguish between capital vs. revenue expenditures, especially in M&A or restructuring scenarios.
2.3 Bond Transactions and Convertible Instruments
IRD’s Position:
• Bond redemption gains are not disposal gains but may be taxed as interest..
• Gains on zero-rated bonds are treated as interest income.
• Conversion of bonds into equity is not a sale; however, subsequent equity disposals are taxable, with bond cost carried over as base cost.
Implication: MNEs with complex treasury portfolios should reassess tax accounting and may need to seek advance rulings to clarify
grey areas.
2.4 In-Kind Dividends and Source of Receipt
IRD’s Position: Distribution of shares in an overseas entity to a Hong Kong company will not be treated as “received in Hong Kong” if the investee has no Hong Kong presence or management.
Implication: Taxpayers must assess the economic nexus of in-kind dividends rather than their form, particularly in group reorganizations and intra-group distributions.
2.5 Clarification on “Received in Hong Kong”
Beyond in-kind distributions, the IRD clarified that income is “received in Hong Kong” only where it is remitted, used, or credited in Hong Kong. Mere booking in financial accounts does not suffice.
Implication: This reinforces the principle that substance and actual receipt drive FSIE taxability.
3. Compliance and Substance Requirements
For foreign-sourced income to remain exempt, taxpayers must satisfy substance or participation requirements:
• Adequate local business presence (people, premises, and expenditure).
• For participation exemption, sufficient ownership in foreign subsidiaries.
The IRD emphasizes meticulous record-keeping, including:
• Dividend declarations
• Bond agreements and redemption records
• Expense allocations for disposals
• Evidence of overseas management and control
This mirrors international practices, aligning Hong Kong with the EU’s substance-based tax frameworks.
4. Practical Implications for Multinational Enterprises
• Accounting vs. Tax Events: FSIE taxation hinges on actual receipts, not accounting entries.
• Timing of Substance: Conditions must be met in the year of accrual or declaration, not retrospectively.
• Complex Financial Instruments: Hybrid and convertible instruments create timing and classification challenges, requiring proactive planning.
• Expense Classification: Distinguishing capital vs. revenue is vital to avoid disallowed deductions.
• Documentation Burden: Robust tracking systems are essential for compliance.
ONC Tax highlights that refinements in 2023–24 have raised the compliance burden, particularly for MNEs with cross-border treasury and
financing structures.
5. Recommendations by ONC Lawyers
• Seek Advance Rulings: Especially where hybrid instruments or in-kind dividends create ambiguity.
• Align Group Policies: Standardize dividend flows, intercompany agreements, and reporting practices across global operations.
• Update Internal Controls: Ensure coordination between tax and finance functions to track real economic flows.
• Prepare for Future Guidance: The IRD is expected to issue further examples and clarifications in response to evolving business models and international feedback.
Conclusion
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The IRD’s July 2025 FAQs mark another important step in clarifying the scope and operation of the FSIE regime. While greater certainty now exists for dividends, disposal gains, bonds, and in-kind distributions, the regime continues to pose challenges for businesses with complex offshore structures.
By aligning tax policies with global standards while maintaining its territorial system, Hong Kong seeks to balance competitiveness with compliance. Businesses that proactively adapt — with strong documentation, substance, and professional advice — will be best placed to ensure compliance and optimise their international tax position.
For tailored advice on Hong Kong tax structuring, contact the ONC Tax Advisory team.
