The Foreign Source Income Exemption Rule (FSIE)
Welcome to our introductory video on the Foreign Source Income Exemption Rule (FSIE). FSIE is the most important tax reform in Hong Kong for Year 2022 as it has significant impact on Hong Kong’s famous source-based taxation principle starting from 1 January 2023. In short, additional requirements have been imposed for Hong Kong entities to pursue offshore claim on certain income. In this video, we will be highlighting all the important elements of the FSIE regime.
First of all...Type of Income under the refined FSIE regime... below are the four types of income subject to additional rules, namely Interest Income, Dividend Income, Disposal Gains from Equity Interest and Intellectual Property Income. Other income like trading profits and service income are not covered in FSIE regime.
The basic rule of the FSIE regime is that it targets at Hong Kong constituent entity of MNE groups only when its passive income is received in Hong Kong. The definition of “Received in Hong Kong” is important and requires more clarifications from the IRD. On the other hand, the IRD promises if the relevant income is subject to both profits tax in Hong Kong due to FSIE Regime and tax of similar nature in other tax jurisdiction, tax credit will be available in Hong Kong, no matter if the counterparty is a DTA partner or not.
In order to pursue offshore claim, taxpayers still have to fulfill the source rule for each type of income. From Year 2023 onward, they have to further fulfill different requirements under FSIE Regime so as to be exempted from Hong Kong profits tax.
First, the Economic substance rule, which is applicable to the Interest Income, Dividend Income, and Disposal Gains from Equity Interest. Taxpayers are required to meet the “adequacy test” to successfully pursue offshore claim. The adequacy test requires taxpayers to employ adequate number of qualified employees and adequate amount of operating expenditures in Hong Kong in relation to the relevant activities. If the Hong Kong company does not maintain any Hong Kong directors or employees, it is unlikely that the Economic Substance Requirement can be fulfilled.
Second, Participation Exemption. For dividend income and disposal gains, even if taxpayers cannot fulfill the Economic substance rule, they are still eligible to pursue offshore claim in Hong Kong if they meet all the requirements under the Participation Exemption. For example, the Income Recipient has to hold at least 5% of the shares or equity interest in the investee company, and no more than 50% of the income derived by the investee company could be passive income. You may refer to the Screen for more detailed requirements.
Third, the Nexus Approach, which applies to income from patents and other IP of similar nature only. Taxpayers are required to use the Nexus formula to calculate the IP income qualifying for non-taxable claim under the FSIE regime /as shown in this Screen. In order to qualify as Qualifying Expenditure, location requirements have to be fulfilled.
This is the end of this introductory video. With offshore claim serving as a significant part of MNE group tax planning, the proposed FSIE regime is going to dramatically affect MNE groups. It is therefore important to perform a Health Check to find out the potential problems and possible solutions before the enforcement on the FSIE regime in Year 2023. Our Tax Advisors are prepared to have a meeting with you, providing your business with some tailor-made advice.