Hong Kong FSIE Update: New Clarity on Foreign-Sourced Income
Territorial Source Principle of Taxation
- Economic substance requirement
Hong Kong will continue to adhere to the territorial source principle of taxation, and determination on the source of profits will not be affected by the introduction of the “economic substance requirement” under the FSIE regime. In other words, in-scope taxpayers can still make offshore claims and be tax-exempt so long as they meet the economic substance requirement, with the source of profits and compliance with the economic substance requirement being considered in distinct and separate contexts.
Covered Income
- Tax treatment for losses sustained from the sale of equity interests outside Hong Kong
In the case where a covered taxpayer sustains a loss from the sale of equity interests outside Hong Kong (“equity interest disposal loss”), the “equity interest disposal loss” can be used to set off against the taxpayer’s assessable profits derived from specified foreign-sourced income that is chargeable to profits tax under the FSIE regime in the year of assessment during the basis period of which the sale proceeds are received in Hong Kong if the taxpayer fails to meet the economic substance requirement and the conditions for participation exemption. Any amount of loss not so set off can be carried forward and set off against the taxpayer’s assessable profits derived from specified foreign-sourced income in subsequent years of assessment.
- Foreign-sourced disposal gain that is of capital nature
All disposal gains would fall within the scope of the FSIE regime whether or not they are capital or revenue in nature.
Compliance Requirement
- Notify the Inland Revenue Department of its receipt of specified foreign-sourced income
A covered taxpayer who receives in Hong Kong any specified foreign-sourced income to which no tax exemption is applicable will have to inform its chargeability to tax within 4 months after the end of the basis period of the year of assessment during which the income is received in Hong Kong (“year of receipt”). In the case where a Profits Tax Return for the year of receipt has been issued, the taxpayer is required to provide details of the income received in the tax return and no separate written notification is required.
- Taxpayer apply for an advance ruling
A taxpayer can apply for an advance ruling under section 88A of the IRO on whether its covered income is exempt from tax under the FSIE regime.
To obtain tax certainty and reduce compliance burden, taxpayers are encouraged to apply to the Commissioner for advance rulings on their compliance with the economic substance requirement of the FSIE regime specified in section 15K of the IRO. The application may cover a maximum of 5 years of assessment.
