IRD Provides Further Guidance on FSIE Issues
Territorial Source Principle of Taxation
- Share of profits from investment in overseas associate
Under the equity method of accounting, an investment in an associate is initially recognized at cost. The carrying amount is then adjusted to recognize the investor’s share of the associate’s profits or losses, with a corresponding amount recognized in the investor’s income statement. A taxpayer’s sharing of profits of an associate recognized by an investor does not render the investor as having earned any of the profits as a dividend before the associate actually declares the earnings as a dividend.
- Deduction for expenses related to disposal gain
For earning a taxable “disposal gain”, any direct costs incurred would generally be tax deductible. However, under section 17(1)(c) of the Inland Revenue Ordinance (IRO), indirect costs that are “capital in nature” would still be disallowable.
- Redemption of bonds and conversion of convertible bonds into equity interest
Under the FSIE regime, a “disposal gain” means any gain or profits derived from the sales of property, while “sales” refers to a transfer of property for valuation consideration. Redemption of bonds and conversion of convertible bonds into equity interest would not be treated as a “sale” and therefore not a “disposal gain”. However, the difference between the redemption price and the cost of a zero-rated bond issued at a discount would be “interest”.
- Receipt of foreign-sourced in-kind dividend in the form of shares in an overseas entity
A covered taxpayer received shares in an overseas entity as an in-kind dividend from its foreign subsidiary and then distributed those shares to its Hong Kong parent company. The investee entity is incorporated outside Hong Kong, its central management and control are exercised outside Hong Kong, and it has no operations or staff in Hong Kong. Generally, in-kind dividends in the form of shares in an overseas subsidiary that has no economic relationship with Hong Kong would not be treated as the taxpayer having “received” the dividend by way of the shares being brought into Hong Kong.
