In October 2021, the European Union included Hong Kong within the listing of Non-Cooperative Tax Jurisdictions (or the watchlist) due to the priority over double non-taxation of foreign-sourced passive income below Hong Kong’s international supply income exemption regime. In response, the Hong Kong authorities proposed a draft laws to refine Hong Kong’s international supply income exemption regime for passive income to forestall cross-border tax evasion. This modification invoice will be launched to the Legislative Council in October 2022 and is predicted to come into power on 1 January 2023 with no grandfathering association (i.e., no transitioning interval). The following abstract is predicated on the newest proposals (the “Reforms”), however these particulars are nonetheless topic to an ongoing session course of.
What are the proposed refinements?
Certain offshore passive income will be deemed to be sourced from Hong Kong and therefore chargeable to earnings tax
Under Hong Kong’s territorial supply precept of taxation, offshore passive income could also be exempted from Hong Kong tax if on the details such income was not sourced from Hong Kong. If these reforms are launched within the present proposed kind, offshore passive income that’s curiosity, mental property (“IP”) income, dividends or disposal good points will be deemed to be sourced from Hong Kong and topic to earnings tax (collectively, “in-scope income”) if:
(a) the income is obtained in Hong Kong by a constituent entity of a multinational enterprise group; and
(b) the recipient entity fails to meet sure financial substance necessities (additional defined beneath) or fails to adjust to the nexus strategy if the income is IP income.
Aside from such in-scope income, it is proposed that different kinds of passive income could proceed to be exempted from Hong Kong earnings tax if really sourced exterior Hong Kong on the details.
Requirement of ample financial substance
Non-IP in-scope offshore passive income obtained in Hong Kong will proceed to be exempted from earnings tax if the taxpayer carries out substantial financial actions (“related actions”) in Hong Kong. For a taxpayer that isn’t a pure fairness holding firm, it is proposed that the related actions will embrace making vital strategic selections, and managing and assuming principal dangers for the corporate’s property. For a pure fairness holding firm, the related exercise will solely embrace holding and managing its fairness participation and complying with the Hong Kong company regulation submitting necessities. Although taxpayers could outsource the related actions, they’d nonetheless have to exhibit ample monitoring and such actions needs to be carried out in Hong Kong and never used to circumvent the financial substance requirement.
To meet the financial substance requirement, the Inland Revenue Department (“IRD”) could take a look at the variety of certified staff and ample quantity of working expenditure incurred in Hong Kong. The IRD will additionally think about the totality of details of every case, such because the enterprise nature, operation scale, profitability, roles and different particulars of staff, and the quantity and kinds of working expenditure incurred.
Please observe that below the present proposal there could be a unique “nexus check” relevant for sure IP income to qualify for preferential therapy. Only income from qualifying IP property can obtain preferential tax therapy, however this class solely covers patents and different IP property with equal capabilities. Marketing-related IP property similar to trademark and copyrights are excluded from preferential tax therapy. Further, the preferential therapy will be primarily based on a ratio of how a lot qualifying expenditures similar to analysis and improvement expenditures are immediately related to the qualifying IP asset and its qualifying income.
Introduction of participation exemption for offshore dividends and disposal good points
Under the proposed Reforms, income from offshore dividends and disposals will be exempted from earnings tax of inscope income if the next 3 components are happy:
(a) the investor firm is a Hong Kong tax resident (e.g., firm included in Hong Kong or usually managed or managed in Hong Kong) or a non-Hong Kong resident individual that has a everlasting institution in Hong Kong;
(b) the investor firm holds a minimum of 5% of the shares or fairness curiosity within the investee firm; and
(c) not more than 50% of the income derived by the investee firm is passive income.
However, observe that the participation exemption is topic to the next anti-abuse guidelines:
– Switch-over rule: if the dividend income or earnings of the investee firm is or are topic to lower than 15% tax in a international jurisdiction, the tax reduction would change to international tax credit score and the investor firm will stay topic to Hong Kong earnings tax, however with a deduction of international tax paid attributable to the income / earnings involved.
– Main objective rule: any preparations which were put into place for (considered one of) the primary objective(s) of acquiring a tax benefit and isn’t real, will defeat the aim of exemption and will be ignored.
– Anti-hybrid mismatch rule: participation exemption will not apply to the extent that the dividend cost is deductible by the investee firm.
The IRD additionally plans to introduce unilateral tax credit score for in-scope offshore passive income to keep away from double taxation to complement the present double taxation reduction.
How will the reform affect you?
The proposed reform will not be relevant to lively income, native corporations with no offshore operations and people. On the opposite hand, in-scope income could be deemed sourced from Hong Kong and be topic to earnings tax. Enterprises with international sourced passive income ought to verify with their tax advisers whether or not they will have ample financial substance for his or her passive income or whether or not they will fall inside any participation exemption to ensure that their in-scope income to stay exempt from earnings tax in Hong Kong.
Though we await additional particulars on the Reform, we might advocate multinational enterprise teams to evaluation their present constructions forward of 2023. Stephenson Harwood is a number one regulation agency that includes company, business, tax, enterprise regulation and regulatory practices in Hong Kong.