Hong Kong Global Tax Reform 2023: what to expect?

Hong Kong is an attractive tax haven in Asia, and for many years it has been a magnet for investors from all over the world with its favorable tax environment. The territorial principle of taxation allows businessmen not to pay taxes in Hong Kong on their foreign income and thereby implement the “total tax-free” scheme.

But, this situation does not satisfy the world community, and Hong Kong began to be pressured because of the harmful and unfair tax system. Thus, under pressure from the European Union, which considers Hong Kong’s principle of territorial taxation such that it contributes to complete tax evasion, a global tax reform is coming in the country. After lengthy negotiations and in order to avoid being blacklisted by offshore jurisdictions, the jurisdiction announced its changes.

What will change?

Hong Kong plans to introduce a tax on foreign profits of multinational companies from January 1, 2023, which are now exempt from taxation.

Thus, the FSIE tax regime is introduced, providing that passive income from abroad (received in Hong Kong) will be subject to income tax. These include: dividends, interest, capital gains and profits received from the sale of shares or equity shares, royalties.

The FSIE regime will only apply to income earned in Hong Kong. Said foreign-sourced income is deemed to be earned in Hong Kong if:

– income is transferred, transferred or imported into Hong Kong;

– income is used to pay off debts incurred in connection with a trade, profession or business carried on in Hong Kong;

– income is used to purchase movable property that is imported into Hong Kong.

For whom is the FSIE regime rules for?

The new tax regime will apply to “multinational companies” that conduct business, trade or other professional activities in Hong Kong.

The concept of multinational companies includes legal entities or structures (trusts) that act as:

– a Hong Kong member of a multinational group of companies;

– happens to be a representative office in Hong Kong of a company that has representative offices in other countries.

Obligations of taxpayers

Companies that under the FSIE tax regime will be required to:

– indicate all their foreign income (sources and amount) in the tax return and the annual income assessment form;

– notify the Hong Kong Inland Revenue Commissioner that the company is subject to the FSIE and will be subject to income tax within 4 months after the annual assessment;

– for 7 years, keep all accounting records of transactions or operations that indicate income from foreign sources.

Exceptions

For the following list of persons, taxation of passive income will not be applied:

• individuals;
• resident Hong Kong companies that have minor interests in foreign companies that are not accountable in Hong Kong;
• resident companies and groups of such companies that are resident exclusively in Hong Kong and do not have representative offices or subsidiaries outside the country;
• government organizations, including pension funds;
• financial sector (banks, payment systems, companies with a financial license);
• non-profit enterprises;
• sphere of investment;
• companies with a special preferential tax regime (insurance, ship leasing, aircraft leasing, corporate treasury centers).

Substance Criteria

To avoid taxation of passive income for multinational companies, you can use the economic presence directly in Hong Kong in the year in which the corresponding profit is received.

The legislator has established different criteria for economic presence (substance) for companies that are purely shareholding (activities are only the ownership and management of assets) and for companies that are not purely shareholding (activities include risks and making strategic decisions).

For the first category of companies, it will be enough to have a minimum substance: at least one resident employee and a local office. The second requires the incurring of local operating costs, a staff of qualified employees and a resident office. It is important that outsourcing is allowed in Hong Kong.

Substance companies will receive full exemption from taxation of dividends, interest and capital gains.

Foreign participation

In addition to meeting the substance criteria, it is also possible to claim tax exemption if the multinational company complies with foreign participation requirements.

If a multinational company has continuously held at least 5% of the ownership interest for at least 12 months before accruing dividends from foreign sources, such dividends and share gains are exempt from taxation.

But, profits from the economic activities of the company that financed the dividends must be taxed in another jurisdiction at a rate of at least 15%. If the income was taxed at a lower rate, instead of a full exemption, a tax credit will be provided.

What should be done?

Under the new regime, the company independently determines whether it falls under the FSIE regime or not. In this regard, we recommend enlisting the support of lawyers to correctly establish all the criteria and develop a scheme for further work, taking into account the introduction of taxation. To mitigate the tax burden, it is possible to consider the restructuring of the company within a multinational group, or compliance with the conditions for the minimum presence of the company.

Each company will be further reviewed for compliance with substance criteria for tax purposes. During the transition period, the Hong Kong Inland Revenue Department may issue a free opinion on economic substance compliance.

In order to avoid unexpected consequences, we recommend that you prepare for these innovations and conduct a full check of your companies. For assistance in these matters, please contact our specialists.