Hong Kong’s 2023 Foreign-Sourced Income Exemption (FSIE) Rules

In 2021, the European Union (EU) added Hong Kong to its tax “grey list,” mainly because Hong Kong did not impose taxes on foreign-sourced income. To be removed from the grey list, the Hong Kong government passed the 2022 Taxation (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance in December 2022. Under the new FSIE regime, only foreign-sourced income that meets specific requirements can qualify for tax exemption. Before the FSIE rules, most foreign-sourced income was exempt from taxation in Hong Kong.

Despite the amendment, the EU refused to remove Hong Kong from the grey list in February 2023 and imposed additional requirements. After nearly a year of deliberation, the Hong Kong government gazetted the 2023 Taxation (Amendment) (Taxation on Disposal Gains) Bill (referred to as the 2023 FSIE) on October 13, 2023, to address the EU’s new demands. The new rules will take effect on January 1, 2024. The implementation of the 2023 FSIE means that it will become even more challenging for Hong Kong businesses to obtain tax exemptions on foreign-sourced income.

A government spokesperson commented on the 2023 FSIE:

“As a staunch supporter of international tax cooperation, Hong Kong has been working closely with the EU and other international organizations to combat cross-border tax avoidance. The legislative proposals align Hong Kong’s foreign-sourced income exemption regime with international tax standards by requiring taxpayers to have substantial economic activities in Hong Kong to qualify for tax exemption on foreign-sourced disposal gains. These measures also prevent shell companies from exploiting double non-taxation on foreign-sourced disposal gains to gain tax advantages. With the implementation of these enhancements, Hong Kong’s tax system will remain competitive, and the territorial source principle of taxation will be preserved. Most taxpayers, including individuals, standalone local companies, and purely local groups, will not be affected. Once the necessary legislative amendments are completed, we will urge the EU to promptly remove Hong Kong from its grey list.”

The EU’s new demands stem from its December 2022 update to the Guidance on Foreign-Sourced Income Exemption Regimes, which expanded the scope of assets subject to economic substance requirements to include assets beyond shares or equity interests. Fortunately, active income from foreign sources remains unaffected. Additionally, non-IP disposal gains derived from or incidental to the business of traders or regulated financial entities, or those benefiting from existing tax incentives, will be excluded from the scope of the 2023 FSIE.

One pleasant surprise in the 2023 FSIE is the introduction of intra-group transfer relief for disposal gains. If the assets are transferred between related entities and meet specific anti-abuse rules, the tax on disposal gains can be deferred.

Let’s take a closer look at the key provisions of the 2023 FSIE.