FSIE: foreign-sourced passive income received in Hong Kong

Background

Responding to EU concerns over double non-taxation of passive income, Hong Kong has since 1 January 2023 operated the refined FSIE regime: specified foreign-sourced income received in Hong Kong by a multinational enterprise entity is chargeable to profits tax unless an exemption condition is met.

Covered income and commencement

Foreign-sourced interest, dividends and IP income have been covered since 1 January 2023, together with disposal gains from assets other than equity; disposal gains from equity interests (capital or revenue in nature) since 1 January 2024 (see table).

“Received in Hong Kong”

Section 15K deems three situations to be receipt in Hong Kong: the income is remitted to Hong Kong; used to satisfy a debt incurred in Hong Kong; or used to purchase movable property subsequently brought into Hong Kong. Foreign dividends and interest left in a holding company’s Hong Kong accounts will normally fall within the first limb.

FSIE: covered income and commencement

The three exemptions

(1) Economic substance (interest/dividends/disposal gains): an entity other than a pure equity-holding entity must carry on adequate specified economic activities in Hong Kong — adequate employees and operating expenditure, and the making of necessary strategic decisions; a pure equity-holding entity faces a reduced test (compliance and accounting, plus adequate human resources and premises in Hong Kong). (2) Participation exemption (dividends and equity disposal gains): a holding of at least 5%, with the investee’s passive income not exceeding 50% of total income; equity disposal gains additionally require a holding of at least 5% for a continuous period of 24 months before disposal. (3) Nexus (IP income): the nexus-fraction test, with more-than-de-minimis non-related income taking the claim outside the exemption.

Consequences of failure

Foreign income received in Hong Kong without a satisfied exemption is taxed in full to profits tax; arrangements lacking economic substance may also attract the general anti-avoidance rule (s.61A). An intermediate holding company with nominee directors and no matching people or spend will struggle on the substance test.

FSIE and offshore claims

FSIE governs foreign passive income received in Hong Kong; an offshore claim governs whether trading profits are Hong Kong-sourced. A group may face both: trading profits under the DIPN 21 source test, foreign dividends and interest under the FSIE exemptions.