Hong Kong Tax Ruling: Substance Requirements for Foreign-Sourced Income Exemption
On 15 September 2023, the Hong Kong Inland Revenue released Advance Ruling Case No. 70, addressing the economic substance requirement outlined in section 15K of the Inland Revenue Ordinance (IRO) under Hong Kong’s new Foreign-Sourced Income Exemption (FSIE) regime. This regime, established by the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022, deems offshore passive income sourced from Hong Kong and subject to profits tax unless specific exemption conditions, including the economic substance requirement for interest, dividends, and disposal gains, are met.
Specified foreign-sourced income (such as interest, dividends, disposal gains, and intellectual property income) received by a member of a Multinational Enterprise (MNE) group conducting business in Hong Kong is treated as arising from Hong Kong and is taxable if received in the territory. However, certain types of specified foreign-sourced income remain exempt from profits tax if the recipient entity fulfills the Economic Substance Requirement (ESR) specified in section 15K of the IRO. These exemptions apply to interest, dividend, and non-IP disposal gain accrued on or after specific dates:
- 1 January 2023: for interest, dividend, or equity interest disposal gain.
- 1 January 2024: for non-IP disposal gain (excluding equity interest disposal gain).
To streamline processes and reduce compliance burdens, MNE entities can seek advance rulings from the Commissioner regarding their ESR compliance.
MNE entities with existing favorable rulings concerning their compliance with the ESR for foreign-sourced interest, dividends, and/or equity interest disposal gain can request an expansion of the ruling’s scope to include non-IP disposal gain (excluding equity interest disposal gain) accrued on or after 1 January 2024. The process for expanding the ruling’s scope will be communicated through letters sent to eligible MNE entities. If applicable, entities can proceed with the application for expansion according to the outlined procedures.
Eligibility Criteria:
To apply for a ruling on ESR compliance, two conditions must be met:
- The applicant must be an MNE entity conducting business in Hong Kong.
- Specified foreign-sourced interest, dividend, or equity interest disposal gain must accrue on or after 1 January 2023, or specified foreign-sourced non-IP disposal gain (excluding equity interest disposal gain) must accrue on or after 1 January 2024.
Application Timing:
Applications can be submitted at any time, covering a maximum of five assessment years starting from 2022/23 or subsequent years.
Processing Time:
Typically, it takes one month to process an application. In cases where additional information is required, applicants will be requested to provide further details.