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Covered income and covered taxpayers
The covered income under the new regime includes foreign-sourced dividend, interest, income derived from the use of intellectual property (IP income) and disposal gain accrued to and received in Hong Kong by a member of a multinational enterprise (“MNE”) group.
An MNE group is a group that includes at least one entity or permanent establishment that is not located or established in the jurisdiction of the ultimate parent entity of the group.
A foreign-sourced income is regarded as received in Hong Kong when:
- the income is remitted to Hong Kong (e.g., remitted to a Hong Kong bank account);
- the income is used to settle debt incurred in respect of a business carried on in Hong Kong; or
the income is used to buy movable property, and the property is brought into Hong Kong.
Exceptions from the Deeming Provision
If the MNE entity satisfies the exception conditions for the specific types of incomes, then the specified foreign-sourced income received in Hong Kong will not be charged. The exception requirements are as follows:
Economic Substance Requirement
An MNE entity will continue to be exempt from profits tax on foreign-sourced interest, dividends, or non-IP disposal gains received in Hong Kong as long as the economic substance criteria is satisfied for the year of assessment in which the income is received. Economic substance requirement mainly looks into the adequate number of employees, premises, operating expenses for carrying out the specified economic activities in Hong Kong.
Nexus Requirement
Certain portion of the income derived from qualifying intellectual property (qualifying IP income) can be exempt from profits tax, and that portion is referred to as “excepted portion”.
Under the nexus method, only income from a qualifying IP asset can be eligible for favorable tax treatment based on a nexus ratio which is defined as the qualifying expenditures as a proportion of the overall expenditures incurred by a taxpayer to develop an IP asset. The percentage of funds allocated to research and development (R&D) serves as a proxy for significant economic activity. This seeks to ensure that there is a direct nexus between the income receiving benefits and the expenditures contributing to that income.
Participation Requirement
An MNE entity which receives foreign-sourced dividend or equity interest disposal gain in Hong Kong can claim tax exemption using the participation requirement as an alternative to the economic substance requirement. The conditions mainly looks at whether there are any permanent establishment in Hong Kong and whether it holds not less than 5% equity interest in the investee entity for a period of not less than 12 months immediately before the foreign-sourced dividend or equity interest disposal gain accrues.
Advance Ruling on Compliance with the Economic Substance Requirement
MNE firms are encouraged to apply to the Commissioner for advance ruling on their compliance with the economic substance requirement in connection to foreign-sourced interest, dividends, and/or non-IP disposal gains in order to lessen the burden of compliance and acquire tax certainty.
Reference/ Citation
