Press Room

28 Feb 2023

Hong Kong: Highlights of the New Foreign Source Income Exemption Regime – Chimezirim Echendu


On the 1st of January 2023, Hong Kong’s (HK) new regime for foreign source income came into effect. The regime seeks to align the preferential foreign source income regime with economic presence, following pressure from the EU.

As might be expected, the Foreign Source Income Exemption (FSIE) covers foreign source interest, dividends, gains from the disposal of equities and income from intellectual property. However, foreign source income of certain entities will not qualify for the exemption. The excluded entities include those offering regulated financial services, such as insurance, banking, and securities trading.

The new regime applies only to multinational enterprises (MNE). A group is formed, per the legislation, where one entity or permanent establishment (PE) of the group is located in a jurisdiction different from that of the ultimate parent entity.

Any legal person (other than a natural person) and any “arrangement” that prepares separate financial accounts, such as partnerships and trusts, can all qualify as “entities” under the legislation. Furthermore, PE’s of an entity of the MNE group, or an agent of the group, will also qualify as an “MNE entity” for the purpose of the legislation.

Deemed Domestic Income

Foreign source income received by a group entity carrying on a profession, trade or business in HK will be deemed to be domestic source income and chargeable to tax in HK unless the group entity is able to meet certain requirements.

The requirements differ depending on the nature of the foreign source income received in HK.  Thus, for foreign sourced interest, the income will be tax exempt if the entity meets the economic substance requirement (ESR). In relation to dividends and gains from the disposal of equities, HK domestic tax will not apply where the entity meets either the ESR or the participation requirement (PR). Finally, for Intellectual Property (IP) income, foreign source income will be exempt from domestic tax if the entity satisfies the nexus requirement (NR).


The ESR is met in relation to a “pure equity-holding” entity if the company has fulfilled the gamut of its domestic registration and filing requirements and has adequate personnel and premises to manage its shareholding in other entities. Furthermore, a “non pure equity-holding entity” will meet the ESR if it has an adequate number of qualified staff to carry out their economic activities in HK and incurs an adequate amount of operational expenses for carrying out its asset holding and management activity in HK.

The NR

This is based on the minimum standard set forth in Action 5 of the Base Erosion and Profit Shifting (BEPS) project of the Organisation for Economic Co-operation and Development (OECD). As such, only income from a qualifying IP asset will qualify for the preferential regime.

The IP income that qualifies for the tax exemption is calculated by multiplying IP income by the Research and Development (R&D) fraction – the latter being the qualifying expenditure as a proportion of total expenditure incurred by the taxpayer in developing the qualifying IP asset.

The PR

This is satisfied if a MNE entity:

  • is resident in HK or has a HK PE and the dividend or disposal gain is attributable to the PE; and
  • has held a minimum of five percent equity interest in the investee company for a continuous period of 12 months immediately before the foreign source income accrues.

The PR is subject to three anti avoidance rules:

i) Switch Over Rule (Subject to Tax Rule)

  • Gains from a disposal will only be exempted if they are subject to a qualifying similar tax in another jurisdiction. If the foreign source income is a dividend, the exemption will only apply if the dividend or the underlying profit from which it is paid is subject to a similar tax in a foreign jurisdiction (profits tax), and the headline corporate tax rate is at least 15%.
  • Where a foreign source disposal gain or dividend is not subject to tax in a foreign jurisdiction, the income will be denied full exemption. Domestic tax will be chargeable, however, and tax credit will be given for any foreign tax paid.

ii) Hybrid Mismatch Rules

  • Where the specified foreign source income is a dividend and tax is paid on its underlying profits in the foreign jurisdiction, the FSIE will not apply if the dividend is deductible in calculating the taxable income of the investee company.

iii) Main Purpose Rule

  • Where the main purpose or one of the main purposes of entering into the arrangement was to obtain a tax advantage, the PR will be denied. The test is whether the arrangement has an underpinning commercial reason which reflects economic reality.
  • Where an entity is unable to satisfy the relevant requirement (ESR, PR or NR) its foreign source income in the year of accrual will be taxable in the year of assessment it is received in HK. Income is regarded as received in HK when it is:
    • remitted, transmitted or brought into HK;
    • used to satisfy any debt incurred in the course of an HK business, trade or profession; or
    • used to buy movable property and the property is brought into HK.

If you want to discuss further, please contact me, Chimezirim Echendu:

Chimezirim Echendu

International Associate

M: +44 (0)7496 410 126 or