The Financial Secretary also referred to the following tax measures and developments that Hong Kong has recently implemented, or which are currently being considered, with a view to promoting Hong Kong’s economic development and enhancing its co-operation on international tax matters.
Chapter 1
Clear guidelines on whether gains on disposal of equity interests are capital gains
An enhancement proposal in mid-March
Today, the Financial Secretary indicated that he will put forward an enhancement proposal in mid-March to provide more certainty on under what conditions gains on disposal of equity interests in another entity would be regarded as onshore non-taxable capital gains in Hong Kong.
For example, in Singapore, there is a safe harbor rule that deems gains on disposal of equity interests as non-taxable capital gains. The conditions for the rule are (i) the investor concerned must hold at least 20% ordinary shares in an investee company and (ii) with a holding period of not less than 24 months.
The initiative for Hong Kong to consider providing similar guidelines is the implementation of the refined foreign-sourced income exemption (FSIE) regime in Hong Kong effective from 1 January 2023.
Under the refined FSIE regime, offshore- or foreign-sourced disposal gains on equity interests will be subject to tax when the gains are remitted to Hong Kong if the economic substance requirement or the participation requirement cannot be satisfied.
The enhancement proposal would facilitate multinational enterprises to structure their disposal gains as onshore non-taxable capital gains in Hong Kong, which should therefore not be subject to the refined FSIE regime.
Chapter 2
Proposed tax concessions for family-owned investment holding vehicles
Strengthening Hong Kong’s asset management sector
With a view to strengthening Hong Kong’s asset management sector and Hong Kong’s profile as an international financial center, the Financial Secretary noted today that a legislative bill providing tax concessions for family-owned investment holding vehicles (FIHVs), managed by an eligible single-family office (ESFO), has already been introduced into the Legislative Council. The bill is currently being scrutinized by a Bills Committee of the Legislative Council.
Under the existing Unified Fund Exemption (UFE) regime contained in the Inland Revenue Ordinance (IRO), Hong Kong is already competitive as a preferred location for fund operations in the region.
Generally, under the UFE regime, the investment income (including incidental income subject to a 5% threshold) of a fund as a collective investment scheme, regardless of its residence, is tax exempt in Hong Kong provided that certain specified conditions are satisfied. This exemption would also extend to special purpose entities (SPEs) employed by such funds in their investment holding structures, e.g., an investment in an investee private company.
However, funds owned by a family may not be eligible for the tax exemption under the UFE regime as they may not qualify as a collective investment scheme. Furthermore, even if they are eligible for the UFE regime, Hong Kong resident beneficiaries of such family-owned funds would potentially be subject to tax in Hong Kong under the deeming provisions of the UFE regime in respect of the tax-exempt profits of such family-owned funds.
It is for the above reasons that a dedicated tax concession regime for FIHVs managed by an ESFO is proposed to be introduced into Hong Kong by the bill.
Under the bill, similar to the concessionary tax treatment granted to funds under the UFE regime, investment income (including incidental income subject to a 5% threshold) earned from qualifying transactions by FIHVs and their SPEs will be taxed at a 0% concessionary tax rate.
The FIHVs and the EFSOs must be at least 95%, in aggregate, beneficially owned by one or more than one member of a family. Members of a family are widely defined to include a person’s spouse, lineal ancestors, lineal descendants and siblings of the person and the person’s spouse. FIHVs and ESFOs could be held by a discretionary trust for a family under certain conditions.
To be eligible for the proposed dedicated tax concession regime, the net asset value of assets specified in Schedule 16C to the IRO of all the FIHVs (including their SPEs) owned by a family that are managed by an ESFO to which the family is related, must be at least HK$240 million for a year of assessment.
However, two qualifying conditions for the proposed dedicated tax concession regime for FIHVs are more stringent than those for the UFE regime.
First, unlike the UFE regime which applies to both resident and non-resident funds, the central management and control or the tax residence of the FIHVs and ESFOs must be exercised in Hong Kong. FIHVs and ESFOs which are managed and controlled by non-resident individuals may therefore potentially be unable to demonstrate that their tax residence is in Hong Kong.
Second, while the UFE regime does not include any substantial activities requirement in terms of the fund or the fund manager (i) employing any number of full-time qualified employees in Hong Kong; and (ii) incurring any amount of annual operating expenditure in Hong Kong, the proposed dedicated tax concession regime for FIHVs requires each of the FIHVs concerned to employ at least two persons under (i) and incur at least HK$2 million under (ii). Furthermore, in addition to the above minimum threshold figures, the bill also imposes an overarching requirement that the number of persons employed, and the amount of annual operating expenditure incurred, are in the opinion of the Commissioner of Inland Revenue “adequate”.
In contrast, in terms of substantial activities requirement, generally speaking the UFE regime only requires that the qualifying transactions of a fund be carried out in Hong Kong by or through a specified person; or arranged in Hong Kong by a specified person, i.e., without imposing any minimum threshold in terms of either (i) and (ii) nor an overarching “adequate” requirement referred to above.
Furthermore, where the investment activities of a number of FIHVs owned by a family are undertaken by a single ESFO, it is unclear how the Commissioner of Inland Revenue will attribute the number of persons employed by the ESFO, and the amount of annual operating expenditure incurred, to each FIHV in determining whether the substantial activities requirement is satisfied for each FIHV. This may create some uncertainties about the application of the dedicated tax concession regime for FIHVs.
Given the above, the government may need to consider whether further refinements to the bill can be made, or if the above issues could be addressed by way of administrative guidance issued by the IRD.
Chapter 3
Public consultation to be launched on the implementation of BEPS 2.0
Intended implementation of BEPS 2.0 in Hong Kong in 2025
In October 2021, in order to tackle so-called base erosion and profit shifting (BEPS) risks arising from the digitalization of the economy, the Organization for Economic Co-operation and Development (OECD)/Group of Twenty (G20) announced a landmark international agreement for a two-pillar solution to reform international taxation rules starting from 2023, (commonly referred to as “BEPS 2.0”). Agreed by Hong Kong as well as over 135 other jurisdictions, the BEPS 2.0 framework represents one of the most ambitious international tax reform projects ever developed.
As part of BEPS 2.0, Pillar Two proposes global minimum tax mechanisms with the objective of subjecting multinational enterprise (MNE) groups whose annual revenues exceed €750 million to a minimum effective tax rate (ETR) of 15% on their profits in every jurisdiction where they operate. The Global Anti-Base Erosion (GloBE) rules – which comprise the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR) – are the primary mechanisms through which Pillar Two seeks to achieve this objective and consist of defensive tax measures that jurisdictions can adopt to collect additional tax (called “top-up tax”) on MNE groups doing business in low-tax jurisdictions.
Last August however, the Hong Kong Secretary for Financial Services and the Treasury (SFST) announced that, in line with the delay of the implementation of BEPS 2.0 – Pillar Two in other jurisdictions, Hong Kong would delay the implementation of the IIR from the original OECD timeline of 2023 to 2024 at the earliest. With respect to the UTPR and the possible adoption of a domestic minimum top-up tax (DMTT) in Hong Kong, the SFST stated that the Government would continue to monitor the implementation targets of other jurisdictions as regards those measures without providing any specific timeline.
Today, with the benefit of the additional documents issued by the OECD on safe harbor and penalty relief, the GloBE Information Return, and the OECD’s most recent publication addressing tax certainty and technical guidance under the Implementation Framework for the GloBE rules, the Financial Secretary announced that a public consultation will soon be launched on the intended implementation of BEPS 2.0 in Hong Kong in 2025.
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Chapter 4
Other tax measures or developments
Referred to by the Financial Secretary
- A review of the existing tax concession measures applicable to funds and carried interest. Hopefully, following the review, the conditions for the tax exemption of (i) interest income of a credit fund would no longer be subject to a 5% threshold and the scope of assets that a fund can invest in would also be extended; and (ii) carried interest received needs not necessarily be from the exempted profits of a private equity fund in Hong Kong or from a fund manager that is chargeable to tax in Hong Kong.
- The enactment of legislation in 2022 waiving stamp duty for market makers in respect of their market-making activities for RMB-denominated stocks of dual-stock counters in Hong Kong. This measure will further promote Hong Kong as an offshore RMB business hub in the internationalization of RMB.
- Legislation to be introduced this year to enhance Hong Kong’s existing preferential tax regime for aircraft leasing. Proposed enhancements would include replacing the 20% tax base concession of the regime (in lieu of granting tax depreciation allowances for aircraft) with a one-off 100% tax deduction of the acquisition cost of aircraft in the first year. This proposal is made in response to the expected soon to be implemented Pillar Two global minimum tax of 15% for in-scope MNE groups. The reason for the proposed change is that the current deemed 80% deduction of the tax base is a permanent difference for deferred tax purposes, thus giving rise to no deferred tax liabilities, thereby dragging down the effective tax rate of the qualifying aircraft lessors under the regime. In-scope qualifying aircraft lessors may therefore need to pay top-up taxes under Pillar Two in respect of the ETR so dragged down. In contrast, the proposed one-off tax deduction of the acquisition cost of an aircraft will be a timing difference, thus giving rise to deferred tax liabilities, thereby having no drag-down effect on the ETR.
- Legislation to be introduced in the first half of 2024 in relation to a patent box regime in Hong Kong under which presumably qualifying income from the exploitation of patents and patent-like intellectual property rights in Hong Kong will enjoy a preferential tax treatment in Hong Kong.
- A proposed tax deduction for one-off lump sum fees paid by telecommunication companies for the rights to use radio spectrums in their business for a number of years.
Summary
Under the backdrop of continued uncertainties in the global economic outlook and that Hong Kong is gradually emerging from the pandemic, we welcome the Financial Secretary’s balanced approach in directing its resources to relieve people’s hardship, stabilize the economy and maintain public confidence as announced.
