FSIE regime: A comparative analysis between Hong Kong and Singapore
Understanding the differences between both regimes allows businesses to better appreciate the different tax outcomes that may arise.
In a keynote speech at the EU – Hong Kong Engagement Forum: Building a Fair Tax Environment through International Cooperation in June 2022, the Secretary for Financial Services and the Treasury of Hong Kong announced that Hong Kong will be making refinements to its tax system to introduce a foreign sourced income exemption (FSIE) regime. The proposed refinements followed a periodic review[1] conducted by the European Union (EU) in October 2021 as part of the initiative to combat against harmful tax competition, wherein it was found that the foreign income exemption regime in Hong Kong, together with some other jurisdictions (including Malaysia), contains harmful tax elements that may result in double non-taxation of offshore passive income.
On 28 October 2022, following active discussions with the EU and key stakeholders in Hong Kong, the Hong Kong government issued the draft bill on the refined FSIE regime, and the proposed refinements (with certain changes made) have since become effective from 1 January 2023 with no grandfathering arrangements.
The purpose of this article is to undertake a comparative analysis of the Hong Kong and Singapore FSIE regime.
Difference in basis of taxation
Before we dive into a comparison of the FSIE regimes in Hong Kong and Singapore, it is important to point out that unlike Hong Kong’s territorial basis of taxation where offshore profits are generally not subject to tax, Singapore generally imposes income tax on all foreign sourced income that is received in Singapore.
As a result of the above difference in taxation of foreign sourced income, the approaches taken by both FSIE regimes are different. Unlike Singapore’s FSIE regime, which exempts specified foreign sourced income received in Singapore by any Singapore tax resident person provided relevant conditions are met, Hong Kong’s refined FSIE regime firstly deems specified foreign sourced income received in Hong Kong to be derived from Hong Kong and therefore chargeable to tax, unless specified economic substance, participation exemption or nexus requirements are met.
Difference in types of incomes covered
Another notable difference between the two FSIE regimes is that Singapore’s regime covers dividend, branch profits and service income. This means that other foreign sourced income, such as interest or royalty income, would not be in scope and would generally be subject to tax when received in Singapore. On the other hand, Hong Kong’s FSIE regime covers four specific types of passive income, namely dividends, disposal gains on equity interests, interest income and income from intellectual property (IP). Such income, if received in Hong Kong, is deemed sourced in Hong Kong unless specified requirements are met[2]. Active income categories (e.g., trading profits and service income) are not affected by this refined FSIE regime, i.e., they continue to be outside the scope of tax in Hong Kong, provided they are sourced outside of Hong Kong based on the existing source rules.
Difference in tax exemption
While both FSIE regimes cover dividend income, Singapore’s regime may appear to provide for a wider scope of tax exemption. Under Singapore’s FSIE regime, the dividend income may qualify for tax exemption if the headline tax rate in the jurisdiction from which the dividend income is derived is at least 15% and the “subject to tax” condition is met. For the purpose of the “subject to tax” condition, it is sufficient that some tax has been suffered and the condition is also deemed to be met where no tax has actually been suffered due to tax incentives granted for substantive business activities. However, to meet the participation exemption requirements in Hong Kong, the Hong Kong company must have continuously held not less than 5% of equity interests in the dividend payor for a period of not less than 12 months and the dividend (or underlying profits out of which the dividend is paid) must have been subject to tax of at least 15%. In addition, there is a further requirement that the main purpose, or one of the main purposes of the arrangement, must not be to obtain a tax benefit in relation to a liability to pay profits tax.
Having said the above, a Hong Kong entity may continue to be exempt from tax on its foreign sourced dividend income received if it meets the economic substance requirement as an alternative to the participation exemption requirements. Nevertheless, what is considered adequate substance may give rise to uncertainty as to whether exemption applies.
Hong Kong, like Singapore, does not tax capital gains. Hence, it is interesting to note that disposal gain from the sale of equity interests under the refined Hong Kong FSIE regime is subject to the same participation exemption or economic substance requirements above. In other words, whether an equity disposal gain is capital or revenue in nature is not relevant under the refined FSIE regime. This position is in contrast with the position in Singapore, where equity disposal gains, whether locally or foreign sourced but received in Singapore, are not subject to tax if they meet certain safe harbour conditions or are substantiated to be capital in nature.
As noted above, foreign sourced interest income is not covered under Singapore’s FSIE regime, and hence, is generally subject to tax when received in Singapore. On the other hand, foreign sourced interest income received in Hong Kong may continue to be exempt from tax in Hong Kong if economic substance requirements are met. This means that the Hong Kong entity must have adequate qualified employees and incur adequate operating expenses in Hong Kong. What is considered adequate depends on the facts of the case and it will be important to strike a balance between meeting the economic substance requirements and making sure that the activities performed in Hong Kong do not result in the interest income being regarded as sourced in Hong Kong.
Difference in nexus approach
Last but not least, Hong Kong has adopted a nexus approach under the refined FSIE regime to determine the amount of foreign-sourced IP income that qualifies for tax exemption in Hong Kong. Under the nexus approach, only specified income earned from a qualifying IP asset will be exempt from tax in Hong Kong and the amount of non-taxable income is computed based on a nexus ratio that references research and development expenses incurred. In the case of Singapore, IP income is not covered under the FSIE regime and foreign sourced IP income is generally subject to tax in Singapore when received. The concept of nexus is only relevant if the entity applies for the IP development incentive, which provides for a concessionary tax rate on qualifying IP income.
It is clear from the above comparisons that the Singapore and Hong Kong FSIE regimes are fairly dissimilar. Hong Kong’s refinements to its FSIE regime takes into account and makes reference to recent tax standards promulgated internationally, such as the concept of a multinational group under the Organisation for Economic Co-operation and Development (OECD) global minimum corporate tax project, economic substance requirements in certain tax haven jurisdictions, and the modified nexus approach in OECD base erosion and profit shifting (BEPS) Action 5 on harmful tax practices.
Difference in concept of “received”
Notwithstanding, there are lessons that may be drawn from Singapore, such as with respect to the concept of “received”. What is considered to be “received” from a Hong Kong FSIE perspective follows closely that from a Singapore tax perspective, in that specified foreign sourced income will be regarded as “received” in Hong Kong if it is (a) remitted, transmitted or brought into Hong Kong, (b) used to satisfy any debt incurred in respect of a trade, profession or business carried on in Hong Kong, or (c) used to buy movable property which is brought into Hong Kong. The Inland Revenue Authority of Singapore has provided additional administrative guidance on a number of scenarios in which the foreign sourced income may be considered as received or not received in Singapore, including where the income is kept in a mixed pool of funds. Similar guidance, if published by the Hong Kong Inland Revenue Department, can provide much needed clarity to affected taxpayers in Hong Kong.
The co-authors of the article are James Choo, Partner, International Tax and Transaction Services Tax from Ernst & Young Solutions LLP, Hwee Leng Aw, Associate Partner, International Tax and Transaction Services and Jasmine Chu, Director, International Tax and Transaction Services from EY Corporate Advisors Pte. Ltd.
