The Foreign Source Income Exemption (FSIE) regime is a tax system implemented in Hong Kong that deals with the taxation of specific types of foreign-sourced income received in Hong Kong. The FSIE regime covers four specific types of passive income: dividends, disposal gains on equity interests, interest income, and income from intellectual property (IP).
The purpose of the FSIE regime is to provide tax exemptions on certain foreign-sourced income under specific conditions, thus promoting international business and maintaining Hong Kong's competitiveness as a global business hub. The FSIE regime was introduced as a refinement to Hong Kong's tax system following a review conducted by the European Union (EU) as part of an initiative to combat harmful tax competition.
Under the FSIE regime, specified foreign-sourced income received in Hong Kong is deemed to be derived from Hong Kong and therefore chargeable to tax, unless specified economic substance, participation exemption, or nexus requirements are met. These requirements are put in place to ensure that the tax benefits are not abused and that the activities generating the income have a substantial connection to Hong Kong.
For example, to meet the economic substance requirements, the Hong Kong entity must have adequate qualified employees and incur adequate operating expenses in Hong Kong. What is adequate depends on the facts of the case, and it's important to balance meeting these requirements with ensuring that the activities performed in Hong Kong do not result in the income being regarded as sourced in Hong Kong.
Furthermore, for dividend income to qualify for tax exemption under the FSIE regime, 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%. Additionally, 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.
It's also worth noting that the FSIE regime has been refined over time in response to international tax standards and requirements, such as those set by the EU. These refinements help ensure that the regime is in line with global norms and expectations, and that it continues to support Hong Kong's role as a major international business and financial center.
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