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Hong Kong’s proposed refinements on foreign source income exemption (“FSIE”) regime for passive income – Part 1

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In response to its inclusion on the “watchlist” for non-cooperative jurisdictions for tax purposes by the European Union (“EU”), the Hong Kong government launched a consultation on the proposed refinements to Hong Kong’s FSIE regime for passive income, mapping out significant changes to address the EU’s concerns such that Hong Kong would not be “blacklisted” by the EU for tax purposes.

The amendment bill in relation to the proposed refinements will be introduced into the Legislative Council in October 2022. The Financial Services and the Treasury Bureau aim to secure the passing of the amendment bill by the end of 2022 and bring the refined FSIE regime into force from 1 January 2023. The Inland Revenue Department will issue administrative guidance on requirements for exemptions and tax credits (please see part 2 below).

1. What is taxable and who is the taxpayer?
Covered income

Under the FSIE, offshore passive income is deemed to be sourced from Hong Kong and chargeable to profits tax if it is:

  1. interest, dividends, disposal gains or intellectual properties (“IP”) income (collectively, “In-scope Offshore Passive Income”);
  2. received in Hong Kong;
  3. by a constituent entity of an MNE group (a “Covered Taxpayer”); and
  4. the Covered Taxpayer fails to meet the relevant economic substance requirement or nexus approach requirements.

Covered taxpayer

The proposed refinements will only apply to multinational enterprise groups (“MNE”) which is defined under the Global Anti-Base Erosion (“GloBE”) Rules promulgated by the Organisation for Economic Co-operation and Development as “any group that includes at least one entity or permanent establishment that is not located in the jurisdiction of the ultimate parent entity”.

Hence, the proposed refinements are not applicable to: (1) stand-alone local companies, (2) purely local group companies or (3) individuals.

2. Exemptions and tax credit

According to the consultation paper, by meeting the relevant economic substance requirements or nexus approach requirements, or qualifying under the participation exemption, an In-scope Offshore Passive Income could still be exempt from profits tax.

Step 1 and 2: economic substance / nexus approach & participation exemption

Interest Dividends Disposal gains IP income

Step 1 

Can the covered income fulfill these requirements?

1a. If yes, the income would not be deemed taxable.

1b. If no:

For interest and IP income, check if the income is qualified for foreign tax credit or unilateral tax credit (see Step 3 below).

For dividends and disposal gains, check if the income is qualified for participation exemption (see Step 2 below).

Economic substance requirements

  • The Covered Taxpayer has to conduct substantial economic activities (“Relevant Activities”) with respect to the relevant passive income in Hong Kong:
  • for a non-pure equity holding company, the Relevant Activities will include (i) making necessary strategic decision, and (ii) managing and assuming principal risks in respect of any assets it acquires, holds or disposes of.
  • for a pure equity holding company (i.e. a company which, as its primary function, acquires and holds shares or equitable interests in companies and only earns dividends and disposal gains in relation to shares or equity interest), a reduced substantial activities test applies and the Relevant Activities will only include (i) holding and managing its equity participation, and (ii) complying with the corporate law filing requirements in Hong Kong.
  • It is possible for the Covered Taxpayer to outsource the Relevant Activities if it is able to demonstrate (i) adequate monitoring of the outsourced activities, and (ii) that the Relevant Activities are conducted in Hong Kong.

How is “substance” being measured?

  • Non-pure equity holding companies have to meet the adequacy test in terms of:
  • (i) employing an adequate number of qualified employees; and
  • (ii) incurring an adequate amount of operating expenditures in Hong Kong in relation to the Relevant Activities.
  • The Inland Revenue Department (“IRD”) will consider whether a taxpayer has met the adequacy test after taking into account a list of factors, including:
  • (i) nature of business;
  • (ii) scale of operation;
  • (iii) profitability;
  • (iv) details of employees employed;
  • (v) the amount and types of operating expenditures incurred, etc.
  • As the adequacy test will be determined based on a totality of facts, there will be no minimum objective threshold in terms of number of employees or operating expenditure.
  • Pure equity holding companies have to meet the reduced substantial activities test, which may be satisfied by:
  • (i) having a director who is a Hong Kong tax resident;
  • (ii) holding annual board meetings;
  • (iii) fulfilling annual filing requirements under the Companies Ordinance, etc.
  • subject to further guidance from the IRD and the draft legislation.

Nexus approach requirements

  • Income from a qualifying IP asset can qualify for preferential tax treatment based on a nexus ratio
  • Nexus ratio = Qualifying expenditures incurred by the taxpayer to develop the IP asset / Overall expenditures incurred by the taxpayer to develop the IP asset
  • This proportion of research and development (“R&D”) expenditures is a proxy for substantial economic activities.

Qualifying IP asset

  • Only covers (i) patents and (ii) other IP assets which are functionally equivalent to patents if those IP assets are both legally protected and subject to similar approval and registration processes (e.g. copyrighted software)
  • Marketing-related IP assets (e.g. trademark and copyright) are excluded from the preferential tax treatment

Qualifying expenditures

  • Only include R&D expenditures that are directly connected to the IP asset
  • Acquisition costs of the IP asset are excluded
  • Only cover expenditures on R&D activities (i) undertaken by the taxpayer within the jurisdiction providing the IP regime (“IP Regime Jurisdiction”); (ii) outsourced to unrelated parties to take place inside or outside the IP Regime Jurisdiction; and (iii) outsourced to resident related parties to take place within the IP regime jurisdiction

Taxpayers may be permitted to apply a 30% uplift on the qualifying expenditures, subject to a cap equal to the overall expenditures incurred by the taxpayer

Step 2

For dividends and disposal gains that are already deemed taxable, can the participation exemption requirements be fulfilled?

2a. If yes, the income can be exempt.

2b. If no, check if the income is qualified for foreign tax credit or unilateral tax credit (see Step 3 below).
N/A

Participation exemption

  • The income concerned will continue to be tax-exempt if:
  • (i) the investor company is a Hong Kong resident person (i.e. a company incorporated in Hong Kong, or if incorporated outside Hong Kong, normally managed or controlled in Hong Kong) or a non-Hong Kong resident person that has a permanent establishment in Hong Kong;
  • (ii) the investor company holds at least 5% of the shares or equity interest in the investee company; and
  • (iii) no more than 50% of the income derived by the investee company is passive income.
  • In terms of the requirement of “Hong Kong resident person”, it may not be necessary for companies to apply for a Hong Kong Tax Resident Certificate. The company should be able to fulfill this requirement by demonstrating control of the company in Hong Kong, having a majority of directors who are Hong Kong residents, conducting business activities in Hong Kong, having meetings in Hong Kong etc.

Anti-abuse rules

  • (i) Switch-over rule
  • If the income concerned or the profits of the investee company is or are subject to tax in a foreign jurisdiction the headline tax rate of which is below 15%, the tax relief available to the investor company will switch over from participation exemption to foreign tax credit.
  • (ii) Main purpose rule
  • If there is any arrangement or series of arrangements undertaken by the investor company with a main purpose (or one of the main purposes) of obtaining a tax advantage that defeats the object or purpose of the exemption, the participation exemption will not be available.
  • (iii) Anti-hybrid mismatch rule
  • Where the income concerned is dividends, the participation exemption will not apply to the extent that the dividend payment is deductible by the investee company.
 N/A

Step 3: double taxation relief – unilateral tax credit

For taxpayers who would suffer double taxation if they fail to get exemption under the refined FSIE regime, it is proposed that a unilateral tax credit will be provided to these taxpayers who paid tax in a jurisdiction which has not entered into a comprehensive avoidance of double taxation agreement with Hong Kong (“Non-CDTA Jurisdiction”).

The proposed unilateral tax credit will only be provided in respect of the In-scope Offshore Passive Income which is taxable under the refined FSIE regime. No such tax credit will be available for:

  • In-scope Offshore Passive Income which is exempt from profits tax under the refined FSIE regime;
  • Tax paid in a Non-CDTA Jurisdiction which relates to income other than the In-scope Offshore Passive Income; or
  • Tax paid in a jurisdiction that has a tax treaty with Hong Kong (in such case tax credit would be made available under the tax treaty).
3. Conclusion

The change in Hong Kong’s FSIE regime is happening soon (possibly on 1 January 2023 as aforementioned) for Hong Kong to keep up with the latest international tax standards. While we await the introduction of the amendment bill, it is advisable for businesses to keep an eye on the latest developments, review the corporate structure with reference to the information currently available and consult a tax adviser if in doubt.

If you have any question regarding the topic discussed above, please contact our partner Victor Ng at victor.ng@oln-law.com for further assistance.

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

OLN is Highly Recommended in the Newly-released Asialaw 2022/23 Rankings

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We are delighted to announce that Oldham, Li & Nie has been again ‘Highly recommended’ by Asialaw.

Asialaw recognises the firm’s expertise in the following practice areas:

  • Dispute Resolution – Highly recommended
  • Corporate and M&A – Recommended
  • Intellectual Property – Recommended
  • Labour & Employment – Recommended
  • Private Client – Recommended
  • Restructuring and Insolvency – Other notable

Oldham, Li & Nie has also been recommended in the following industry sectors:

  • Insurance – Recommended
  • Consumer Goods and Services – Other notable
  • Technology and Telecommunications – Other notable

Asialaw also recognises our Partners, who were ranked in their respective practice areas:

  • Gordon Oldham is recognised as a Senior Statesman in Dispute Resolution
  • Richard Healy is recognised as a Distinguished Practitioner in Dispute Resolution
  • Tracy Yip is recognised as a Distinguished Practitioner in Corporate and M&A
  • Vera Sung is recognised as a Distinguished Practitioner in Intellectual Property
asialaw Profiles 2023

About Asialaw

Asialaw Profiles is the only legal directory featuring comprehensive analysis on Asia’s regional and domestic firms, and leading lawyers from the region.

Profiles are published online in September each year, and this year’s rankings provide law firm and lawyers recommendations in 28 sectors and practice areas and 23 jurisdictions in the region – from Bangladesh to Vietnam.

Intellectual Property for Social Media Influencers

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88% of Hong Kong population is using social media, and this number is growing every minute. It is no surprise that social media has become a lucrative business. Social media influencers (“Influencers”) or key opinion leaders (“KOLs”) are popular and powerful – they create tight bonds with their followers and have the ability to influence their perceptions of brands and hence their spending behaviours. As a result, they are now an important marketing channel for many local and foreign brands. Influencers partner with these brands and generate income by way of endorsement or other forms of support through their profiles on Instagram, WeChat, Facebook, YouTube, TikTok, and other social media networks.

Influencers and KOLs build up and grow their reputations and market values by creating original contents, where multiple intellectual property rights may subsist, that should be managed properly to preserve and maximize their values. At the same time, Influencers and KOLs may overlook the potential risk of infringing others’ intellectual property rights when creating their posts and articles given their contents often ride on photographs and videos officially released by the leading brands in the market which carry protectable intellectual property rights.

Why influencers and KOLs should be concerned about intellectual property rights (“IPR”) of themselves and others?

Intellectual property rights infringements on the internet, unfortunately, are common. If trade mark and copyright are protected with registration, it is easier to enforce them in the event of a dispute, as compared to unregistered rights.

Registration of intellectual property rights makes it clear to others that they are protected. This helps to avoid plagiarism – if other influencers know that the content is protected, they won’t in the first place replicate the content.

Registered intellectual property rights give a social media account more credibility – followers and brands find the contents more trustworthy and risks free.

What types of intellectual property should influencers register?
Copyright

Copyright protects the original influencer’s works of authorship: photographs, videos, posts, art, sound recordings, and other types of content. The social media influencer or KOL is the owner of the content that he / she creates, and can freely distribute, make copies and commercially exploit the original works. Others must get permission or license before using such copyrighted contents unless a legal based exception, such as “fair use”, applies.

In Hong Kong, it is not necessary to register a copyrighted work as the copyright subsisting therein automatically arises upon the creation of an original work. Having said that, from the perspective of enforcement, the social media influencer may wish to register or deposit a copyright work if it is of significant value in the event it is stolen by a third party.

Trademark

Trademark is a design, logo, phrase or any graphic representation that differentiates one brand from the others in the marketplace. The personal name or nick name of the social media influencer or KOL is the brand name that should be property protected by trade mark registration to preserve and generate its value.

Website domain

The website domain in itself does not carry an intellectual property right yet the domain name usually contains a word, a name or a phrase forming the brand name of the social media influencer or KOL which can be registered as a trade mark.

Intellectual property policies of different social media platforms
The future of protecting intellectual property on social media

To grow exposure and reputation, social media influencers or KOLs often create different types of original contents which are highly susceptible to legal risks. With the internet evolving at such a fast pace, we anticipate infringement of IP right in social media online platforms will increase taking new and more sophisticated forms. Hence, it is imperative for social media influencers and KOLs to be more cautious and proactive to protect their original works going forward. It should not be taken for granted that because nothing bad has happened so far and therefore they will continue to be safe going forward.

It is also important to respect others’ IP rights and not to replicate others’ contents without prior permission.

If you would like to know more about protecting social media influencers or KOLs’ intellectual property rights, please contact us.

Disclaimer: This article is for reference only. Nothing herein shall be construed as legal advice, whether generally or for any specific person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

The Succession of Digital Assets: NFTs, Cryptocurrency or Online Accounts

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There has been an increase of wealth distributed in various forms of digital assets or platforms.  For example, NFTs, cryptocurrencies such as Bitcoin or Ethereum or even online social media or gaming accounts may have substantial value in them. Investment is no longer restricted to its traditional forms, leading to the emergence of many alternative assets investments, most of which are done on an anonymous basis.

To consider how to plan the succession of digital assets, it would be useful to distinguish between digital assets that are transferable and those that are non-transferable.

Transferable Digital Assets

Transferable digital assets include cryptocurrency, NFTs, funds kept in online accounts such as Alipay or WeChat pay.  These can generally be passed down by including provisions in a will. Most countries may treat them the same as any traditional assets (such as bank accounts or real estate property) and require a form of grant of representation to access the digital assets. 

Some companies may even provide the feature on their software platform whereby the user can designate an individual as an emergency contact to receive the data in the user’s account under conditions specified by the user, such as upon the user’s death or incapacity. This feature would potentially allow an executor or trustee nominated in the user’s will (if there is one) to gain access to valuable personal, financial and business information after the user’s death even before presenting an authenticated grant of probate to the company, as well as to act on such information for the benefit of the user’s next generation pursuant to the will.  For example, Apple has a policy known as Legacy Contacts where the person who is set as a Legacy Contact can access photos, messages, notes (but not passwords, music, subscriptions, etc.) with just the access key generated when the Legacy Contact was set and the death certificate.

Given the popularity of digital assets, popular trading platforms for cryptocurrency and other digital assets already have some form of structured policy for dealing with account holders who have passed away.  Some trading platforms have adopted the traditional requirements of dealing with any other physical asset, i.e. requiring beneficiaries to provide the grant of representation, death certificate and other supporting documents to allow access into the deceased person’s account, whilst other platforms give their users options to complete their know-your-client procedure which allows the platform to identify the person using the account, and therefore assist beneficiaries in accessing such accounts.

However, as currently there is no uniform standard on how to pass on digital assets, the best and simplest method is to make sure your beneficiaries are able to find out not only what digital assets you own.  Importantly, and due to the highly secured and encrypted nature of digital assets such that a form of password or key is required to access the assets, it may be important to store such passwords in a safe place but also make your beneficiaries aware of how to access such passwords and keys.

Non-transferable Digital Assets

Non-transferable digital assets are usually digital assets that are licensed for personal use, but not owned in a legal sense.  These include email accounts, social media handles and accounts or mobile app accounts and information contained therein. These generally cannot be passed down simply by a will and may require non-conventional estate plans.

Despite the personal nature of these non-transferable Digital Assets preventing them from being passed down, it is possible to preserve these in accordance with the wishes of the deceased person.  For example, Instagram offers a service known as “memorialising” the deceased person’s account, which allows the memorialized account to be kept as if it was frozen in time.  Facebook offers a further service that allows the person to designate a legacy contact to manage the memorialized account to a certain extent (such as writing a pinned post to share a final message or to update the profile picture, but not allowing removing or changing past posts etc.).  YouTube also provides an estate planning service known as Inactive Account Manager, which allows the person to designate who should have access to the information or whether the account should be deleted.  Otherwise, individuals may need to go through hoops of customer service and in the end not even be able to access any personal or important information.

Inheritance tax considerations

Digital assets (in particular cryptocurrencies) can fluctuate in value rapidly.  In Hong Kong, where estate duty has been abolished, this generally does not create any concern.  However, digital assets may also be based in other jurisdictions that impose inheritance tax, and therefore the applicable jurisdiction of the digital asset or the company through which the digital assets are held before investing in such should be given consideration and taken into account when conducting estate planning.

Conclusion

With diversified forms of valuable assets and technological advancements offering new solutions to asset succession and security, individuals face more considerations than ever in wealth protection and succession.  It is highly recommended that a legal framework should be carefully planned to ensure their wealth can be preserved free from unwanted interference.

Disclaimer: This article is for reference only.  Nothing herein shall be construed as legal advice, whether generally or for any specific person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

Last-Minute Tax Planning before Migrating from / Temporarily Moving Out of Hong Kong

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Tax consideration, while an essential and integral part for any migration planning,  is unfortunately often neglected part or left till the last minute, likely because Hongkongers have been too used to or sometimes even “spoiled” by the simple and low tax system in Hong Kong. The hard reality, however, is that the popular emigration destinations such as the UK and Canada adopt a more complex and heavier tax system, the concept of which is alien to most Hongkongers.

What are the top last-minute tips for pre-immigration tax planning?

Destination countries’ tax rates are generally much higher than those of Hong Kong. To avoid tax “disappointment”, tax planning might efficiently minimize your tax exposure. Many of the tax-saving moves, however, can only be done while you are still a Hong Kong tax resident. It is thus advisable to allow sufficient time before your actual departure to consult tax lawyers.  The more preparation time you allow, the more you can achieve. If you are leaving in a rush and only last-minute planning could be done, we would suggest that you at least go for the following:

Updating Current Market Value of existing investment

Unlike Hong Kong, most destination countries impose tax on residents’ worldwide income, meaning that even your investment gains generated in a foreign location (i.e. Hong Kong) could be subject to local tax. This led to much concern by Hongkongers as many of them accumulated wealth via land appreciation of their real estate investment in Hong Kong. The gains could potentially be subject to worldwide tax. The good news is that most of these destination countries do not retrospectively tax the gains before the person becomes its tax resident on the condition that one could prove that the gains were generated while he/ she was still a Hong Kong tax resident. For those migrating to Canada and the UK, this would usually mean sufficient record to show the current market value of the investment, such as surveyor reports immediately prior to entrance of destination countries. For those migrating to the US, it should be noted that such valuation exercise (or what is known as the “Step-up in basis” in the US) cannot be done by a nominal way and must be associated with real transactions.

Executing Will for Hong Kong assets

Inheritance tax could be as high as 40% in the UK which is quite an astronomical figure for Hongkongers since estate duty in Hong Kong has been abolished from 2006 onwards. While there is no inheritance tax in Canada per se, in effect the tax exists because the CRA charges on one’s gain at the time of his/ her death by regarding the event as deemed disposition of one’s assets. The Hong Kong Will allows you a possible argument that Hong Kong remains your place of domicile and thus no estate duty should be imposed. The argument is especially strong if you are only a tax resident of the UK but have not acquired domicile there (i.e. a UK non-dom).

For those who wish to continue employment and receive salaries from Hong Kong, will their salaries be subject to tax in their new country of residence?

The UK and Canada both tax their residents on worldwide income, which means that any revenue, including rental income from HK property, salaries from HK employment, will be subject to local taxes.

Relief is, however, available thanks to the Double Tax Agreements (“DTA”) between Canada and Hong Kong. Under the DTA, Canadian tax residents (with dual residency in Hong Kong) will only be subject to taxation in Hong Kong on salaries deriving from a Hong Kong employment or profits from a business carried on in Hong Kong. Further, for withholding tax on dividends, that will generally be limited to a maximum of 15%.

As for the UK, a resident not domiciled in the UK (referred to as “non-dom”) may also benefit from special taxation rules on foreign-sourced income. However, British citizens returning to the UK cannot claim this “non-dom” status.

Many people left HK in a rush amid the recent Covid-19 outbreak merely temporarily to stay away from the pandemic. Many of them are under Hong Kong employment contracts. Are there any tax implications for them and their employers?

An employee staying in another country for too long may be unintentionally construed as tax resident of that country solely due to the number of days he/she stays there. We have a client who originally intended to pay a short visit to Canada only but turned out staying there for a year due to sudden outbreak of Covid and travel restriction. In usual circumstance, a continuous stay of over 183 days in a tax year in Canada would be deemed tax resident there and thus subject to worldwide tax. Certainly, Covid was a peculiar external factor. We were of the view that given the existence of other factual patterns, client does have an arguable defence to resist the suggestion that he was a Canadian tax resident.

Private companies should also pay close attention if there are HR arrangement in place allowing employees to work from another country while under a Hong Kong employment. Activities done by the employees in such foreign countries might unintentionally be construed as the companies having presence/ establishment there. If such activities generate much profit for the companies, the employers might even potentially be subject to local corporate taxes where the employees work. It is always advisable to consult your tax advisers if in doubt.

OLN provides a range of migration, corporate restructuring and tax advisory services.  If you have any questions on the above, please contact us.

Disclaimer: This article is for reference only.  Nothing herein shall be construed as legal or tax advice, whether generally or for any specific person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

Copyright (Amendment) Bill 2022 gazetted for LegCo reading on 8 June 2022

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The Copyright (Amendment) Bill 2022 (https://www.legco.gov.hk/yr2022/english/brief/citbcr070928_22020525-e.pdf) was gazetted last Friday after the 3-month public consultation. A very aligned view of IP practitioners and stakeholders is to have the new Copyright provisions enacted as law without any further delay. 

The key 5 legislative proposals are:
 
1. To introduce an exclusive technology-neutral communication right for copyright owners in light of technological developments;
 
2. To introduce criminal sanctions against infringements relating to the new communication right;
 
3. To revise and expand the scope of copyright exceptions to allow use of copyright works in certain common Internet activities; facilitate online learning and operation of libraries, archives and museums; and allow media shifting of sound recordings, etc;
 
4. To introduce “safe harbour” provisions to provide incentives for online service providers to co-operate with copyright owners in combating online piracy and to provide reasonable protection for their acts; and
 
5. To introduce two additional statutory factors for the court to consider when assessing whether to award additional damages to copyright owners in civil cases involving copyright infringements.

The Secretary for Commerce and Economic Development will introduce the Bill into LegCo for first and second readings on June 8. The LegCo Panel on Commerce and Industry supports the legislative proposals. The new Copyright law is expected to launch for the summer!