In response to international concerns over tax avoidance and double non-taxation, Hong Kong implemented the Foreign-Sourced Income Exemption (FSIE) regime effective from 1 January 2023. This new framework was introduced after the European Union placed Hong Kong on its 2021 watchlist for potentially harmful tax practices. In this guide, we’ll break down how the FSIE regime works, key updates under FSIE 2.0, and what businesses need to know to stay compliant.
Content Outline
Key Takeaways
Introduction of the FSIE Regime in Hong Kong
Implemented from 1 January 2023, the FSIE regime brings Hong Kong’s tax practices in line with international standards to prevent tax avoidance and address the EU’s concerns over double non-taxation.
Who Is Affected by the FSIE Regime
The regime targets multinational enterprises (MNEs) operating in Hong Kong with limited local substance, while excluding local-only companies, individual taxpayers, and certain regulated entities.
Types of Income Covered
FSIE applies to four types of passive foreign-sourced income: dividends, interest, equity disposal gains, and IP income—provided they are received in Hong Kong.
Exemption Conditions and Requirements
To qualify for tax exemption, MNEs must meet one of the following: Economic Substance Requirement (ESR), Participation Exemption, or Nexus Exemption, depending on the income type.
Advance Ruling Option for Tax Certainty
Businesses can apply for an advance ruling from the IRD to confirm compliance with FSIE conditions, helping reduce compliance risks and clarify tax obligations.
What Is Foreign Sourced Income Exemption (FSIE)?
The Foreign Sourced Income Exemption (FSIE) is a tax regime introduced by Hong Kong to align with international tax standards and address concerns raised by the European Union (EU). Under this regime, certain types of foreign-sourced income, such as dividends, interest, intellectual property (IP) income, and equity disposal gains, are exempt from taxation in Hong Kong if they meet specific conditions and economic substance requirements.
The FSIE regime aims to enhance the transparency and fairness of the taxation system by reducing the risk of double non-taxation, where income could be exempt from tax in both the foreign jurisdiction and Hong Kong. This regime is applicable to businesses and individuals with foreign-sourced income and aims to attract global investment while ensuring that Hong Kong complies with international tax guidelines.
Who Does The Foreign Sourced Income Exemption (FSIE) regime Apply To?
The new FSIE regime applies to members of Multinational Enterprise Entity (MNE) groups (i.e. MNE entities) carrying on a trade, profession or business in Hong Kong unless they qualify for the exemption conditions.
The FSIE regime does not apply to:
- Local companies without foreign operation
- Local group based companies (without overseas constituent entities)
- Individual taxpayers
Moreover, regulated financial entities and MNEs beneficial from the current preferential tax regimes of Hong Kong are generally spared from the new FSIE regulation, if certain requirements can be complied with.
What Type Of Incomes Are Covered In FSIE Regime?
The FSIE regime covers four types of foreign-sourced passive income which include:
- Dividends income,
- Interests income,
- Share disposal gains, and
- Income from intellectual property (IP), such as royalties.
Only foreign-sourced income received within Hong Kong is subject to the FSIE regime. The income must fulfill the following requirements in order to be considered “received in Hong Kong” under the FSIE regime:
- When it is remitted to, transmitted, or brought into Hong Kong implying a transfer into a local bank account.
- When it is used to settle any debt arising from a trade, profession, or business in Hong Kong.
- When it is used to purchase movable property that is subsequently brought into Hong Kong.
Which Entities Are Affected by the FSIE Regime ?
The Foreign-Sourced Income Exemption (FSIE) regime targets multinational enterprises (MNEs) operating in Hong Kong that receive foreign-sourced income but have limited or no economic substance in the region. The goal is to prevent the abuse of tax exemptions that could lead to double non-taxation. However, the FSIE regime does not apply to:
- Local enterprises with no offshore operations
- Companies in purely local groups with no foreign affiliates
- Individual taxpayers
Additionally, regulated financial entities and MNEs benefiting from Hong Kong’s existing preferential tax regimes may be exempt from the FSIE regime under certain conditions.
FSIE Exemption Conditions
The four types of foreign-sourced passive income could be exempted from Hong Kong Profits Tax under the FSIE regime if the following conditions are met:
- the economic substance requirement (ESR),
- the participation exemption or
- the nexus exemption
The exemption condition can be different from each type of foreign-sourced income to another. The specific exemptions for each income type are described in the table below:
The economic substance requirement covers interests, dividends, and share disposal gains while the participation exemption covers only the latter two.
On the foreign-sourced income from IP, only the nexus exemption is applicable.
The Economic Substance Requirement (ESR)
Non-IP income, such as dividends income, interest income and share disposal gains are applied in the Economic Substance Requirement (ESR) under the FSIE regime. Hong Kong Profits Tax if a covered taxpayer is sufficiently substance in Hong Kong.
To claim offshore benefits, ESR requires MNE entities to prove Hong Kong’s economic substance according to international standards. The following adequacy tests are also applied:
(1) hiring enough competent employees and
(2) expending a suitable amount of operating expenses in Hong Kong related operations
As long as proper oversight is maintained and outsourcing standards are met, outsourcing is permitted. The Inland Revenue Department (“IRD”) does not have any limits on the economic substance requirement so the specific requirements will be different on a case-by-case basis. There will be less strict requirements for pure equity holding companies with dividend income and equity interest disposal gains. Before the interest income source regulation, such as the credit test or operation test, is applied, non-pure equity-holding companies that receive interest income must show the strategic choices and loan financing arrangements in Hong Kong.
Participation Exemption
Moreover, the participation exemption can be granted for foreign source dividends and capital gains from the disposal of shares (excepting interests) under the FSIE regime if the requirements for the participation exemption are fulfilled. These conditions include:
- The income recipient should be a Hong Kong tax resident or a non-resident with a permanent establishment in Hong Kong.
- The income recipient must own at least 5% of shares or equity interests of the investee entity for at least 12 months, before the foreign-sourced dividend income is earned.
Under the Inland Revenue Ordinance (IRO), there are anti-abuse rules which cover the participation exemption, such as the subject to tax condition, anti-hybrid mismatch rule, and main purpose rule, all of which should be considered carefully.
- The investee company must have at least 15% corporate income tax rate.
- Based on main purpose test (General Tax Anti-Avoidance Rule), the participation exemption will not apply if the Inland Revenue Department finds that the main goal of the entire arrangement is to evade taxes; and
- The anti-hybrid mismatch rule states that the investee company’s dividend payments cannot be deducted from taxes.
Nexus exemption
Foreign-sourced passive income from patents or software-related copyrights is exempt from taxes under the FSIE regime’s Nexus exemption. Though marketing-based IP assets, such as trademarks and copyrights are taxable and not qualified for this exemption.
The IP income in the form of tax exemption, earned from the qualifying IP assets, is calculated by using the following formula:
In regards to the qualifying expenditure, the following considerations should be noted:
- The taxpayer can carry out the R&D activity themselves or contract with an outsourced unaffiliated party, wherever they may be located;
- If R&D activity is contracted to an outsourcing party, it should be conducted in Hong Kong:
- IP acquisition costs are not regarded as qualifying expenditures;
- A 30% increase in qualifying expenditure is possible (depends on the total operating expense limit):
- Offshore benefits are limited when R&D activity is outsourced to foreign companies;
- In general, R&D expenditures made to foreign group corporations are not tax deductible;
- There may be significant Hong Kong profits tax obligations if IP income is not eligible for offshore benefits.
Key Summary of Exemption, Income Types and Requirements
| Exemption | Economic Substance Requirement (ESR) | Participation Exemption | Nexus Exemption |
| Income Type | – Interest income – Dividend income- Share disposal gains | – Dividend income- Share disposal gains | IP Income |
| Requirements | 1. Hiring enough skilled workers; 2. Incurring a suitable amount of operating expenses in Hong Kong associated with the related operations; and 3. Allowing outsourcing as long as proper monitoring and compliance with outsourcing standards are met. | 1.The recipient must be a tax resident of Hong Kong or a business owned by a non-tax resident; 2. The recipient must hold at least 5% of the shares for a minimum of 12 months prior to receiving passive income; 3. Anti-abuse regulations are applied | 1. This applies to qualifying intellectual property (IP) assets, such as patents and copyrights); 2. It is calculated using qualifying expenses that the taxpayer paid to generate the IP assets; 3. IP acquisition costs are not considered as qualifying expenses. |
Advance Ruling & FSIE Regime
To determine if the economic substance requirement (ESR) will be met or not and whether the income is subject to profits tax under the FSIE regime and to ease the compliance burden of the taxpayers, they can seek an advance ruling from the IRD.
A ruling is in force for 5 years and it is legally binding. An application can be lodged as an individual or as a group, that is either (1) as the entity itself or (2) as the entity and other entities of the same MNE group in Hong Kong. The conditions for a group application are:
- Contractual arrangements are defined in the service agreement made with the applicant and other MNE entities of the specified economic activities concerned in the form of outsourcing to one entity.
- The applicant and/or its representative must have written consent of the other entities of the MNE group to authorize the group application (and must supply the Commissioner with the written consent on request).
- The service agreement duly copied should be submitted along with the application.
When to apply?
The advance ruling normally takes about 21 working days for the IRD to process the application and can be applied at any time.
Taxpayers can enjoy the profits tax exemption under the FSIE when a positive ruling is obtained from the IRD. Or, taxpayers can explore the possibilities of tax management, under the advice of a tax lawyer, such as business restructuring with a view to maintain/obtain the tax efficiencies.
Related Article: 2025 Tax Filing Season: Tax Deadline in Hong Kong You Need To Know About
How FastLane Group Can Help?
Does the FSIE regime have any effect on the tax liability of passive income of your company? Do you think about developing your economical substance in Hong Kong? Is restructuring of your current business and investment structure viable?
FastLane Group is available to respond to your questions, provide personalized tax advice, and deal with the consequences of tax reforms.
The range of services that we provide includes the application for an advance ruling on ESR compliance and the FSIE regime income taxability, a deep analysis of the impact of the FSIE regime on your company, as well as expert advice on maintaining your tax efficiency. For a tax health check, we recommend a preliminary meeting to establish your tax position, mitigate risks and preserve financial health. Trust in our ability and knowledge to protect your company’s future. Contact us today for a consultation.
