Effective from October 5 2021, Hong Kong SAR has been added to the EU’s ‘grey list’ of non-cooperative jurisdictions for tax purposes following a review of the foreign-source income exemption regimes.
The EU considers certain aspects of Hong Kong SAR’s territorial tax system may facilitate tax avoidance or other tax practices they regard as harmful. In particular, the EU considers that corporations without substantial economic activity in Hong Kong SAR and that are not subject to Hong Kong SAR tax in respect of certain foreign sourced passive income (such as interest and royalties) could lead to situations of ‘double non-taxation’.
In a press release issued by the Hong Kong SAR government on October 6 2021, the government stressed that Hong Kong SAR will continue to adopt the territorial system of taxation to maintain Hong Kong SAR’s competitiveness.
The territorial concept looks at the location where the profits of a corporation are derived and profits which are foreign sourced are not taxed in Hong Kong SAR, regardless of the tax residency or place of incorporation of that corporation.
While Hong Kong SAR is committed to making the necessary changes, the proposed amendments will target corporations without substantial economic activity in Hong Kong SAR that make use of passive income to evade cross-border taxes. The legislative amendments will not affect individual taxpayers.
For financial institutions, there would not be any additional tax burden given offshore interest income derived by financial institutions is already subject to Hong Kong SAR profits tax.
Annex II of the EU list of non-cooperative tax jurisdictions is effectively a watchlist. The EU will further monitor the situation and consider moving Hong Kong SAR to a blacklist if the identified harmful aspect of its tax system does not change. Punitive measures against blacklisted jurisdictions include denial of deduction of payments made, increased withholding taxes, application of controlled foreign company rules, taxation of dividends and administrative measures.
That said, the EU has granted the affected jurisdictions until December 31 2022 to make the necessary changes. Hong Kong SAR has agreed to amend the relevant legislation by the end of 2022 and implement the relevant measures in 2023.
The government is actively engaging with the EU and will request to swiftly remove Hong Kong SAR from the ‘grey list’ after amending the necessary legislation.
The government further states that it will consult stakeholders on the specific contents of the legislative amendments and strive to minimise the compliance burden of corporates.
While Hong Kong SAR is still considering how to effect the changes, changes to the territorial system in Hong Kong SAR could be one of the most significant changes to Hong Kong SAR profits tax for many years and is likely to impact companies making an offshore claim on passive income in Hong Kong SAR, especially where they have limited substance in Hong Kong SAR. Businesses should keep abreast of developments and work with their tax advisors to understand the implications.
The EU Council statement dated October 5 2021 can be accessed here.
Lewis LuPartner, KPMG ChinaE: lewis.lu@kpmg.com
John TimpanyPartner, KPMG ChinaE: john.timpany@kpmg.com
