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FSIE regime expansion: Covering capital gains for Hong Kong

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Lewis Lu and John Timpany of KPMG China discuss the coming refinement of Hong Kong SAR’s foreign-sourced income exemption regime.

On February 14 2023, the EU concluded the latest review of its list of non-co-operative jurisdictions for tax purposes (see the EU’s press release here). Hong Kong remains on the grey list (Annex II of the EU list of non-cooperative jurisdictions for tax purposes). For more background on the grey listing of Hong Kong, please refer to KPMG’s publications released in September 2021 and March 2022.

Changes to the tax treatment of foreign-sourced capital gains

In response to the EU's inclusion of Hong Kong in its grey list in October 2021, Hong Kong has implemented the revised foreign-sourced income exemption (FSIE) regime for dividends, interest, equity disposal gains and IP income. This has been in place since 1 January 2023 to comply with the EU’s guidance on FSIE regimes originally published in 2019.

After examining the FSIE reforms of various jurisdictions, the EU’s Code of Conduct Group updated its guidance on FSIE regimes in respect of treatment of foreign-sourced capital gains. In December 2022, the EU updated the guidance to explicitly require capital gains, as a general class of income covered by an FSIE regime, to be subject to the economic substance requirement. Unfortunately, Hong Kong is therefore required by the EU to make further legislative amendments regarding the treatment of foreign-sourced capital gains by the end of 2023, for implementation with effect from January 2024.

This change in approach could affect other jurisdictions in the region as well.

What’s next

The next round of updates of the EU tax lists is scheduled for October 2023.

The Hong Kong Government issued a press release on February 15 2023 to announce that it will further refine the current FSIE regime. This is regarding foreign-sourced disposal gains in relation to assets other than shares or equity interests considering the EU's updated guidance.

According to the press release, under the to-be-formulated refined FSIE regime, foreign-sourced capital gains in relation to assets, regardless of their financial or non-financial nature, received by MNE entities in Hong Kong will remain exempt from tax. This is provided that the economic substance requirement is complied with.

The government will launch a consultation on the proposed amendments to the FSIE regime and aims to affect the necessary legislative amendments by the end of 2023.

Separately, the government announced in another press release issued on February 13 2023 that it will propose an initiative to enhance tax certainty of onshore gains on disposal of equity interests. It will launch a trade consultation on the initiative in mid-March this year.


The forthcoming changes suggest that, similar to the treatment of foreign-sourced equity disposal gains under the existing FSIE regime, these asset disposal gains received by MNE entities in Hong Kong will continue to be tax exempt in the future if the economic substance requirement is complied with.

When formulating the revised taxation regime of foreign-sourced capital gains in Hong Kong, it is recommended that the government considers putting in place various measures to minimise the impact of the changes on businesses in Hong Kong, such as:

  • Excluding gains derived by taxpayers enjoying a preferential tax regime (with a substantial activity requirement) in Hong Kong where the gains are derived from the required profit-producing activities under the regime;

  • Excluding gains derived from disposal of overseas immovable property;

  • Deferring the taxation of gains derived from intra-group transfer of assets; and

  • Offering a reduced profit tax rate for gains derived from capital assets (as opposed to ordinary business income).

When determining the quantum of the foreign-sourced asset disposal gain that is within the scope of the FSIE regime, the cost of the asset should be rebased to its fair value as of 1 January 2024. Given the mechanism in section 15BA(3) of the Inland Revenue Ordinance to rebase assets moving from capital to revenue accounts already exists, it would seem appropriate to allow a similar mechanism for rebasing the asset disposed in determining the quantum of the foreign-sourced asset disposal gain under the FSIE regime.

As for the onshore equity disposal gains of which a capital claim is still available, various stakeholders (including KPMG) have expressed concerns about the uncertainty currently faced by taxpayers on making a capital claim on such gains. The government’s plan to launch a trade consultation to seek comments from stakeholders on increasing the tax certainty on such capital claims is welcomed, and KPMG will actively participate in the government consultation.

It is recommended that the government considers introducing a bright-line test for such capital claims similar to (or even better than) the one currently adopted by Singapore. Likewise, the impacted Hong Kong entities should consider taking the opportunity of the government’s consultation to voice out their concerns.

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