Motion on “Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Bill 2022” (2022.12.14)

MR CHAN KIN-POR (in Cantonese): Thank you, Deputy President. In my capacity as the Chairman of the Bills Committee on Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Bill 2022 (“the Bill”), I now brief the Council on the main deliberations of the Bills Committee.

The Bill seeks to amend the Inland Revenue Ordinance so as to implement a new foreign-sourced income exemption (“FSIE”) regime, with a view to addressing the concerns of the European Union (“EU”) over the possible risks of double non-taxation arising from the current tax arrangement in Hong Kong, and avoiding the blacklisting of Hong Kong by EU for tax purposes.

Members of the Bills Committee generally supported the Bill, and conducted detailed deliberations on the economic substance requirement under the proposed FSIE regime, including the adequacy test to be satisfied by taxpayers. Members were concerned how the Administration could ascertain that a taxpayer had employed an adequate number of qualified employees and incurred an adequate amount of operating expenditures in Hong Kong, particularly when many enterprises had adopted remote working mode and arranged employees to work from home amidst the epidemic and digital transformation. Moreover, members enquired whether a pure equity-holding entity must set up an office in Hong Kong in order to meet the relevant requirement.

The Administration has explained that in considering whether a taxpayer has satisfied the adequacy test, the Inland Revenue Department (“IRD”) will consider relevant factors such as the nature of business, scale of operation, the number of employees and the amount of operating expenditures involved in the relevant activities. The presence of office premises is only one of the factors in determining whether a taxpayer has a substantial economic presence in Hong Kong. To enhance tax certainty, taxpayers may apply for an advance ruling on their compliance with the economic substance requirement, such that they may avail themselves of the relevant streamlined reporting requirements.

Regarding the nexus approach, which will apply in determining the extent of foreign-sourced qualifying intellectual property (“IP”) income to be exempt from tax, members requested the Administration to explain the tax arrangement for qualifying IP income if, after exemption from profits tax, the patent application is withdrawn, abandoned or refused subsequently. Members also urged the Administration to put in place tax concession measures to encourage more research and development (“R&D”) activities in Hong Kong and promote the development of Hong Kong into an IP hub.

The Administration has explained that where the excepted portion of a qualifying IP income derived from a patent application is not chargeable to profits tax in a year of assessment due to the operation of the nexus requirement and the patent application is withdrawn, abandoned or refused in a subsequent year of assessment, the excepted portion of the income would be regarded as specified foreign-sourced income received in Hong Kong in that subsequent year of assessment and be chargeable to profits tax at the assessment rate. The Administration will explore devising a preferential tax regime for Hong Kong-sourced IP income to encourage more R&D activities in Hong Kong.

The Bills Committee has examined the “subject to tax” condition under the participation exemption for dividends and disposal gains, including the rationale for benchmarking the applicable rate for the condition at 15% under the proposed FSIE regime.

The Administration has explained that the “subject to tax” condition only applies to entities unable to comply with the economic substance requirement. The condition aims at ensuring that the relevant foreign-sourced dividend and disposal gain have been adequately taxed in a foreign jurisdiction before they may be tax-exempt in Hong Kong. The Administration considers 15% to be a reasonable benchmark for the applicable rate having regard to the “subject to tax” condition in other jurisdictions and the minimum tax rate specified under the relevant rules promulgated by the Organisation for Economic Co-operation and Development.

Members were concerned about the impact of the proposed FSIE regime on the tax competitiveness of Hong Kong, and whether Hong Kong would be relieved from being included on the EU blacklist and would be removed from the watchlist if the Bill was passed and the proposed FSIE regime took place with effect from 1 January 2023 as scheduled.

The Administration has advised that one of the intended objectives of the proposed FSIE regime is to uphold the tax competitiveness of Hong Kong. The proposed FSIE regime is in line with the international standards, and comparable with the FSIE regimes of other jurisdictions. Regarding EU’s concerns, the Administration pointed out that the Bill is prepared based on the key legislative building blocks as confirmed by EU in June 2022. As such, the Administration is confident that the Bill can relieve Hong Kong from being blacklisted by EU. The Administration has stressed that no substantial impact will be brought to Hong Kong even if EU keeps Hong Kong on its watchlist, which only reflects that the jurisdictions have committed to implementing reforms in order to meet the international tax standards supported by EU.

The Bills Committee noted that in the light of EU’s latest position, the Administration would introduce amendments to delete the definition of “excluded entity”, amend the definition of “specified foreign-sourced income” and make corresponding amendments to the definition of “MNE entity”. The Bills Committee agreed with the amendments proposed by the Administration.

President, the following are my personal views on the Bill.

In recent years, EU and other international organizations have from time to time requested Hong Kong to amend its laws and regulations in order to meet and satisfy their standards. If Hong Kong refuses to respond, it may be placed on the relevant watchlists or even blacklists. Worse still, Hong Kong may eventually be sanctioned by the countries concerned, which will carry considerable implications for Hong Kong. The present legislative amendment exercise is a typical example. We have to accede to the request in order to maintain Hong Kong’s competitiveness.

First of all, I would like to commend the Financial Services and the Treasury Bureau (“FSTB”) and IRD for addressing this matter so promptly and effectively. After receiving EU’s invitation in October last year, they immediately engaged in several rounds of discussions with EU. When the legislative proposal was at last finalized in October this year, they still kept on discussing with EU in an endeavour to fight for a better deal for and protect the interests of Hong Kong.

At the same time, FSTB and IRD launched a three-month consultation exercise with stakeholders, inviting the business sector, the accounting sector, and tax-related organizations to get involved. Over 10 engagement sessions were organized and a total of 27 written submissions were received. After receiving views from these sectors, the Administration engaged in discussions with EU again. At last, except for a small number of issues relating to the tax structure, the vast majority of stakeholders’ views have been properly addressed and incorporated into the Bill.

The Bill was introduced into the Legislative Council (“LegCo”) in early November. Since it is necessary to complete the legislative exercise within this year so as to meet the deadline set by EU, the schedule for the exercise is very tight, with just a month or so. In view of this, FSTB officials tirelessly explained the contents of the Bill to Members in a bid to gain the support of LegCo. I am honoured to be the Chairman of the Bills Committee, and I did my utmost to strive for an early completion of the scrutiny work.

At the beginning, the Government was worried that in view of the complexity of the Bill, more time might be needed for scrutiny and the Bill might not be passed before the end of the year. However, it turned out that the Government did adequate preparatory work, including consulting stakeholders and taking on board most of their views, giving Members clear explanations about the contents of the Bill before the meetings, and addressing all the issues properly in advance. Furthermore, the Government gave detailed reply to Members’ professional questions at the Bills Committee meetings to their satisfaction. In the end, the Bills Committee completed the scrutiny work smoothly after holding just two meetings.

President, I would describe the Government’s present legislative exercise with “three plentys”: plenty of sympathy, plenty of explanations, and plenty of compromises. By “plenty of sympathy”, I mean the officials sympathize with the difficulties of the sectors. By “plenty of explanations”, I mean the Government had successive meetings to enhance the communication with stakeholders and Members. By “plenty of compromises”, I mean the Government has satisfied the demands of stakeholders as far as possible.

In fact, the opposition camp obstructed the Government’s policy implementation in the past, resulting in continued tensions between the executive authorities and the legislature, which naturally posed many problems for legislative work. However, with “patriots administering Hong Kong” now, LegCo monitors the Government in a constructive manner, and the executive authorities and the legislature cooperate with each other. With no malicious obstruction anymore, the Government does not need to face meaningless political disputes, but focuses its efforts on each and every aspect of legislative exercises, seriously responds to the demands of stakeholders, makes compromises, and convinces Members with facts. It is natural that legislative work can be completed smoothly. I hope various government departments can learn from this experience and adopt the same attitude and approach in the future. I believe legislative work will then be taken forward with great ease.

Thank you, President.

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