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Hong Kong FSIE Regime: IRD issues further clarifications (July 2025)

The Hong Kong Inland Revenue Department (IRD) continues to refine the administration of the Foreign-Sourced Income Exemption (FSIE) regime. On 24 July 2025, the IRD published additional FAQs that provide welcome clarification on the treatment of dividends, disposal gains, bond transactions and in-kind distributions. These developments are particularly relevant for multinational enterprise (MNE) groups with offshore investment and treasury structures.

Below is a practical summary of the latest guidance, read together with earlier IRD positions.

1. FSIE Regime – brief context

Hong Kong’s FSIE regime, introduced in 2023 and expanded from 1 January 2024, represents a significant shift from its traditional territorial tax system. Foreign-sourced passive income received in Hong Kong is now taxable unless specific exemption conditions (economic substance or participation exemption) are met.

Originally limited to interest, dividends, equity disposal gains and IP income, the regime was extended in 2024 to cover non-equity disposal gains, increasing both scope and compliance complexity.

1. Key clarifications from the IRD (July 2025 FAQs)

(a) Share of profits from overseas associates – not a dividend

The IRD confirms that a Hong Kong taxpayer’s share of profits from an overseas associate recognised under the equity method (HKAS 28) does not constitute a dividend for FSIE purposes. Such accounting entries merely reflect changes in the value of the investment and do not represent an actual distribution of profits.

Only when profits are formally declared and distributed by the overseas associate will the income be treated as a dividend under the FSIE regime.

Practical implications

• FSIE exposure depends on the year of dividend declaration, not the year in which profits are recognised in the income statement.
• Substance or participation exemption conditions must therefore be satisfied in the year the dividend is declared.
• As dividend declarations are not reflected in profit and loss accounts, taxpayers should implement controls to track declarations and distributions separately from accounting results.

(b) Deductibility of expenses relating to disposal gains

Where foreign-sourced disposal gains are deemed taxable under the FSIE regime, the IRD confirms that such gains are computed by reference to disposal proceeds less acquisition cost and direct expenses incurred on acquisition and disposal (e.g. legal fees, brokerage fees and stamp duty).

Other expenses incurred in producing the disposal gain may also be deductible, provided they satisfy the normal deduction rules under the Inland Revenue Ordinance. Capital expenditure remains non-deductible, and certain expenses (such as interest) are subject to specific statutory conditions.

Practical implications

• Detailed documentation is required to distinguish direct disposal costs from other expenses.
• Careful analysis is needed to determine whether expenses are capital or revenue in nature.
• Interest and financing costs should be reviewed against statutory deductibility requirements, particularly in acquisition-driven structures.

(c) In-kind dividends – shares in overseas entities

The IRD clarifies that an in-kind dividend in the form of shares in an overseas entity will generally not be regarded as “received in Hong Kong” where the investee entity is incorporated and managed outside Hong Kong and has no Hong Kong operations or personnel.

This position is consistent with the IRD’s earlier advance ruling practice and reinforces a substance-based approach to determining the location of receipt.

Practical implications

• The tax outcome depends on the economic nexus and management location of the investee entity, rather than the mere fact that shares are distributed.
• In-kind distributions are particularly relevant in group reorganisations and upstream dividend planning.
• Taxpayers should carefully document the overseas nature of the investee’s management and operations.

(d) Clarification of “received in Hong Kong”

Beyond in-kind dividends, the IRD reiterates that foreign-sourced income is regarded as received in Hong Kong only if it is:

• remitted to Hong Kong;
• used or applied in Hong Kong; or
• used to satisfy a debt incurred in respect of a trade or business carried on in Hong Kong.

Mere recording of income in Hong Kong-based accounting records or financial statements is insufficient to constitute receipt.

Practical implications

• FSIE analysis is driven by actual cash flows and economic use, not bookkeeping entries.
• Treasury and finance teams must align operational practices with tax reporting positions.
• Clear audit trails should be maintained to demonstrate where and how foreign-sourced income is received or applied.

1. Looking ahead

While the July 2025 FAQs provide helpful clarity, FSIE remains an evolving regime. Further guidance from the IRD is expected as new fact patterns emerge. Taxpayers with complex offshore, investment or treasury structures should consider advance rulings where uncertainty exists.

Marie-Gabrielle du Bourblanc - LPA Law