The Hong Kong government plans to introduce a new tax scheme called the Tax Certainty Enhancement Scheme (“the Enhancement Scheme”), to enhance Hong Kong’s attractiveness as an international investment and business hub.

Under this scheme, taxpayers will have greater certainty of non-taxation of their onshore gains on disposal of equity interests. In other words, whether to pay taxes on profits made from selling equity interests in Hong Kong.

The scheme is currently under consultation and targeted to be implemented from 1 January 2024.

Current tax rules

Following the territorial source system adopted in Hong Kong, if a gain from disposal of equity interests is sourced offshore, it is not subject to tax in Hong Kong.

If a taxpayer’s equity interests are considered capital assets rather than trading assets, any disposal gain can be claimed as capital in nature, which is also non-taxable in Hong Kong. This is because Hong Kong does not impose tax on capital gains.

To determine whether equity interests are considered capital assets, the Hong Kong Inland Revenue Department (“IRD”) generally uses the ‘badges of trade’ approach. However, this is sometimes disputable between the IRD and taxpayers.

The Enhancement Scheme

In the Enhancement Scheme, equity interests include ordinary shares, preference shares and partnership interests.

Eligible investors include legal persons and arrangements that prepare separate financial accounts, such as a partnership and a trust. Eligibility is irrespective of whether the investor is resident of Hong Kong or not.

Basic conditions

Under the Enhancement Scheme, it is proposed that onshore gain from disposal of equity interests will not be taxable in Hong Kong if an eligible investor holds:

1. at least 15% of the total equity interests in the investee entity; AND
2. does this for a continuous period of at least 24 months, ending immediately before the date of disposal of such interests.

The investee concerned is not required to be a company. In addition, it can be listed or non-listed and incorporated/established in or outside of Hong Kong.

Exclusion

1. Excluded investor entities
   The proposed Enhancement Scheme does not normally consider insurers as eligible investors. This is because, according to the current ‘badges of trade’ approach, any gain on disposal of equity interests by an insurance business is usually not seen as capital in nature.
   
2. Excluded interests
   To prevent abuse of the Enhancement Scheme, it is proposed that non-listed equity interests in investee entities that engage in the following property-related businesses should be excluded from the scheme. This applies regardless of whether the properties are located in- or outside of Hong Kong.
   • property trading;
   • property development (subject to exception – see Note 1 below)
   • property holding (see Note 2 below) 

Notes:

1. The conditions for exception are as follows:
   • The investee entity uses the immovable property developed to carry on its own business (including the business of letting immovable properties) to derive trade income; and
   • The investee entity did not undertake any property development activity in the past 60 months before the disposal of equity interests.
     
2. Exclusion applies to the investee entity that holds immovable properties with a value exceeding 50% of the entity’s total assets.

If the onshore gain from disposal of equity interests cannot meet the exclusions or conditions for exception under the Enhancement Scheme, then the ‘badges of trade’ approach will be used to determine the taxability.

Conclusion

The proposed Enhancement Scheme is good news for taxpayers, especially those with equity investments and/or planning to expand or restructure their businesses.

The Scheme’s scope of coverage is broad and the conditions for entitlement seem to be quite clear. However, it is important to wait and see how the proposed Scheme develops.

Meanwhile, should you have any tax-related questions about equity investments or other matters, you can contact our tax professionals via the form below.