Are you a multinational corporation with operations spanning multiple countries? Do you receive dividends from overseas subsidiaries or interest from cross-border loans? Hong Kong’s tax landscape has undergone significant changes in recent years, transforming how cross-business income is taxed. The traditional approach of relying solely on offshore sourcing claims is no longer sufficient. This guide explores the current strategies for managing cross-business dividends and interest in Hong Kong’s evolving tax environment, focusing on compliance with the new Foreign-Sourced Income Exemption (FSIE) regime and other international tax developments.

Hong Kong’s Territorial Tax System: The Foundation

Hong Kong operates under a territorial tax system, which means only profits sourced in or derived from Hong Kong are subject to profits tax. This fundamental principle has historically made Hong Kong attractive for international business, as offshore-sourced income was generally not taxed. However, recent legislative changes have significantly modified this landscape, particularly for certain types of passive income.

Understanding Cross-Business Dividends and Interest

Cross-business dividends and interest refer to payments flowing between related entities across different jurisdictions. These financial flows are essential for multinational groups but now face increased scrutiny under Hong Kong’s refined tax rules.

The FSIE Regime: A Game Changer

The Foreign-Sourced Income Exemption (FSIE) regime represents the most significant change to Hong Kong’s territorial tax system in decades. Phase 1 began in January 2023, and Phase 2 expanded the regime in January 2024. The FSIE covers four types of foreign-sourced passive income received in Hong Kong by multinational enterprise (MNE) entities:

• Dividends: Including those from equity interests
• Interest: From lending activities
• Disposal gains: From sale of equity interests
• IP income: Royalties and similar payments

Tax Management Strategies for Dividends

Under the FSIE regime, foreign-sourced dividends received in Hong Kong are taxable unless they qualify for the participation exemption. Here are the key strategies for managing dividend taxation:

1. Participation Exemption Requirements

To qualify for dividend exemption under the FSIE participation exemption, companies must typically meet these conditions:

1. Ownership Threshold: Generally 15% or more ownership in the dividend-paying entity
2. Holding Period: Minimum holding period requirements may apply
3. Substance Requirements: The dividend-paying entity must have adequate economic substance in its jurisdiction
4. Anti-Abuse Rules: Must not be structured primarily for tax avoidance

2. Holding Company Structures

Establishing a Hong Kong entity as a regional holding company remains viable but requires careful planning:

• Centralized Management: Use Hong Kong as the hub for regional treasury and investment management
• Substance Creation: Ensure adequate employees, physical presence, and decision-making in Hong Kong
• Compliance Focus: Align structures with FSIE requirements and maintain proper documentation

Interest Income Management Strategies

Foreign-sourced interest income faces different treatment under the FSIE regime. Unlike dividends, interest generally requires economic substance in Hong Kong to qualify for exemption.

Economic Substance Requirements for Interest

For interest income to qualify for exemption under the FSIE nexus approach, the Hong Kong entity must demonstrate adequate economic substance. This typically includes:

• Qualified Employees: Adequate number with relevant expertise
• Operating Expenditure: Sufficient expenditure in Hong Kong
• Physical Presence: Office space and facilities
• Decision-Making: Core income-generating activities conducted in Hong Kong

Global Minimum Tax (Pillar Two) Impact

Hong Kong enacted the Global Minimum Tax (Pillar Two) rules on June 6, 2025, effective from January 1, 2025. This adds another layer of complexity to cross-business tax planning:

Key implications for cross-business income:

• Top-up Tax: Hong Kong implemented a domestic minimum top-up tax (HKMTT)
• FSIE Interaction: Need to assess how FSIE exemptions interact with Pillar Two calculations
• Group Planning: Requires holistic view of group effective tax rates across jurisdictions

Risk Management and Compliance

Effective tax planning must include robust risk management strategies. Here are the key areas to focus on:

1. Substance Requirements

Lack of economic substance is the single biggest risk under the FSIE regime. Ensure your Hong Kong entity has:

• Genuine business activities aligned with income streams
• Adequate local management and staff with relevant expertise
• Physical presence and operational capabilities
• Commercial rationale beyond tax considerations

2. Documentation and Record-Keeping

Comprehensive documentation is essential for defending your tax positions:

1. Intercompany Agreements: Clearly documented terms for all cross-border transactions
2. Transfer Pricing Documentation: Robust analysis supporting arm’s length pricing
3. Board Minutes: Records of key decisions and commercial rationale
4. FSIE Compliance Files: Evidence supporting exemption claims
5. Substance Documentation: Proof of economic activities in Hong Kong

Practical Implementation Strategies

Here are actionable steps for implementing effective cross-business tax strategies:

Regional Headquarters (RHQ) Structure

Establishing a genuine regional headquarters in Hong Kong can provide multiple benefits:

• Centralized Functions: Management, financing, and holding activities
• Substance Creation: Build adequate economic substance to support FSIE claims
• Efficiency Gains: Streamlined group treasury and investment management
• Treaty Benefits: Access to Hong Kong’s extensive DTA network

Cross-Border Financing Structures

For intercompany lending and financing arrangements:

1. Commercial Terms: Set interest rates and terms comparable to independent parties
2. Documentation: Prepare comprehensive transfer pricing documentation
3. Substance: Ensure lending activities have genuine economic substance in Hong Kong
4. Treaty Planning: Utilize DTAs to reduce foreign withholding taxes

Hong Kong remains an attractive jurisdiction for international business, but the rules have evolved significantly. Successful tax planning for cross-business dividends and interest now requires a balanced approach that combines strategic structuring with robust compliance. Focus on creating genuine economic substance, maintaining comprehensive documentation, and staying informed about ongoing international tax developments. As the global tax landscape continues to evolve, proactive planning and regular review of your structures will be essential for maintaining both tax efficiency and compliance.