With effect from 5th October 2021 Hong Kong has been added to the EU list of non-cooperative countries and territories for tax purposes.
1. Hong Kong has been on the EU watch list for tax purposes since 5th October 2021
The list is designed to combat tax fraud, tax evasion, tax avoidance, and money laundering. By doing so, the EU pursues the enforcement of diligent practice in cross-border tax standards in light of its tax bases.
The list includes third countries that abuse tax practices or embezzle revenues resulting from the corporate taxes of EU Member States. The aim is to bring about a positive transformation of the tax procedures and tax legislation of the countries on the list.
If third countries that do not yet fulfil all international tax requirements want to implement reforms in the sense of the EU, they are listed in a document on the status of cooperation, which functions as a watch list. If all requirements in the tax area are met, they are taken off the list again. However, if countries do not change the identified harmful points in the tax system, they may be moved from the watch list to the final blacklist of non-cooperative countries and territories for tax purposes.
Penalties include denial of deduction of payments, higher taxes, application of controlled foreign company rules, taxation of dividends, and administrative measures.
2. Amendment of Hong Kong's territorial tax system planned by 31 December 2022
Following a review of the tax exemption regimes for foreign source income (offshore income), Hong Kong has been placed on the Watch List . This also means that Hong Kong agrees to amend the relevant legislation. The EU believes that aspects of Hong Kong's territorial tax system could facilitate tax avoidance or other tax practices that are considered harmful. In addition, the EU is concerned that companies that do not carry out substantial economic activity in Hong Kong are not taxed on certain passive offshore income (such as interest and royalties), which can lead to "double non-taxation". The change to Hong Kong's territorial tax system will be one of the most significant changes to profits tax and will have a fundamental impact on many resident companies. The EU has given a deadline of 31st December 2022 to make the necessary reforms. If no changes are made to the tax system, Hong Kong will be blacklisted.
3. Impact on the taxation of offshore profits of foreign companies in Hong Kong
The SAR government is responding to the EU watch list in a supportive manner to help and participate in the fight against cross-border tax evasion. Therefore, Hong Kong has committed to amend the tax law by the end of 2022 and to implement corresponding measures in 2023. However, Hong Kong will continue to apply the principle of territorial taxation, whereby offshore profits are generally not subject to Hong Kong profits tax. The government wants to maintain a simple, safe, and low tax system to maintain competitiveness. Individual taxpayers are not affected by the change in the law. Only companies that do not carry out substantial economic activity in Hong Kong and use passive income to evade taxes across the border are covered. Although the EU has placed Hong Kong on the watch list, Hong Kong companies will not be affected by tax safeguards. After amending the relevant tax regimes, the Hong Kong government will request the EU to remove Hong Kong from the list.