Update: treaty access between Hong Kong and the CIS

For groups with capital corridors between Hong Kong and the Commonwealth of Independent States — the post-Soviet grouping that includes Russia, Kazakhstan, Ukraine, Azerbaijan, Armenia, Georgia, and their neighbours — treaty access has become a more exacting exercise than it was three years ago. The question of whether a Hong Kong entity can claim relief under a relevant double-taxation agreement is no longer settled by formation documents alone.

Treaty access between Hong Kong and the CIS (the Commonwealth of Independent States, the regional organisation of former Soviet republics) depends on satisfying both the economic-substance conditions of Hong Kong's foreign-sourced income exemption regime (the FSIE regime, in force from 1 January 2023, as amended) and the anti-abuse provisions embedded in the relevant bilateral double-taxation arrangement. Both must be addressed together; addressing one without the other leaves the position exposed.

This briefing covers what is driving the current pressure on treaty positions, who is affected across the Hong Kong–CIS corridor, and the immediate steps that groups should be taking now.

What is creating the current pressure on treaty positions?

The FSIE regime, which came into force on 1 January 2023 and has since been amended, imposes economic-substance conditions on specified foreign-sourced income received in Hong Kong by a resident entity. Dividends, interest, royalties and gains on disposal of equity interests received in Hong Kong from an offshore source are within scope. Where an entity cannot demonstrate the requisite substance, the income is treated as taxable profits arising in Hong Kong, regardless of the position at the treaty level.

That change has run directly into a second pressure: CIS-side authorities have sharpened their scrutiny of the beneficial-ownership and principal-purpose tests that nearly all the relevant double-taxation arrangements now carry. A Hong Kong entity interposed between a CIS operating group and an offshore centre no longer attracts treaty rates — whether for dividends flowing out of the CIS or for interest and royalties — unless it can satisfy the treaty's own anti-avoidance tests. The two regimes, the FSIE conditions and the treaty tests, now operate as a dual gate. Groups that passed through that gate under an earlier version of the rules may no longer do so without structural adjustment.

In our cross-border tax practice, we are regularly instructed by groups with CIS-origin holding chains that assumed the Hong Kong position was settled at formation. The current environment is producing adverse assessments and treaty-denial notices, particularly in respect of dividend streams from Kazakhstan, Azerbaijan, and the Central Asian jurisdictions where Hong Kong–CIS capital flows have grown.

Who is affected across the Hong Kong–CIS corridor?

The groups most immediately exposed are those using a Hong Kong holding entity to receive income from a CIS subsidiary or joint-venture vehicle. That includes manufacturing and natural-resources groups, financial services businesses with Eurasian exposure, and private-capital vehicles structured through Hong Kong above a CIS operating layer.

The corridor is not uniform. Where a Hong Kong entity is receiving dividends from a CIS jurisdiction whose double-taxation arrangement with Hong Kong includes a principal-purpose test (a limitation under which treaty benefits are denied where one of the main purposes of an arrangement was to obtain them), the evidential burden on the Hong Kong entity is real. Demonstrating business purpose requires documented commercial rationale, active decision-making records, and personnel or contracted services in Hong Kong proportionate to the functions performed.

Groups structured with a BVI or Cayman entity above the Hong Kong holding company face an additional complication. The CIS-side treaty position runs to the Hong Kong entity; the offshore layer above it must not erode the substance analysis. Where royalty or interest payments flow up from the CIS through Hong Kong to an offshore parent, the treaty and FSIE conditions apply to the Hong Kong entity's receipt, and the CIS withholding analysis applies at the point the payment leaves the CIS.

For a practical reference on the related analysis for Mainland China treaty positions through Hong Kong, see our earlier briefing on treaty access between Hong Kong and Mainland China, which covers the same dual-condition logic in the Mainland context. The structural considerations mapped in our analysis of tax-efficient holding routes between the BVI and Hong Kong are also directly relevant where an offshore layer sits above the Hong Kong entity.

What action is required now?

Groups with Hong Kong entities currently claiming treaty benefits on CIS-source income should carry out a documentary review of the substance and beneficial-ownership position before the next income cycle. Waiting for an assessment notice is not a workable approach. The FSIE regime's substance conditions are assessed by reference to the accounting period in which the income is received. If the conditions are not met for a period in which income was received, the exposure is retrospective to that period.

The immediate steps are: first, map the income flows — by type, by treaty, and by the CIS jurisdiction involved; second, assess whether the FSIE conditions are met for each category of specified foreign-sourced income received in Hong Kong; third, review the treaty's anti-abuse provisions and the beneficial-ownership and principal-purpose documentation held by the Hong Kong entity; and fourth, identify whether structural adjustment is needed and, if so, the sequence in which it should be implemented without triggering a taxable event in the CIS or in Hong Kong.

Our Tax Positions practice advises on source and substance analysis under the FSIE regime, treaty access across the Hong Kong–CIS corridor, and the interaction between Hong Kong's territorial system and the anti-avoidance provisions in the relevant bilateral arrangements.

The sequence above describes the standard analytical position. Where the facts of your structure differ — in particular, where multiple CIS jurisdictions are involved or where the holding chain passes through more than one tier — the order of steps and the priority of the analysis will change accordingly.

To discuss the treaty position for your Hong Kong–CIS holding structure and identify any immediate exposure, contact us at info@lockhartyip.com.

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Related

• Tax Positions
• Treaty Access Between Hong Kong Mainland China Mainland 2
• Tax Efficient Holding Route Between Bvi Hong Kong 3

This publication is general information and does not constitute legal advice. For advice on your situation, contact info@lockhartyip.com.