The recent ‘Grey-listing’ of Hong Kong and Malaysia by the European Union (EU) – placing Hong Kong and Malaysia on its watchlist for blacklisting, unless they implement a tax reform prior to 2023 to amend the way they tax foreign investment income. In both jurisdictions, foreign investment income is not taxable regardless of whether the income is remitted and regardless of whether the receiving company has any economic substance. This enables investors to use companies without any economic substance to earn foreign investment income without being taxed on the income in these jurisdictions.

The EU requires Hong Kong and Malaysia to amend their tax legislation to either tax the foreign investment income or to introduce economic substance requirements; or other conditions which will make it less convenient to use these jurisdictions predominantly for international taxation planning purposes.

In relation to corporate investors Malaysia withdrew its tax exemption rule for foreign investment income (an exception applies until 2026 to foreign dividend income) with effect from 1 January 2022, meaning that offshore-sourced investment income is now generally subject to income tax in Malaysia if it is remitted to Malaysia. The question is whether this will be sufficient. Hong Kong has yet to take any measures so the international investment community will be watching closely.

If either jurisdiction fails to introduce satisfactory rules during 2022, the EU may decide to put them on its blacklist of tax havens, which may cause certain EU member states to impose punitive measures on the payment of investment income to companies in Hong Kong or Malaysia (e.g., higher withholding tax rates, non-deductibility for corporate income tax), and subsidiaries may be taxable in the hands of the EU-based parent company under controlled foreign company tax provisions in the EU member states. These jurisdictions might become less attractive for investment or as a gateway to Asia to EU investors.