A review of prc and hong kong tax developments

Transcription

1 TAX quarterly NEWSletter A review of prc and hong kong tax developments December 2012

2 In This Issue CHINA 04 relaxing CONTROLS 06 GOOD NEWS FOR INVESTORS 09 JUST LIKE HOME 11 TAXING GAINS 13 APPEALING CHANGE HONG KONG 15 O CANADA! Editors Column Welcome to our December edition of the Tax Quarterly Newsletter. Much has happened in China and Hong Kong since our last report in September and we are excited to share our views on implications of the latest tax legislation and treaties. We begin our quarterly review of China 1 with Relaxing Controls, underlining the significant changes implemented by Circular 59, specifically focusing on how it will affect inbound and outbound investments. Good News for Investors discusses the procedures and restrictions introduced by Decree 8, detailing when and how investors can use equity interests from Chinese registered companies to inject capital into foreign invested enterprises. In Just Like Home, we consider how the application procedure for permanent residency status in China has changed with the introduction of Circular 53 and how the rights and obligations of foreigners with permanent residency permits have been clarified since Order No. 74. Continuing with our Hong Kong review, O Canada! analyses how the new comprehensive double tax treaty agreement between Hong Kong and Canada will affect the tax liabilities of citizens of the two countries and the potential economic benefits. Surprise! seeks to provide guidance on the implications of the new property cooling measures that came into effect hours after being introduced. Finally, in Trapped we deliberate on the travel ban placed on Hong Kong based Australian lawyer Sarah Armstrong when she tried to board a flight from Mongolia. Furthermore, we consider the recent measures the Hong Kong government has taken to promote an Islamic bond market in Hong Kong and provide updates on the latest double taxation treaties. We welcome your feedback and any questions you may have about this edition of the Quarterly Newsletter. 18 SAME OLD SECTION 39E? 19 SURPRISE! 22 TRAPPED 24 BEING ISLAMIC 25 Tidbit: Updates on newly signed tax treaties Patrice Marceau Foreign Legal Consultant Hong Kong and Regional Taxation T patrice.marceau@dlapiper.com Daniel Chan Partner China Corporate and Tax T daniel.chan@dlapiper.com Stephen Nelson Partner T stephen.nelson@ dlapiper.com 25 Tidbit: Updates on treaties with France and Switzerland 26 recognition OF TAX GROUP IN ASIA Todd Beutler Foreign Legal Consultant T todd.beutler@dlapiper.com Anderson Lam Partner T anderson.lam@dlapiper.com 1 As usual, we caution that, under current Chinese regulations, foreign lawyers such as DLA Piper are not formally admitted to practise law in the People s Republic of China and, as a result, we are not permitted to render legal opinions on matters of PRC law. Our comments herein should not be construed as legal advice on any of the topics discussed herein. Furthermore, there is no official translation of the Enterprise Income Tax law, the Implementing Rules or the notices and circulars referred to herein; the translations from Chinese are our own rather than official translations. We do not take any responsibility on whether or not the translation expressions properly convey the exact meaning of their Chinese counterparts. Ultimately, only the Chinese version is relevant and you should not act upon anything you may read herein without further consultation with a proper advisor.

3 PEOPLE S REPUBLIC of china 03

4 RELAXING CONTROLS On 19 November 2012, the State Administration of Foreign Exchange (SAFE) promulgated the Circular on Further Improvements and Adjustments to Foreign Exchange Administration Policies of Direct Investment 2 (Circular 59), which came into effect on 17 December Circular 59 aims at replacing some approval requirements with new registration arrangements, simplifying administration procedures for investments while enhancing the risk control measures. We highlight below the major changes: Direct Investments Pre-approval requirements for account opening and remittance of funds are replaced with registrations with banks, including: approvals for opening of foreign exchange expenses accounts, foreign exchange capital accounts, assets realization accounts and deposit accounts; approvals for remittances into assets realization accounts and special accounts for offshore lending; and approvals for remittances of preliminary costs for outbound investments; In addition, foreign exchange capital accounts and asset realization accounts may now be opened in multiple locations. Re-investments A foreign investor may now re-invest or increase his or her capital contribution in a Foreign Invested Enterprise (FIE) with income earned in China, equity and other capital funds, undistributed profits and registered foreign loans without the need for pre-approval. A China Holding Company (CHC) may re-invest in China without the need for foreign exchange registration (except where the investment is made together with a foreign investor, then foreign exchange registration of the invested company is required). In addition, approvals for remittance of foreign exchange profits, dividends and bonus to CHC are removed. Acquisitions The procedures for foreign exchange registration of capital contribution by foreign investors are simplified. If a foreign investor acquires shares from a Chinese party and pays the whole share price in foreign exchange, the system of SAFE will automatically complete the registration upon the bank entering the relevant information into the system. There is no pre-approval required. 2 Huifa[2012] No Tax Quarterly Newsletter December 2012

5 Offshore Lending Restrictions on offshore lending by both domestic companies and FIEs are relaxed. A FIE may extend loans to its foreign shareholder subject to a limit which equals to the sum of distributed profits (which has not been paid out) and undistributed profits attributable to the foreign shareholder. On the other hand, a domestic company may extend loans offshore using its foreign exchange loans obtained in China. Observation Circular 59 relaxes foreign exchange controls and is expected to increase efficiency and reduce barriers of both inbound and outbound investments. However, as certain approval requirements are now replaced by a new registration system, banks will inevitably undertake more responsibilities for documentation reviews and information reporting. Successful implementation of the new measures will depend on the efficiency of banks and the co-operation between banks and investors. 05

6 GOOD NEWS FOR INVESTORS Decree 8 On 21 September 2012 the Ministry of Commerce (MOFCOM) promulgated the Provisional Regulations on Capital Contribution to Foreign Invested Enterprises (FIEs) in Form of Equity Interests 3 (Decree 8). Taking effect on 22 October 2012, Decree 8 formally sets out the requirements and procedures for investors, both domestic and foreign, to invest in FIEs (Investee Company) using the equity interests they own in companies registered in China (Equity Company). Background China s Company Law permits capital contributions for investments in China to be made with non-cash assets. However, prior to the promulgation of Decree 8, there were no formal procedures and detailed regulations in place to guide investors and the approval authorities (i.e. local counterparts of MOFCOM) regarding equity contribution to FIEs). As a result, investors either shied away from such form of capital contribution or were restricted from doing so due to uncertainties and variations in the practice of local MOFCOM counterparts. Decree 8 helps to fill in the gap of the regulatory uncertainties and provides guidance on this subject. What Made Possible Decree 8 applies where domestic and/or foreign investors seek to: establish a new FIE (i.e. WFOE or JV); increase the registered capital of an existing non-fie, thus converting it into an FIE; and increase the registered capital of an existing FIE and changing the shareholding structure of the FIE. In other words, investors now can achieve the above restructuring purposes by using their existing equity interest as capital contribution to a new or existing FIE. Restrictions However, not all forms of equity interests will be accepted as a kind of capital contribution. It is a pre-requisite that the equity interest to be used for the capital contribution be free from any encumbrances, complete, and legally transferable. Decree 8 also provides for the circumstances under which equity may not be used as capital contribution, notably the equity of real estate enterprises, foreign invested holding companies and venture capital FIEs. Decree 8 reiterates the Company Law s requirement that all non-cash capital contributions to a company must not exceed 70% of its total registered capital. This means that the sum of the value of the equity that is counted towards the registered capital of the Investee Company (Equity Contribution Value or ECV) plus other non-cash assets contributed to the Investee Company must not exceed 70% of the Investee Company s total registered capital. Accordingly, there could be instances where injection of additional cash by an investor cannot be avoided in order to meet this requirement. 3 MOFCOM Decree 2012, No Tax Quarterly Newsletter December 2012

7 Decree 8 clarifies that although the ECV counts towards the total registered capital for registration and approval purposes, it does not count towards registered capital for the determination of maximum foreign currency borrowing and customs duty exemption for imported equipment. As such, using existing equity interest as capital contribution would not bring in extra benefit to the invested FIE in such regards. Aside from the above, investors should note that the relevant restrictions on foreign investment, as well as listing rules and regulations, still apply to FIEs and listed companies, whether or not Decree 8 is relevant. A Case Study Investors who are holding equity in companies in China and wish to make further investments in China or cooperate with Chinese partners may want to consider, or re-consider, how capitalizing on current investments may decrease the need for upfront injection of cash. In the example below, we assume a foreign investor wishes to partner with a Chinese party that has a subsidiary with certain distribution networks, clients or other attractive characteristics that the foreign investor lacks, or due to regulatory restrictions, needs to form a joint venture. Both investors will contribute the equity they each possesses in their respective subsidiaries to a newly formed joint venture (New JV) as their respective capital contributions. Since the equity contribution is a kind of non-cash capital contribution, it must not exceed 70% of New JV s total registered capital. Therefore, the investors (or one of them) must contribute cash which equals to no less than 30% of the registered capital of New JV. After the equity contribution, the two investors become shareholders of New JV. The companies whose equity was contributed to the formation of New JV are now direct subsidiaries of New JV, and are both considered domestic companies. The structure is illustrated in the diagram below. Foreign Investor 100% Cash Cash 60% 40% China Investor 100% WFOE (Equity Co 1) Equity New JV (Investee Co) Equity China Sub (Equity Co 2) 100% 100% Domestic Co (Equity Co 1) Domestic Co (Equity Co 2) Before Decree 8 came into force, investors might face with various hurdles in reaching this structure. For instance, investors might need to take the standard route of setting up a new joint venture and capitalizing it with enough cash to acquire the subsidiaries, which would involve significant cash injection from investors. In addition to the cash benefits, investors should keep an eye out for potential tax benefits for reorganizations provided for under Circular 59 issued by the Ministry of Finance and the State Administration of Taxation 4. Although it is not clear whether the tax authorities would apply the special tax treatment provided in Circular 59 to various restructurings under Decree 8, we suggest that each case should be considered individually. 4 Caishui [2009] No

8 The Procedures Under Decree 8, the investor or Investee Company should go through the following steps before filing an application for equity contribution. 1. review the transferability of the relevant equity interests, obtain a valuation by a Chinese valuation firm of the equity to be used for the capital contribution and a legal opinion from a Chinese law firm regarding the completeness and transferability of the equity; 2. ensure that the restrictions on foreign investments as set out in the Foreign Investment Industrial Guidance Catalogue and Guidance for Foreign Investment Directions do not apply; 3. where necessary, spin-off any business or assets forbidden for foreign investment; and 4. Execute an equity contribution agreement. When these steps are completed, either the investor or Investee Company should compile and submit an application to the in-charge MOFCOM for approval. Upon obtaining the MOFCOM approval, investors and the Investee Company shall attend to post-approval procedures, which are required to complete the investment process. Such procedures may vary depending on whether the Equity Company remains a FIE. Decree 8 is a welcoming clarification on the use of non-cash assets to invest in FIEs, and particularly good news for investors in a cash strapped economy wishing to restructure or even to make new investments in China. Of course, similar to many other application-approval procedures, details of the actual application of Decree 8 shall be tested in practice, and variations in local practice will be avoidable. 08 Tax Quarterly Newsletter December 2012

9 JUST LIKE HOME In 2004, the Ministry of Public Security and the Ministry of Foreign Affairs jointly issued the Order No. 74 regarding the criteria and procedures for application for Chinese permanent resident permit by foreigners. On 25 September 2012, a total of 25 central government authorities, including the State Administration of Taxation (SAT), released and enacted a follow up circular the Administrative Measures on Entitlements of Foreigners with Chinese Permanent Residency in China 5 (Circular 53) to clarify the rights and obligations of foreigners who become permanent residents in China (Foreigner Permanent Residents). One of the most significant aspects of Circular 53 is that it makes clear that Foreigner Permanent Residents are liable to pay individual income tax in accordance with Chinese tax laws and tax treaties. Circular 53 also stipulates various preferential treatments on the work and living of Foreigner Permanent Residents, as well as simplification of the process for employment in China. In essence, Foreigner Permanent Residents enjoy the following treatments: Living in China Type Preferential Rights Simplified Process Residence No limit on the length of stay No visa is required for entry if a Foreigner Permanent Resident holds a valid passport and the foreigners permanent residence permit Employment Work permit is not required Those who meet specified requirements can apply for the Foreign Expert Certificate and the Homecoming Expert Certificate with priority Housing Eligible for participating in the China Housing Provident Fund and enjoys the flexibility to withdraw or transfer the benefits when leaving the place of work Allowed to buy commercial houses for personal use whether or not having worked or studied in China for more than 1 year Social Insurance Transportation Covered by the Chinese social insurance system Receives same treatment as Chinese citizens in the motor vehicle driving license application and motor vehicle registration Procedures for social insurance transfer or termination are now simplified Foreigners permanent residence permit is acceptable as valid identification proof for boarding domestic flights, purchasing domestic train tickets and hotel check-in 5 Ren She Bu Fa [2012] No

10 Doing Business in China Type Preferential Rights Simplified Process Investment Foreign Exchange Allowed to establish FIEs by technology contributions or other methods and to invest in foreign direct investments by using Renminbi obtained from legal sources Entitled to the same rights as Chinese citizens when going through formalities of banking, securities and other financial transactions Income generated in China can be converted into foreign currency and transferred overseas provided that tax has been duly paid and tax clearance certificate has been obtained Procedures for the review and approval of foreign investment projects and establishment of the FIEs are simplified Foreigners permanent residence permit can be used as identification proof when conducting foreign exchange businesses 10 Tax Quarterly Newsletter December 2012

11 TAXING GAINS In Beijing, income derived from equity transfer is taxable under the Individual Income Tax (IIT) Law at a flat rate of 20%. However, the collection of such tax has not been strictly enforced on individuals, especially when complex onshore and offshore matrices are used to avoid the IIT. Early in 2009, the SAT expressly provided in Notice on Strengthening the Administration of the Individual Income Tax on Gains Derived from Equity Transfer 6 (Circular 285) that IIT shall be declared or withheld when share transfer takes place. Taxes on any gain derived from the transfer should be paid after a transfer agreement is signed and before a change of the registration at the Administration of Industry and Commerce (AIC) shall be completed. Essentially, the tax clearance certificate provided by the tax authority in charge becomes the pre-requisite for registering the equity transfer with the competent AIC. While Circular 285 requires that equity transfer carried out by individuals follows the fair market value principle, there is no clear guidance in the circular as to how fair market value should be determined. Notice on Tax Assessment of Taxable Income Derived from Equity Transfer for the Purpose of Individual Income Tax 7 (Notice 27) issued in 2010 by SAT explains the circumstances under which a taxation basis is considered as obviously lower than fair market value without justifiable reasons. Despite all of the above measures attempting to reinforce the collection of taxation on income derived from equity transfer, the lack of information exchange between tax authorities and the AIC appeared to have allowed room for tax leakage. To close the regulatory loopholes, in 2011, the SAT and AIC jointly issued Notice on the Strengthening the Cooperation between the Tax Authorities and the AIC on Information Exchange of Share Trade 8 (Circular 126), requiring tax authorities to conduct information exchange with AIC on a monthly basis and such communication should complete within 15 days following the end of the month. Subsequent to Circular 126, in 2012, the Beijing local tax authority issued two announcements with a similar title Announcement on Enhancing the Administration of the Collection of Individual Income Tax on Income Derived from Equity Transfer (Announcements No. 5 9 & No. 6). These two announcements provide further details on the general procedures on handling the declaration and withholding of IIT for equity transfer in Beijing. 6 Guo Shui Han [2009] No Announcement of SAT [2010] No Guo Shui Fa [2011] Announcements of the Beijing Local Taxation Bureau [2012] No. 5 and 6. The announcement No. 5 was jointly issued by SAT and AIC. 11

12 Particulars Tax declaration period Authority in-charge Assessment of tax basis Materials required for submission New Requirements The transferor or the transferee as the withholding agent shall submit tax declaration return or withholding return within 15 days following the end of the month in which the transferee obtains income or before filing the shareholder change with AIC. Reporting shall be made to the in-charge local tax authorities of the target company of which the equity is being transfer. Where tax basis is notably and unreasonably low, the tax authority shall review the basis according to one of the methods listed in the Announcement of the State Administration of Taxation [2010] No. 27, which includes the net asset value per share of the target company, the price other shareholders of the same enterprise would pay, and the transfer price of another company in the same industry. In the event that the transfer price is significantly low without proper justifications, the in-charge tax bureau is entitled to make adjustment. Documents to be submitted to the tax authority include the equity transfer agreement, Articles of Association, capital verification certification and balance sheet of the target company at the end of the month preceding the month when the transfer agreement was entered into. Announcements No. 5 and No. 6 took effect in Beijing on 1 October Similar notices are also being introduced in other cities, including Qingdao and Hebei. The strengthened cooperation between tax authority and AIC at local levels is a clear signal that taxpayers should be more attentive to their tax duties. 12 Tax Quarterly Newsletter December 2012

13 APPEALING CHANGE In the PRC, the State Administration of Taxation (SAT) is responsible for the collection of taxes and enforcement of state revenue law. If a tax payer wants to dispute a tax collection statutory notice, he will have to go through a tax administrative appeal procedure where a review committee composed of both internal and external experts may be set up to study the relevant case and recommend actions. Recently, the Administrative Review Committee of Appeal of SAT (ARC) has been set up, which will be the highest body within the SAT reviewing appeals of administrative dispute by taxpayers. It was reported that the rulings of the ARC will be the final station of appeal and will be binding for both tax administration and tax payers. At the ceremony announcing the creation of ARC held on 26 October 2012, Vice-minister of the SAT, Xie Xuezhi, said that the establishment of ARC was a big step in the course of development of tax administrative appeal work as well as in moving tax compliance work forward. It was further reported that around 11 to 16 internal SAT officials and eight external experts will sit on the committee. The eight external experts will consist of the chief editor of China Tax News (the largest tax newspaper in the PRC), professors from universities and representatives from Chiese tax law firms. The establishing of ARC reflects the importance the SAT is putting on external opinion as tax administrative appeals has become a common solution to tax disputes. 13

14 HONG KONG 14 Tax Quarterly Newsletter December 2012

15 O CANADA! On 11 November 2012, Hong Kong signed a comprehensive double taxation agreement (CDTA) with Canada, bringing the total number of CDTAs concluded by Hong Kong to twenty-six. This is also the second CDTA Hong Kong has concluded with a North American country. Out of over 16,500 Canadians living in Hong Kong, those who are still deemed residents of Canada currently have their income earned in Hong Kong taxable both here and at home. The CDTA with Canada will allow them to offset tax paid here against tax payable in Canada. The same will apply to certain Hong Kongers working in Canada. By clearly setting out the allocation of taxing rights between Hong Kong and Canada, the CDTA will help cross-border investors better assess their potential tax liabilities and boost economic and trade ties between the two jurisdictions. Who Benefits? The CDTA will only apply to persons who are residents of either Hong Kong or Canada. A company incorporated in Hong Kong automatically qualifies as a Hong Kong resident but a company incorporated outside Hong Kong will only be treated as a Hong Kong resident if it is centrally managed and controlled in Hong Kong. This is a more stringent test than the normally managed and controlled test often used in other CDTAs that Hong Kong has concluded. If there are issues of dual residency (where, by definition in the CDTA with Canada, a person other than an individual is a resident of both Hong Kong and Canada under the CDTA), they must be settled by mutual agreement between the Commissioner of Inland Revenue of Hong Kong and the Minister of National Revenue of Canada or their authorized representatives. Where there is no such agreement, no treaty benefit under the CDTA will be granted. Benefits to Hong Kong Residents Business profits Active business profits of a Hong Kong resident enterprise will not be taxed in Canada unless they are attributable to a permanent establishment (PE) maintained by the Hong Kong company in Canada. If a Hong Kong enterprise maintains a PE in Canada, only the profits attributable to the PE will be taxed in Canada. Further, a Hong Kong resident enterprise will not be liable to Canadian tax if it merely maintains a buying office in Canada for the sole purpose of making purchases for the Hong Kong resident enterprise. Branch tax Generally, the net business income earned in Canada by a non-resident company that carries on business in Canada through a branch is taxable at the full corporate tax rate. In addition, a tax of 25% must be paid on any after-tax profits that are not invested in qualifying Canadian property. 15

16 The protocol to the CDTA with Canada provides for business profits attributable to a Canadian PE, or income from the trading of immovable property in Canada by a Hong Kong resident company, that have been re-invested in Canada, to be exempt from the additional 25% branch tax. For other cases, the CDTA reduces the branch tax from 25% to 5%. Benefits for airlines and ship owners Profits derived from international traffic by Hong Kong resident airlines and ship owners will not be subject to tax in Canada. The income of a Hong Kong resident airline, however, will still be charged to tax in Hong Kong at the corporate rate of 16.5%. Primary adjustment to business profits In circumstances where a Hong Kong resident enterprise transacts business with an associated Canadian resident enterprise, and the profits accruing to the Canadian resident enterprise are less than what would accrue on an arm s length basis, the Canadian tax authorities are entitled to make a primary adjustment to increase the profits of the Canadian resident enterprise to an arm s length result. In order to avoid double taxation, the Hong Kong tax authorities must, under the Article 9 of the CDTA, make an appropriate adjustment to the profits of the Hong Kong resident enterprise. However, the same provision prevents the tax authorities in Hong Kong and Canada from making a primary adjustment to the profits of an enterprise after the expiry of time limits provided in the domestic laws, and in any case, after seven years from the end of the relevant taxable year. There is no limitation in cases of fraud or wilful default. Reduced withholding tax (WHT) rates and Anti-avoidance provisions Under the CDTA, WHT rates on dividends, interest and royalties deriving from Canada and received by a Hong Kong resident are reduced as follows: Dividends Interest Royalties Normal WHT rate 25% 0 / 25% 10 0 / 25% HK/Canada treaty rate 5 / 15% 11 0 / 10% 12 10% However, these benefits on the reduced WHT rates are denied when one of the main purposes of any person concerned is to obtain such benefits. Further, according to Article 26 of the CDTA, Canada may apply its domestic laws to prevent tax avoidance, including measures relating to thin capitalization. Avoidance of double taxation If a Hong Kong resident is subject to both Hong Kong and Canada income tax, he/she may credit the tax paid in Canada on such income against the Hong Kong tax liability on the same income. The tax credit available cannot exceed the Hong Kong tax charged on the same income. 10 in general, Canada imposes no WHT on interest paid to non-domestic residents who are dealing at arm s length with the payer. However, there is a 25% WHT which applies to interest paid or credited to related non-residents. 11 A reduced rate of 5% applies if the beneficial owner of the dividends is a company controlling directly or indirectly 10% or more of the voting power in the dividend paying company. 12 A 0% rate applies where the recipient of the interest is the Hong Kong government, the Hong Kong Monetary Authority, a political subdivision or a local authority of the Hong Kong government, or any wholly-owned agency or instrumentality of the Hong Kong government, a political subdivision or a local authority as agreed from time to time between the competent authorities of Hong Kong and Canada; or a Hong Kong resident dealing at arm s length with the payer. 16 Tax Quarterly Newsletter December 2012

17 Capital gains on disposal of shares Under the Canadian tax law, non-residents in general will not be subject to income tax on capital gains derived from the disposal of shares in a company or interest in a partnership that does not derive its value principally from real or immovable property located in Canada. There is no additional relief given to Hong Kong residents under the CDTA. Mutual agreement procedure If a person is assessed by the tax authorities of Hong Kong or Canada or both in a manner inconsistent with the provisions of the CDTA, he/she can use the mutual agreement procedure (MAP) to present the case to the competent authority of his/her resident side for consideration. Such submission will have to be done within three years from the date of the first notification of the actions resulting in taxation not in accordance with the CDTA. If possible, such competent authority will resolve the case on its own or, if necessary, seek to resolve the case with the competent authority of the other contracting party. When an agreement is reached under the MAP, it must be implemented within the time limits provided for in the domestic laws of the contracting parties. In the event a case cannot be solved by the competent authorities through the MAP, the CDTA allows for a case to be submitted for arbitration, the procedures of which shall be established in an exchange of notes between Hong Kong and Canada. Effective date Assuming that the relevant ratification procedures for the CDTA are completed in 2013, the CDTA shall have effect in Hong Kong for any year of assessment beginning on or after 1 April 2014, and in Canada for taxation years beginning on or after 1 January

18 SAME OLD SECTION 39E? Many readers might remember the never ending saga between Dr Hon Lam Tai-Fai 13 and the Secretary of Finance on the application of Section 39E of the Inland Revenue Ordinance (IRO). To recap, Section 39E of the IRO is a specific anti-avoidance rule that aims to limit tax avoidance opportunities in the form of machinery or plant leasing arrangements. According to the provision, the tax authorities, with the courts support, have denied depreciation allowance when a Hong Kong taxpayer s machinery or plant are used outside Hong Kong by other parties, even when Hong Kong taxpayer bears all the cost of the machinery and the factory produces exclusively for the Hong Kong taxpayer. In TQN March 2011, we discussed how on 19 January 2011, the government had once again denied Dr Lam s request for the relaxation of Section 39E. Now, not to our surprise, with a new administration in office, Dr Lam unswervingly raised this issue of Section 39E in the Legislative Council. On 31 October 2012, Dr Lam said that since the new Chief Executive has indicated in his election manifesto that [the government] will support Hong Kong manufacturers in restructuring their business models to tap the domestic market on the Mainland, the issue of Section 39E might be viewed differently by the current administration. Therefore, with new hope, Dr Lam queried whether the government of the current term would consider accepting the recommendation of relaxing Section 39E put forward by the Joint Liaison Committee on Taxation in The government had said in November 2010 that officials has concluded there were no justifiable grounds to relax Section 39E because that would be against the basic taxation principles of territorial source and tax symmetry and there were no effective measures to plug any possible tax avoidance loopholes. Therefore, the government then could not see any need to assess any potential economic benefits from the relaxation of Section 39E. Much to Dr Lam s dismay, the current administration also takes the view that Section 39E should not be relaxed. The explanation given was the same as in November 2010, namely that the relaxation would be a violation of basic tax principles of tax symmetry and territorial source. The current administration has also made clear that there is no plan to assess the economic benefits arising from the relaxation of the restriction of Section 39E. Once again, when it comes to the relaxation of Section 39E, the government has given a resounding No for an answer. Will this setback put a halt to Dr Lam s quest to get the authorities to see his view on section 39E? After all these years, what more does it take for the authorities to change their minds? 13 Dr Hon Lam Tai-fai is the representative of the industrial (second) functional constituency (effectively, the Chinese Manufacturers Association of Hong Kong). Please refer to the article titled Section 39E: A Continuing Saga in TQN March 2011 and the article titled Section 39E: An(other) Update in TQN December Tax Quarterly Newsletter December 2012

19 SURPRISE! On Friday 26 October 2012 the Hong Kong Government introduced new property market cooling measures. These new measures came as a surprise and were announced only hours before going into effect, on 27 October Stamp Duty regime prior to 27 October 2012 In Hong Kong Stamp Duty ( SD ) is a tax charged on documents which evidence certain kinds of transactions, including the transfer of shares and immovable property. With respect to the transfer of shares, SD applies to instruments which prove the sale and purchase of Hong Kong stock. The SD tax for the transfer of shares is charged at a base rate of HK$ 5 plus 0.2% of the consideration stated on the transfer document and payable equally by the buyer and seller (i.e. 0.1% on the sale note and 0.1% on the purchase note) 14. With respect to immovable property such as real estate, SD applies to any instrument that affects the transfer of immovable property in Hong Kong 15. SD is levied at a progressive rate ranging from a base charge of HK$ 100 for properties with a market value less than HK$ 2M to rates up to 4.25% of the consideration stated on the transfer document for a property with a market value above HK$ 21,739,120. However if the Hong Kong tax authority determines that the fair market value of the transferred property is higher than the consideration stated on the transfer document, SD will be charged based on such fair market value, regardless of the type of transaction. This SD may be imposed by way of an additional assessment. In addition to the general SD described above, the Hong Kong tax authorities introduced a Special Stamp Duty (SSD) in November 2010 to curb skyrocketing residential property prices and cool speculative buying. SSD applies to the buyer and seller with respect to the transfer of residential property on or after 20 November 2010, either by an individual (regardless of citizenship, residence or domicile) or a company (regardless of where it is incorporated), where the transferred property is resold within 24 months. SSD is levied based on the property price and the rates, which vary depending on the time the seller holds the property before a sale, are as follows: Holding Period SSD rate Residential properties held for six (6) months or less 15% Residential properties held for more than six (6) months but for no more than 10% twelve (12) months Residential properties held for more than twelve (12) months but no more than 5% 24 months However, an exemption exists where the property is sold or transferred to close relatives, defined under the SSD rules as an individual s spouse, parents, children, brothers and sisters. 14 The amount of consideration on the date the note being executed. 15 Head 1 of Schedule 1, Stamp Duty Ordinance. 19

20 Stamp Duty regime post 27 October 2012 The second round of property market cooling measures further tightened the SSD regime. Residential property acquired on or after 27 October 2012, either by an individual or a company (regardless of where incorporated), and resold within 36 months, is subject to the following revised SSD rates: Holding Period SSD rate Residential properties held for six (6) months or less 20% Residential properties held for more than six (6) months but for no more than 15% twelve (12) months For residential properties held for more than twelve (12) months but no more 10% than 36 months When assessing whether or not a residential property transaction is subject to SSD, and if so, at which rate, the following flow chart may prove helpful: Has the seller acquired the residential property on or after 20 November 2010? No Yes No SSD Has the seller acquired the residential property on or after 27 October 2012? No Yes Has the seller held the residential property for 24 months or less? Has the seller held the residential property for 36 months or less? No Yes No Yes No SSD 15%: held for 6 months or less. No SSD 20%: held for 6 months or less. 10%: held for more than 6 months, but for no more than 12 months. 15%: held for more than 6 months, but for no more than 12 months. 5% held for more than 12 months, but for no more than 24 months. 10% held for more than 12 months, but for no more than 36 months. 20 Tax Quarterly Newsletter December 2012

21 Furthermore, the new measures introduced a 15% Buyer s Stamp Duty (BSD) on all buyers of Hong Kong residential property who are either companies (regardless of where incorporated) or are individuals who are not -Hong Kong permanent residents (non-hkprs). The BSD will be charged in addition to the existing SD and the SSD, if applicable. In contrast to SD and SSD, BSD is imposed solely on the buyer or the transferee. No sooner was the ink dry on the new legislation then Hong Kong s property developers came up with a structure to circumvent BSD. Under the structure, a developer would transfer its residential property to a subsidiary then sell the property via a transfer of the subsidiary s shares to non-hkprs, hence allowing the buyers to avoid BSD. Unfortunately for the developers, the Hong Kong tax authorities responded immediately and closed this loophole by announcing the insertion of a clause effecting that if a company transferred residential property to a subsidiary on or after 27 October 2012 and thereafter sold the subsidiary s shares to a non-associated body corporate or person within two (2) years after the property transfer, such property transfer would not be exempted from the payment of BSD. Currently, the Hong Kong tax authorities are evaluating several situations under which an exemption to BSD may be granted. For example, they are assessing whether or not to grant an exemption to BSD for the transfer of residential property to a close relative who is not a HKPR or to HKPR(s) jointly with close relative(s) who are not HKPRs. Discussion The newly introduced property market cooling measures, in particular BSD, have sparked heated debates and general discontent, especially amongst property developers. Furthermore, there have been comments that the measures will negatively impact Hong Kong s reputation as one of the most free market economies in the world. The fact is that the newly introduced BSD regime has not yet reached its final form and is still under review on certain points, in particular with regard to possible exemptions. Interestingly, Singapore introduced property cooling measures similar to BSD in December In spite of this attempt, residential property prices are still climbing, and therefore the measures could be considered to have failed. Only time will tell whether Hong Kong will be successful in pricking the city s property bubble. 16 Association in this context means that one of the transferor or transferee must be the beneficial owner of not less than 90% of the issued share capital of the other, or a third such body corporate must be the beneficial owner of not less than 90% of the issued capital of the transferor and transferee. Furthermore it is also a requirement that this association must continue for at least 2 years after the date of execution of the transfer documents. 21

22 TRAPPED In October, Australian lawyer Sarah Armstrong was prohibited from boarding a flight to Hong Kong from the Mongolian capital of Ulan Bator. The 32-year old chief legal counsel of SouthGobi Resources, a subsidiary of Rio Tinto, had not been arrested, nor had she been charged with anything. Instead, it was reported that the Hong Kong based lawyer was held as a witness in a complicated matter between SouthGobi Resources and the Mongolian Mineral Resource Authority (MRA) involving allegations of bribery and money laundering. This would be the second time in three years that Rio Tinto, one of the world s largest privately-owned mining companies, has been accused of such crimes in the area. In 2009, Australian executive Stern Hu and three Chinese employees were found guilty of bribery and stealing business secrets. Hu was jailed for a total of 13 years and fined RMB 1M. Now it appears Rio Tinto is in trouble again, this time with tax evasion added to the charges of corruption and money laundering. While investigating the former head of the MRA, the Mongolian Independent Authority Against Corruption (IAAC) found that he had reissued four expired mining licenses to SouthGobi Sands, a division of SouthGobi Resources, and transferred another, valued at US$2B in 2010, to a director of the company. During the investigation, the IAAC uncovered tax fraud violations totaling MNT 150B (US$104M). As the two finance directors responsible for the tax fraud violation have since resigned and no longer reside in Mongolia, the government has no legal grounds to pursue a case against them. Instead, they are investigating the administration of Rio Tinto, which supposedly is where Armstrong comes in to play. Although Mongolian officials claim Armstrong is a key witness in their case against Rio Tinto, it has been speculated that Armstrong was instead targeted in relation to allegations of bribery and high-level corruption she filed against Mongolian officials in July. The complaint, which also alleged that the Mongolian government attempted to seize hundreds of millions of dollars worth of coal from SouthGobi Sands, prompted international mediation between the company and the Mongolian government. Armstrong also filed notice of an investment dispute against the Mongolian government on behalf of SouthGobi Resources earlier this year regarding pre-mining agreements on licenses that were not granted. Armstrong is not the only Rio Tinto employee banned from leaving Mongolia. US citizen Justin Kapla, president of SouthGobi Sands, has been subject to a travel ban since April 2012 when he was detained as a witness in a case involving corruption allegations against Mongolian officials. Although neither Kapla s nor Armstrong s passports have been confiscated and they are free to travel within Mongolia, it is unknown when they will be able to leave the country. The travel ban was imposed on Armstrong only a couple weeks after Rio Tinto refused to renegotiate its US$6.2B Oyu Tolgoi mining contract in light of the 2013 Mongolian draft budget. The 2009 agreement granted Turquoise Hill Resources, of which Rio Tinto is the majority shareholder, a 66% share of the Oyu Tolgoi copper mine and fixed corporate income and profits tax rates for the life of the mine. The draft budget would increase taxes and royalties on the mine by US$300M. Rio Tinto rejected the renegotiation request, stating that it had already invested US$6B into constructing the mine and has created jobs for thousands of Mongolians. 22 Tax Quarterly Newsletter December 2012

23 This is not the first time the Mongolian government has attempted to renegotiate the 2009 agreement with Rio Tinto. In 2011, it attempted to increase its share in the mine to 50% and increase royalty rates. It was argued that higher tax rates on the Oyu Tolgoi mines would provide compensation for locals who blame the mine for ruined crops and dead livestock and ease tensions over the unpopular mining project with the community. These attempts at renegotiation can be damaging to Rio Tinto. Escalation to international arbitration could result in time delays and cost increases for the multinational mining company which is scheduled to start mining copper and gold at Oyu Tolgoi in the first half of Despite the threats of increased tax rates and royalties for mining companies, Mongolia remains one of the prime mining destinations for Australian law firms and mining companies. Yet Armstrong s detainment may affect Australian mining interests and cause companies to hesitate before investing. As Mongolia continues to depend heavily on foreign investors to boost economic growth through the mining sector, travel bans on employees of mining giants like Rio Tinto and threats of increased taxes could cause problems Mongolia may find difficult to dig its way out of. 23

24 BEING ISLAMIC Islamic bonds are becoming a trendy vehicle for investments as global investment increases in the Middle East. The Hong Kong government is keen to promote and facilitate the market for Islamic finance, with the understanding that financial products must be tailored to be Shariah compliant. In the Islamic world money is considered to have no intrinsic value and is purely a store of wealth and a medium of exchange; therefore there is no time value of money and financial instruments such as bonds, loans or deposits that involve paying or receiving interest are not acceptable under traditional Islamic law. Over the last year the Hong Kong government has looked into amending the Inland Revenue Ordinance and the Stamp Duty Ordinance to facilitate a taxation framework for Islamic bonds as exists with conventional bonds. On 29 March 2012 the government published a consultation paper on the Proposed Amendments to the Inland Revenue Ordinance (Cap.112) and the Stamp Duty Ordinance (Cap.117) to Facilitate Development of an Islamic Bond (i.e. Sukuk) Market in Hong Kong. The conclusions of the consultation were released on 29 October 2012, with most respondents welcoming the proposed amendments. There were a few comments addressing taxation, such as what type of Sukuk structures would qualify for the related special tax treatment. The amendment bill will propose a clause to empower the Financial Secretary to amend certain parts of tax laws, so that tax regime can accommodate the evolving Islamic bonds market. Islamic bonds, while not subject to interest payments, still offer payments that come from productive sources such as rental income or trading assets that were generated from the initial investment. The consultation paper proposed that these payments still be considered a form of interest payment for taxation purposes. The consultation conclusions said that there would need to be a good balance between addressing tax avoidance issues and avoiding undue restrictions on market development, and defining what payments from Islamic bonds would be considered interest payments, and what effect these payments will have on balances. 24 Tax Quarterly Newsletter December 2012

25 TIDBITS Updates on newly signed tax treaties Two Comprehensive Agreements for the Avoidance of Double Taxation (CDTA) were published on 19 October One was signed between Hong Kong and Malaysia on 25 April 2012 and the other with Mexico on 18 June The agreements will avoid double taxation between Hong Kong and Malaysia and Hong Kong and Mexico, so that income that has already been taxed in Hong Kong from Malaysian or Mexican residents will not need to be taxed again in the two countries. This will bring tax savings in royalties, interest, profits from international shipping and airlines, and fees for technical services. Updates on treaties with France and Switzerland The agreement between Hong Kong and France for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital was entered into on 21 October 2011, effective from assessment year 2012/13. The main implication for Hong Kong resident corporations is that under provisions of the CDTA, they will be exempt from branch remittance tax on income derived in France. Prior to the CDTA, a 25% withholding tax would be imposed on the after-tax profits of a foreign corporation as if they were dividends, meaning that the entity would be subject to both Hong Kong and French income tax. Similarly, a French resident corporation deriving income in Hong Kong would also be fully taxed in both countries. Therefore, the CDTA enables Hong Kong residents to make tax savings in relation to items such as dividends and royalties received from France, and international airline and shipping profits earned in France. It was also announced on 7 November 2012 that the CDTA signed with Switzerland had entered into force on 15 October