Using Hong Kong for China Operations

Transcription

1 The Practical Application of China Business October 2010 Volume XI - Number VIII English French German Italian Spanish Daily Business News Available at Using Hong Kong for China Operations An overview of Hong Kong Holding and Trading Companies In This Issue: Common Advantages to Using Hong Kong Companies Incorporation Procedures for Hong Kong Companies Accounting and Financial Requirements in Hong Kong Hong Kong s Double Tax Agreements Daily Business News Available at O ct

2 Welcome to the October issue of China Briefing In the October issue of China Briefing we look at the special administrative region of Hong Kong and the advantages a Hong Kong company can provide for business operations in Mainland China. Hong Kong remains one of Asia s top metropolises for international business and, since its return to the People s Republic of China in 1997; it has continued to attract foreign investors interested in using the city as a stepping stone to the mainland. In this issue, we first examine the different types of holding companies that are available to foreign investors and the advantages they can impart, from ease of incorporation to a favorable tax regime. Then we run through the incorporation procedures for establishing a company in the territory. We also lay out the accounting and financial requirements that affect Hong Kong companies and give a brief introduction to Hong Kong s double tax agreements. The articles in this issue of China Briefing were researched and written with the help of the China-based foreign direct investment and tax consultancy Dezan Shira & Associates. The firm has a presence in 10 Chinese cities including offices in Hong Kong, Shenzhen, Guangzhou and Zhongshan. Contact details can be found within the magazine should you need assistance or advice. Best Regards, Andy Scott Managing Editor, China Briefing Corporate Establishment, Tax, Accounting & Payroll Throughout Asia China Briefing Daily News Business Advisory, Accounting, Payroll, Taxation and Audit Services Throughout Emerging Asia info@dezshira.com Ten China Offices Five India Offices Two Vietnam Offices Visit Our Other Regional Resources INDIA BRIEFING WEEKLY ROUND UP Sign up today for our complimentary China and Asia business and regulatory round up at VIETNAM BRIEFING EMERGING ASIA Produced in association with Dezan Shira & Associates since This Month s Cover Art This month s cover art, Sapphire (oil on canvas), is by the artist Song Guangzhi. Born in Huadu, Guangdong Province, Song graduated from the Guangzhou Academy of Fine Arts and obtained his post-graduate degree from the Central Academy of Fine Arts. He is currently an associate professor at the Guangzhou Academy of Fine Arts where he is the deputy director of the print making department. The cover is reproduced courtesy of the artist and Oriental Vista Gallery. The gallery aims to promote contemporary art through discourse and exhibitions, increasing the awareness of the general public towards contemporary and avant-garde art. Integrity and professionalism are our foundations for the bridge between the art market, artists and art collectors. Oriental Vista Gallery is located at 19 Shaoxing Lu, Shanghai, China. pr@ovgallery.com. All materials and contents 2010 Asia Briefing Ltd. No reproduction, copying or translation of materials without prior permission of the publisher. Contact: editor@china-briefing.com

3 Using Hong Kong Companies for China Operations [ By Rosario Di Maggio, Dezan Shira & Associates ] Hong Kong is one of Asia s top cities for international b u s i n e s s a n d h a s continuously been ranked as one of the world s freest economies by several business observers and watchdogs, including the Index of Economic Freedom published annually by The Wall Street Journal and The Heritage Foundation which this year put the city at the top of its list for the 16th time in a row. Since its return to Mainland China in 1997, the Hong Kong Special Administrative Region has consistently enhanced its position as a platform for foreign investors to enter China, allowing the city to steadily increase in importance as a regional hub for sourcing and trading operations. Political stability, rule of law and an independent legal system, free market principles, the free flow of information, and English as one of the two official languages are among the keys of such success. This issue of China Briefing will look at how Hong Kong is used by foreign investors in their China strategy and, specifically, when it makes sense for foreign investors to use Hong Kong companies as holding companies for their investments on the mainland or as a trading company to source from China or sell to it. Common advantages to using Hong Kong companies There are several advantages in terms of structure and strategy to using a Hong Kong company if you are a foreign investor: 1) Easy to incorporate and relatively cheap to maintain: the incorporation procedures take a few working days and the overall legal requirements are very limited 2) Strategic and commercial holding for Asian operations: Hong Kong is a perfect platform to establish a regional headquarters to run operation in Asia; Hong Kong human capital is considered among the best in Asia 3) Favorable tax regime and freedom of capital movement: the standard profits tax rate in Hong Kong is only 16.5 percent and the salary tax is among the lowest in the world; there is no capital gains tax, dividends or interest tax, sales tax, import tax or value-added tax (apart from alcohol, hydrocarbon oil and tobacco); Hong Kong regulations also allow companies to claim offshore status, enabling them total tax exemption on profits sourced outside of Hong Kong 4) Use of a Hong Kong sub-holding to shield an ultimate holding based elsewhere and an invested company often in a jurisdiction considered risky for some reason 5) Use of a Hong Kong company as a holding or sub-holding to conduct shares allocations and disinvestments; a Hong Kong holding can in fact be easily sold, restructured or deregistered In terms of costs and operation, running a limited liability company in Hong Kong can be very inexpensive. In fact, Hong Kong allows the establishment of virtual companies. In other words, a company does not need a real office, but only a legal address; and does not need employees, but only a company secretary whose only duty is to keep a file of the company documents and keep the company in compliance. The company will also be required to prepare profits tax returns and submit an annual audit report prepared by a local CPA firm. Because of these limited requirements, hundreds of law, accounting and consulting firms offer such a service for a reasonable fee in the territory. In choosing a service provider, however, we strongly recommend background checks and opting for accredited firms. As with anywhere else, being out of compliance can be costly, while operating a company China Briefing October

4 Using Hong Kong Companies for China Operations in Hong Kong from a remote location elsewhere might require a level of trust in local agents. Hong Kong holdings Because Hong Kong is a separate jurisdiction from Mainland China, with a distinct legal system and tax regime, it has become one of the primary sources of the most common structure used by foreign companies to hold direct investments in China the so-called special purpose vehicle (SPV). An SPV is an entity established in a jurisdiction that has a favorable tax regime, allowing the investor to structure tax-efficient cross border investments. It is this legal entity that has made Hong Kong the number one source of foreign direct investment into China. Last year, the territory accounted for over half of the US$90 billion in total FDI inflows to China, amounting to US$54 billion, an increase of 31.6 percent year-on-year. According to China s National Bureau of Statistics, between 1990 and 2009, nearly 45 percent of all FDI into China came from Hong Kong. And although these figures are probably heavily inflated by the round-tripping of Mainland Chinese capital, 1 Hong Kong remains by far the most important entry gate of FDI into China. In addition to the advantages mentioned above, Hong Kong holdings for China investments also enjoy some other specific advantages, including a preferential 5 percent withholding tax rate when repatriating profits earned in the Chinese subsidiary against the 10 percent standard rate. The Closer Economic Partnership Arrangement between Hong Kong and China is yet another advantage. CEPA allows qualifying companies to receive preferential approvals and other advantages like no tariffs on 90 percent of Hong Kong-made products to the mainland and faster market entry to China for Hong Kong-based service providers. Trading companies Hong Kong is also commonly used as a trading platform or regional commercial headquarters for many multinational companies and SMEs alike when sourcing from or selling to China and other emerging Asian markets. Companies interested in sourcing operations (garments, industrial parts, consumer goods) are often headquartered here. These companies will usually have their management located in Hong Kong, and keep small local offices nearby their supplier s plant in Mainland China or elsewhere in Asia, with a light structure on the ground and a few local employees dealing with quality control or supplier searches. Companies interested in selling in China will also need a presence on the ground to find distributors, promote their products and perhaps set up a showroom. The trend today however, is toward relocation from Hong Kong to the mainland. Companies are cutting costs and most of the work is done on the ground while the potential avenues for the business to grow are on the mainland rather than in Hong Kong. Moreover, China s legal framework is becoming clearer every year. While competition requires the ability to provide more services and have a more structured presence on the ground, the Chinese authorities are pushing for foreign investors to be registered and taxed where the profits are sourced, which often means in China. The trend is the same for small businesses (companies with an annual turnover between US$500,000 and US$4 million) which use Hong Kong companies as trading entities to buy from Mainland China and then sell elsewhere, and vice versa. The relatively low cost of maintenance and low requirements still make Hong Kong a perfect location for most of these businesses to have their (virtual) base. Business opportunities, supplier and client requirements and compliance issues are also pushing these SMEs to expand their structure into China. China s tax oversight It is worth noting that the Chinese authorities, and especially the State Administration of Taxation, are becoming stricter when dealing with Hong Kong companies doing business in Mainland China. Under Article 2 of the current corporate income tax law, an offshore company could be deemed as PRC tax resident based on the principle of place of effective management. In other words, foreign investors using Hong Kong companies to run their business but with management, offices and/or personnel based in Mainland China might be deemed as subject to corporate income tax in China on their Hong Kong company profits. With the Implementation Measures for Special Tax Adjustments (Circular 2) on January 9, 2009, the SAT has provided a stronger regulatory basis to deny double tax agreement tax benefits for SPVs that lack economic substance (Article 94) and thereby to prevent tax avoidance by both related and unrelated parties of the enterprise. In February 2009, the SAT released Circular 81 (Guoshuihan [2009] No. 81) to address China s preferential dividend withholding tax under double tax agreements. As mentioned above, the China-Hong Kong double tax agreement entitles Hong Kong companies to a lower withholding tax of 5 percent when repatriating dividends. The circular is aimed to prevent non-tax resident enterprises from claiming China s tax benefit and advantages through treaty shopping practices, and reflects the implementation of the anti-avoidance principle against the use of SPVs. According to Circular 81, the following conditions must be met for the recipient of the dividend to enjoy the treaty benefit: The recipient of the dividend (in our case, the Hong Kong company) must be a tax resident of the other treaty (in our case, Hong Kong SAR) jurisdiction The recipient of the dividend must be the beneficial owner of the dividend 1 Preferential tax treatment guaranteed to FDI flowing into China before 2008 had a large impact on enticing mainland capital to illegally exit and then re-enter the country as FDI in order to benefit from lower tax rates. 4 China Briefing October 2010

5 Using Hong Kong Companies for China Operations The dividend must qualify as a dividend under the tax law of China Other conditions that the SAT may impose Although the above requirements are not unusual by international standards, the Chinese authorities are now entitled to ask for documentary evidence that meet the requirements. Another provision of Circular 81 empowers tax bureaus in China to investigate and refuse treaty benefits when the existence of the SPV is considered an end in itself with the only scope of business being obtaining a more favorable treatment on dividends under a tax treaty. Another important regulation, Guoshuifa [2009] No. 82, was released on April 2, The circular states that an offshore corporation primarily controlled by Chinese shareholders is subject to tax as a PRC tax resident when: The main location of operational management is exercised in China Main financial and HR decisions are made or approved in China The main assets, accounting books and records, company seals, board and shareholder meeting resolutions are located and maintained in China 50 percent or more of voting board members or senior executives reside in China Other important aspects affecting offshore entities doing business with Mainland China include the emergence of Chinese capital gains tax claims from Chinese tax authorities when the offshore holding goes through restructuring or sells their China entities, and the strengthening of transfer pricing control measures. (For more information, please see the March 2009 issue of China Briefing Magazine). While Hong Kong does not appear on the Organization for Economic Cooperation and Development s list of Jurisdictions Committed to Improving Transparency and Establishing Effective Exchange of Information in Tax Matters, some countries, namely Italy, still consider Hong Kong as tax haven jurisdiction. The tax authorities in such countries will usually scrutinize any transaction to and from Hong Kong and will expect their citizens or companies establishing business there to provide evidence showing the business substance of such transactions or corporate establishments. Moreover, the last few years have seen a flourishing of double tax agreements between Hong Kong and several other countries, including Austria, Belgium, Brunei, Hungary, Indonesia, Ireland, Kuwait, Liechtenstein, Luxembourg, the Netherlands, the People s Republic of China, Thailand, the United Kingdom and Vietnam. For more information on Hong Kong s double tax treaties, please see pages 10 and 11. Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in China, Hong Kong, India and Vietnam. The firm provides specific Hong Kong secretarial services including company set up, annual maintenance and tax return filing, bookkeeping, annual audits, annual registration fees, and annual business license renewals. Contact info@dezshira.com or visit China Briefing s Business Legal, Tax and Investment Library TECHNICAL SERIES Guides to Setting up Representative Offices, Wholly Foreign-Owned Enterprises, Joint Ventures, China s Taxes, Mergers and Acquisitions, Intellectual Property Rights, Transfer Pricing and Human Resources in China REGIONAL SERIES Guides to Beijing and Northeast China, Shanghai and the Yangtze River Delta, South China and the Pearl River Delta, Central China, West China, China s Second and Third Tier Cities and China s Neighbors Available in hardcopy or PDF sales@asiabriefingmedia.com Also available from the publishers of China Briefing: India Briefing and Vietnam Briefing Magazines and the emerging Asia web site 2point6billion.com

6 Incorporation Procedures for Hong Kong Companies [ By Joe Sze, Dezan Shira & Associates ] Under current Hong Kong legislation, there are three different types of business organization available: 1) Sole proprietorship 2) Partnership 3) Company Sole proprietorship A sole proprietorship is a business that is run by a single individual where the sole proprietor contributes his capital and experience, is personally entitled to all of the profits, and takes the risk for any debts that the business incurs. The liability of sole proprietor is unlimited. Sole proprietorship is required to register under the Business Registration Ordinance. Partnership A partnership is the relation which subsists between individuals carrying on a business in common with a view of profit. A partnership is a business that is formed by at least two partners (and, with few exceptions, no more than 20 partners), where each partner is liable jointly with the other partners for all debts and obligations incurred by the firm. The liability of partner is unlimited. Partnerships are required to register under the Business Registration Ordinance. Company Companies (in which the liability of the members can be limited or unlimited) can be classified into the following types: 1. Private company 2. Public company 3. Listed company 4. Non-Hong Kong company Private company The private company is by far the most common type of company incorporated in Hong Kong. According to the statistics provided by the Hong Kong Companies Registry, the total number of private companies registered in Hong Kong was 805,558 by June 2010, whereas the total number of public companies was 10,204. According to the section 29 of the Companies Ordinance, the expression private company refers to a company which, in accordance with its articles: 1. Restricts the right to transfer its shares 2. Limits the number of its members to 50, not including persons who are in the employment of the company and persons who, having been formerly in the employment of the company, were while in that employment, and have continued after the determination of that employment to be, members of the company 3. Prohibits any invitation to the public to subscribe for any shares or debentures of the company A private company does not have to submit its annual financial statements to the Companies Registry so its financial position is not disclosed to the general public. Public company Any company that fails to satisfy section 29 is a public company. A public company has to submit its annual returns together with each set of accounts to be certified by a director, manager or the secretary as being a true copy and must include a directors report and an auditor s report on the company s accounts to the Companies Registry annually. Listed company A listed company is a company which has shares or debentures that are traded on the stock exchange. Only public companies can apply to the stock exchange for a listing. Therefore, a listed company must also be a public company (a public company does not necessarily have to be a listed company). Non-Hong Kong company Non-Hong Kong companies are companies incorporated outside Hong Kong which for some reason establish a place of business in Hong Kong. These companies are required to register as non-hong Kong companies with the Companies Registry within one month of setting up in Hong Kong. A non-hong Kong company is also required to submit an annual return together with the company s accounts to the Companies Registry annually. 6 China Briefing October 2010

7 Incorporation Procedures for Hong Kong Companies Establishing a Hong Kong private company The first requirement in establishing a new private limited company is the registration of a name. Such a name can be an English name, or a Chinese name, or both. Since 1991, the name reservation system has been abolished and no provisional approval of the company name is needed by the Registrar of Companies. The name of limited companies must end with the word limited. Limits to the registration of a name include: 1. The chosen name has already been registered and is currently in use by another company as shown in the Registrar s index of company names 2. The chosen name is the same as that of a body corporate incorporated or established under an ordinance 3. The chosen name would, in the opinion of the chief executive, constitute a criminal offence 4. The chosen name would be, in the opinion of the chief executive, offensive or otherwise contrary to the public interest Memorandum and articles of association The memorandum and articles of association should be prepared for the incorporation of the company. The memorandum of association should contain the name clause, domicile clause, liability clause, capital clause and subscription clause. Private companies are not required to state their objects in their memorandum. The articles of association are the internal regulations of the company for example, the powers of the directors. The three restrictions contained in section 29 must be included into the articles of association when incorporating a private company. Incorporation form A person who wishes to form a private company shall apply to the Registrar using an incorporation form. The form will contain the following information: Company name As previously discussed. Company s registered office A company should have a registered office in Hong Kong to which all communications and notices may be addressed; Care of addresses or post office box numbers are not acceptable. Authorized share capital Authorized share capital is the amount of capital with which the company proposes to be registered. The number and par value of shares must be stated and there is no requirement that a company s share capital be denominated in Hong Kong currency. Capital duty is payable at the rate of HK$1 for every HK$1,000 (or part thereof) of the nominal share capital. Issued share capital The total amount of share capital is to be taken by the shareholders; shares are issued to the shareholders in exchange for their contributions to fund the company s business or operation. Shareholder A private company must have at least one shareholder; the shareholder can be an individual or corporation. If an individual is the shareholder, they do not need to be a Hong Kong resident. The shareholder is the owner of the company. They cannot run the business of the company if they are not the director. The shareholder and director can be the same person. Company secretary Every company needs to have a secretary. This secretary is normally called a company secretary and is the officer of the company. Unless the company is a listed company, the secretary of a company can be an individual who ordinarily resides in Hong Kong or a corporate body that has its registered office or a place of business in Hong Kong. Director A private company must have at least one director. The director can be an individual or corporation. If an individual is the director, they must be at least 18 years of age but do not need to be a resident of Hong Kong. The director is the manager of the company; they run the business of the company. The powers of director are conferred by the articles of association. Incorporating a private company Documents to be submitted to the Companies Registry for the incorporation include: 1. Incorporation form Form NC1 (for a company limited by shares) 2. A copy of the company s memorandum of association and articles of association, if any, certified as true by a founder member of the company Normally, a certificate of incorporation of a company limited by shares will be issued in four working days of submission. The company legally exists on the date of incorporation on the certificate. Within one month from the date of incorporation, irrespective of whether actually in business or not, a company will need to register under the Business Registration Ordinance. Every company will need a metal seal on which it will need to have its name engraved in legible characters. Annual compliance A company is required to renew its business registration certificate annually. A private company with share capital should forward its annual return to the Registrar of Companies within 42 days of the company s anniversary of incorporation. Every company should hold a general meeting as its annual general meeting in addition to any other meetings during the year and should specify the meeting as such in the notices calling for the meeting. The company must hold its first annual general meeting within 18 months of incorporation. At this annual general meeting, the directors of the company will need to lay before the company a profit and loss account. Please contact Dezan Shira & Associates for more information about incorporating a company in Hong Kong at hongkong@dezshira.com or visit China Briefing October

8 Accounting and Financial Requirements for Hong Kong Companies [ By Eunice Zhou and Rachel Wang, Dezan Shira & Associates ] According to Hong Kong s Company Ordinance, every company needs to keep proper accounting books with respect to all money received and expended by the company, the matters in respect of which the receipt and expenditure takes place, all sales and purchases of goods by the company, and the assets and liabilities of the company. The accounts will disclose with reasonable accuracy the financial position of the company, and will enable the preparation of the company s balance sheet and any other documents required by the Company Ordinance. The balance needs to give a true and fair view of the state of affairs of the company as at the end of its financial year, and every profit and loss account of a company shall reflect accurately the profit or loss of the company for the financial year. Company accounts are required to be kept for seven years from the end of the financial year to which the last entry refers. Tax compliance As mentioned, Hong Kong s simple and business-friendly tax system is a major attraction for foreign investors. Main advantages include: A low tax rate on profits 16.5 percent (15 percent for persons other than corporations) for 2009/2010 No tax on capital gains and dividends Generous capital allowance Territorial principle of taxation allowing Hong Kong companies to claim offshore status and tax exemption on profits sourced outside Hong Kong Hong Kong has only three direct taxes: profits tax, employment income tax and property tax. All Hong Kong companies are required to keep sufficient records, in English or Chinese. These records must include income and expenditure to enable their assessable profits to be readily ascertained, with statutory requirements to record certain specified business transactions. Business records must be retained for at least seven years after the date of the transaction to which they relate. Failure to keep sufficient records may result in a fine of HK$100,000. Under the Hong Kong tax regime, there is no time limit on the carrying forward of tax losses, and losses cannot be carried backward. Profits tax Each person carrying out a trade, business or profession in Hong Kong needs to pay profits tax on the assessable profits arising in or derived from Hong Kong from such a trade, business or profession. A person is liable for Hong Kong profits tax if the following conditions are satisfied: The person must carry on a trade, profession or business in Hong Kong The profits to be charged must be from that business, profession or trade carried on by the person in Hong Kong The profits must be profits arising in or derived from Hong Kong Hong Kong s tax administration, the Inland Revenue Department, is only interested in profits which are directly sourced in Hong Kong. The principle of territorial basis must be taken into consideration at every stage of profits tax planning. As there is no distinction made between residents and non-residents, a resident may therefore derive profits from abroad without being taxed; conversely, a non-resident may be taxed on profits arising in Hong Kong. Typical cases of Hong Kong taxable businesses include: Providing consulting services in the territory of Hong Kong Buying or selling goods where the contracts are negotiated and agreed on 8 China Briefing October 2010

9 Accounting and Financial Requirements for Hong Kong Companies in Hong Kong, or the goods are stored in Hong Kong Selling Hong Kong land as real estate as part of a profit-making venture Business activities that are conducted through an agent in Hong Kong The profits tax rate for corporations was increased from 16 percent to 17.5 percent from the year of assessment 2003/2004 and then reduced to the current 16.5 percent from 2008/2009. For unincorporated businesses, the profits tax rate was increased from 15 percent to 15.5 percent in the year of assessment 2003/2004, to 16 percent from 2004/2005, and reduced back to the current 15 percent from 2008/2009. Profits tax is charged on the assessable profits for a year of assessment and generally, all expenses incurred by the tax payer in production of chargeable profits are tax deductible. The tax year in Hong Kong can be as follows: April 1 through March 31 of the following year The year that ends on the date when the annual accounts are made up (if that day is not March 31) A special period prescribed by the Inland Revenue Ordinance when a business has commenced, ceased or changed its accounting date Profits tax returns The first profits tax return will be issued by the Inland Revenue Department 18 months after the company s incorporation. The IRD will issue the second and following tax returns after the end of the tax year, which will need to be completed within 30 days of receiving the return. An extension to this time limit may be available where a tax agent (usually a professional tax adviser) represents a taxpayer. The tax return can be extended as follows: Extended Accounting date due date Jan. 1, 2010 Mar. 31, 2010 Nov. 16, 2010 No Extension Apr. 1, 2010 Nov. 30, 2010 (May 2011) Dec. 1, 2010 Dec. 31, 2010 Aug. 15, 2011 Offshore status Hong Kong adopts a territorial source principle of taxation which means that only profits sourced in Hong Kong are taxable here. The principle itself is very clear but its application in particular cases can be, at times, contentious. The questions of whether a business is carried on in Hong Kong and whether profits are derived from Hong Kong are largely questions of fact. Generally, the leading principle is to look to what the taxpayer has done to earn the profits in question and where he has done it. The basic approach is to ascertain what the operations that gave rise to the profits are and where they are undertaken. The Hong Kong authorities have adopted a plain approach to this, although each case needs to be considered in light of its own particular circumstances and facts There are two common types of tests: Contract effected test The contract effected test is used for income from trading transactions. The important factor here is whether or not the contract of purchase or sale is made in Hong Kong. This includes negotiation, conclusion and execution of the contract. The following factors are also considered: How were the goods shipped? How were sales solicited and orders processed? How were the goods procured and stored? How was financing arranged? How was the payment made? Operation test The operation test is for cases other than trading and money lending (manufacturing income and passive income). For commission income, when applying for tax exemptions, one should ask a number of questions: What is the originating cause of the income? Did the originating cause take place in Hong Kong? What has been done to earn profits and where was it done? For more information or advice on Hong Kong s tax regime, please contact Dezan Shira & Associates at tax@dezshira.com or visit ASIA BRIEFING The China Tax Guide (Fourth Edition) To order a copy, please contact sales@asiabriefingmedia.com Visit the Asia Briefing Bookstore Tax Planning China s Tax Law and Administration Corporate Income Tax, Value-added Tax, Withholding Tax and Business Tax Representative Office Tax Treatments Export Tax Rebates Consumption Tax Rates Expatriate Individual Income Tax and Permitted Benefit Allowances Statutory Audit Obligations for Foreign Enterprises General Accounting Treatments on Significant Audit Areas Annual Audit Issues Commonly Queried Upon Inspection Related Party Transaction Documentation Requirements China s Double Tax Treaties Regulations Concerning China-Hong Kong Cross Border Treatments China Briefing October

10 Hong Kong s Double Tax Agreements [ Jennifer Lu, Dezan Shira & Associates ] Double taxation arises when two or more tax jurisdictions overlap, such that the same item of income or profit is subject to tax in each. In Hong Kong, which has adopted the territoriality basis of taxation, only income or profits sourced in Hong Kong are subject to tax. Income or profits that are derived from a source outside Hong Kong by a local resident are in most cases not taxed by the Hong Kong tax administration. Notwithstanding this, the Hong Kong Special Administrative Region government (HKSARG) recognizes that there are merits in concluding double taxation agreements (DTAs) with the territory s trading partners. A DTA provides certainty to investors on the taxing rights of the contracting parties, helps investors to better assess their potential tax liabilities on economic activities, and provides an added incentive for overseas companies to do business in Hong Kong; and likewise, for Hong Kong companies to do business overseas. Therefore, it has been the policy of the HKSARG to establish a DTA network that would minimize exposure of Hong Kong residents and residents of the DTA partner to double taxation. On the other hand, the Inland Revenue (Amendment) Ordinance 2010 passed in January 2010 provided a legal basis for HKSARG to adopt the more liberal 2004 OECD model for exchange of information with its DTA partners. The ordinance amends the existing law by inserting a few new sections, stating more details on how information can be exchanged between Hong Kong and the government of the territory under the DTA. At the same time, all of the five newly signed DTAs with Hungary, Kuwait, Austria, the United Kingdom, and Ireland have included some additional clauses on disclosure of the information to safeguard against possible abuse of the related amendment of the ordinance. China-Hong Kong DTA China and Hong Kong reached a double tax agreement on August 21, This replaced the 1998 agreement and went into force on January 1, 2007 for mainland taxpayers and on April 1, 2007 for Hong Kong taxpayers. The China-Hong Kong DTA withholding tax rates appear in the chart below. Although dividends received by foreign investors from a foreign investment enterprise in the mainland are exempt from mainland taxation under the old arrangements, the provision in the new agreement provides some reassurance for Hong Kong investors against any possible withdrawal of this exemption at a later date. The reduced withholding tax rates are among the lowest rates available in double tax treaties signed by the mainland. Capital gains tax Under Article 5 in the 2nd Protocol of the China-Hong Kong DTA from 2008, a full tax exemption is available in the mainland on capital gains obtained by a Hong Kong investor from the disposal of shares in a mainland company, provided that the Hong Kong investor directly or indirectly holds less than 25 percent of the shares within 12 months prior to the share transfer. As there is no tax on the sale of capital assets in Hong Kong under any older arrangements, this could prove beneficial to Hong Kong investors. Income from employment There is an important change in the basis period for counting the number of days of presence in the mainland for Hong Kong employees who frequently visit the mainland, from one calendar year to a 12 month period. This has made it harder for tax residents on one side to claim exemption from taxes on the other side. Under the double tax agreement, a resident of one side is exempt from tax on the other side if they satisfy all the following criteria: They are present on the other side for a period or periods not exceeding an aggregate of 183 days in any 12 month period commencing or ending in the taxable period concerned The remuneration is paid by, or on behalf of, an employer who is not a resident of the other side The remuneration is not borne by a permanent establishment that the employer has on the other side Exchange of information Various guidelines have been issued on this topic. While it does allow some information to be exchanged, it is more restrictive and only allows information necessary for carrying out the provisions of the new arrangement or the domestic laws of the mainland and Hong Kong concerning taxes. The two governments are not obliged to supply information which is not obtainable under domestic law or the normal course of administration, and which would disclose any trade, business, industrial, commercial or professional secrets. For additional information on Hong Kong s double tax agreements and advice regarding cross border tax treatments, please contact Dezan Shira & Associates at tax@dezshira.com or visit 10 China Briefing October 2010

11 Country Hong Kong s Comprehensive Double Tax Agreements Date of signing Effective date (On or after the date specified) Hong Kong s Double Tax Agreements Withholding tax rates on passive income Dividends Interest Royalties Austria May 25, 2010 Awaiting notification 0 / 10% 1 Nil 3% Belgium December 10, 2003 Y/A 2004/ / 5 / 15% 2 10% 5% Brunei March 20, 2010 Awaiting notification Nil 0 / 5% / 10% 3 5% Hungary May 12, 2010 Awaiting notification 5 / 10% 4 0 / 5% 5 5% Indonesia March 23, 2010 Awaiting notification 5 / 10% 6 0 / 10% 7 5% Ireland June 22, 2010 Awaiting notification Nil 0/10% 8 3% Kuwait May 13, 2010 Awaiting notification 0 / 5% 9 0 / 5% 10 5% Liechtenstein August 12, 2010 Awaiting notification 0% % 12 Luxembourg November 2, 2007 Y/A 2008/ / 10% 13 Nil 3% Mainland China August 21, 2006 Y/A 2007/ / 10% 14 0 / 7% 15 7% Netherlands March 22, 2010 Awaiting notification 0 / 10% 16 Nil 3% Thailand September 7, 2005 Y/A 2006/ % 10 / 15% 17 5 / 10 / 15% 18 The United Kingdom June 21, 2010 Awaiting notification 0/15% 19 0% 20 3% Vietnam December 16, 2008 Y/A 2010/ % 0 / 10% 21 7 / 10% 22 Notes: 1. The 0% rate applied if the beneficial owner of the dividends is a Hong Kong company holding directly at least 10% of the share capital of the Austrian company. The 10% applies to all other cases. 2. The 0% rate applies if the beneficial owner is a company holding at least 25% of the share capital of the paying company for an uninterrupted period of at least 12 months as at the dividend payment date. A 10% holding results in a maximum source tax of 5%. The 15% rate applies to all other cases. 3. The 0% rate applies to interest payments to the HKSARG and certain government institutions. The 5% rate applies to interest payments to any bank or financial institution. The 10% rate applies to all other cases. 4. The 5% rate applied if the beneficial owner of the dividends is a Hong Kong company holding directly at least 10% of the share capital of the Hungarian company. The 10% applies to all other cases. 5. The 0% rate applies to interest payments to the HKSARG, Hong Kong Monetary Authority and a financial establishment appointed by the HKSARG and mutually agreed upon by competent authorities of the two contracting parties. The 5% rate applies to all other cases. 6. The 5% rate applies if the beneficial owner of the dividends is a Hong Kong company holding directly at least 25% of the share capital of the Indonesian company. The 10% rate applies to all other cases. 7. The 0% rate applies to interest payments to the HKSARG and certain appointed institutions. The 10% rate applies to all other cases. 8. The 0% rate applies to interest payments to the HKSARG, Hong Kong Monetary Authority, certain statutory bodies, institutions or funds owned or appointed by the HKSARG, a bank or similar financial institution, and a recipient that is established in Hong Kong to provide benefits under pension arrangements recognized for tax purposes in Hong Kong; or to interest paid by a bank or similar financial institution, with respect to indebtedness arising as a consequence of the sale on credit of any equipment, merchandise or service. The 10% rate applies to all other cases. 9. The 0% rate applies if the beneficial owner of the dividends is the HKSARG, any of its institution or other entity wholly-owned directly by it. The 5% rate applies to all other cases. 10. Currently, Kuwait does not impose any withholding tax on interest. The treaty rates represent the maximum rates applicable should a withholding tax on interest be levied in Kuwait in future. The 0% rate applies to interest payments to the HKSARG, Hong Kong Monetary Authority, any institution set up by the HKSARG, any entity established in Hong Kong all the capital of which has been provided by the HKSARG or its institution. The 5% rate applies to all other cases. 11. Unlike most of Hong Kong s other CDTAs, the HK-LI CDTA does not include a share holding requirement for a beneficial owner of dividends to qualify for the withholding tax exemption under the HK-LI CDTA. 12. There is currently no withholding tax levied on royalties. However, if Liechtenstein imposes a withholding tax on royalties in future, the rate will be capped at 3% under the HK-LI CDTA. 13. The 0% rate applies if the beneficial owner of the dividends is a company holding directly at least 10% of the share capital of the company paying the dividends or a participation with an acquisition cost of at least EUR1.2 million in the company paying the dividends. The 10% rate applies to all other cases. 14. The 5% rate applies if the beneficial owner of the dividends is a Hong Kong company holding directly at least 25% of the share capital of the China company. The 10% rate applies to all other cases. 15. The 0% rate applies to interest payments to the Government or the recognized institutions. The 10% rate applies to all other cases. 16. The 0% rate applies if the beneficial owner of the dividends is (a) a Hong Kong company holding directly at least 10% of the share capital of the Dutch company provided that (i) the Hong Kong company is listed on a recognized stock exchange or (ii) at least 50% of its shares is owned by a company listed on a recognized stock exchange and that company is a resident of either contracting party or a resident of a member State of the European Union;(b) a bank or insurance company (c) a Contracting Party, a political subdivision or local authority thereof or an institution created by any of those or the Government of either Contracting Party; (d) a headquarters company for a multinational corporate group (as further defined in the protocol to the treaty); (e) a pension fund or scheme; or (f) any other company that is not mainly established, acquired or maintained to secure the benefits of exemption from dividend withholding tax. The 10% rate applies to all other cases. 17. The 10% rate applies if it is paid to financial institutions or insurance companies and interest paid with respect to indebtedness arising from the sales on credit of any equipment, merchandises or services on arm s length basis. The 15% rate applies to all other cases. 18. The 5% rate applies to royalties for the use, or the right to use any copyrights of literary, artistic or scientific work. The 10% rate applies to royalties for the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process. The 15% rate applies to all other cases. 19. The 0% rate applies where the beneficial owner of the dividends is a pension scheme. The 15% rate applies when the beneficial owner of the dividends is a Hong Kong resident. 20. The 0% rate applies except where the anti-treaty shopping provisions in the HK/UK DTA apply. 21. The 0% rate applies to interest payments to the HKSARG and recognized institutions. The 10% rate applies to all other cases. 22. The 7% rate applies to royalties for the use, or the right to use, any patent, design or model, plan, secret formula or process. The 10% rate applies to all other cases. HKSARG: Hong Kong Special Administrative Region Government China Briefing October

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