10 November 2017 Global Tax Alert Hong Kong releases new practice note on concessionary tax regime for qualifying aircraft leasing activities EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: www.ey.com/taxalerts Executive summary On 27 October 2017, Hong Kong s Inland Revenue Department (the IRD) issued Practice Note No. 54 (DIPN 54), related to the newly enacted law on 7 July 2017 1 that introduced a concessionary tax regime for qualifying aircraft lessors (QALs) and qualifying aircraft leasing managers (QALMs) in Hong Kong. DIPN 54 provides its interpretation of: (i) the leasing of aircraft to an aircraft operator indirectly via an intermediate lessor; (ii) the substantial activity requirement ; (ii) the safe-harbor rule applicable to aircraft leasing managers; and (iv) the limitation on deduction for payments made by a connected taxpayer to a QAL or QALM. DIPN 54 also provides guidance on the information and documents to be submitted when a taxpayer under the concessionary tax regime commences an aircraft leasing activity in Hong Kong, applies for a certificate of residence (CoR) from the IRD confirming their residence in Hong Kong, or lodges an advance ruling application.
2 Global Tax Alert Detailed discussion Summary of the concessionary tax regime for QAL and QALM in Hong Kong Corporations that meet the specified conditions may make a written irrevocable election to apply the concessionary tax regime. Under the concessionary regime: Qualifying profits 2 of QALs and QALMs will be taxed at the 8.25% concessionary tax rate. In lieu of tax depreciation allowances, the deemed taxable income from the leasing of aircraft to an aircraft operator by a QAL will be equal to 20% of the lessor s tax base consisting of gross rentals less deductible expenses other than tax depreciation allowances. Leasing of aircraft to an aircraft operator indirectly through an intermediate lessor If, due to various commercial reasons, a QAL leases their aircraft indirectly to a non-hong Kong aircraft operator through an intermediate lessor who is not itself an aircraft operator, DIPN 54 indicates that the IRD may still consider the QAL to be eligible for the 8.25% profits tax concession based on the facts of each case. Substantial activity requirement of QAL and QALM A QAL or QALM must meet substantial activity requirements by carrying out the profit producing activities by themselves in Hong Kong or arrange to carry out such activities in Hong Kong as one of the specified conditions of the concessionary tax regime. DIPN 54 explains that the core income generating activities which produce the qualifying profits of a QAL or QALM include: raising funds; agreeing on funding terms; identifying and acquiring aircraft to be leased; soliciting lessees; setting the terms and duration of leases; monitoring and revising lease agreements; managing any risks and maintaining documentation. For lessors that are established as a special purpose vehicle (SPV) to hold an aircraft, DIPN 54 states that it may be necessary to consider whether the SPV has sufficient nexus with the active conduct of aircraft leasing activity in Hong Kong, including the engagement of an aircraft leasing manager carrying on business in Hong Kong, to be treated as a QAL. Taxpayers are required to submit a realistic business plan for carrying out their aircraft leasing activities in Hong Kong in the year of commencement for the assessment of the substantial activity requirement. Taxpayers who wish to have certainty regarding their eligibility for the concessionary tax regime may apply for an advance ruling. Safe-harbor rules applicable to aircraft leasing managers There are safe-harbor rules under which a corporation not dedicated solely to carrying out the qualifying aircraft leasing management activities would still qualify as a QALM. In satisfying the safe-harbor thresholds, 3 the accounting profits and asset values as reflected in the audited financial statements will generally be relevant, regardless of the source of the profits and location of the assets concerned. Apportionment of the value of an asset would be allowed if it is partly used for qualifying aircraft leasing management activity. DIPN 54 also states that the equity investments in group companies and dividends may be excluded in the calculation to enable a holding company which also undertakes aircraft leasing management operations to more easily qualify as a QALM. DIPN 54 also indicates that a corporation can serve both as an aircraft lessor and an aircraft leasing manager rendering services to third parties. In such a situation, each activity may be considered separately for qualifying the concessionary tax regime. Limitation on tax deduction for payments made by a connected taxpayer to a QAL or QALM To prevent tax arbitrage through aircraft leasing transactions between connected persons, the tax deduction of the payor on the payments made to a connected QAL or QALM will be limited by reference to the amount of tax reduction enjoyed by the recipient under the concessionary tax regime. DIPN 54 clarifies that such limitation would not apply if the payor and the recipient are both qualified for the concessionary tax regime, where there would be no tax arbitrage.
Global Tax Alert 3 Documents to be furnished in CoR application An aircraft lessor may be required to provide a lessee with a CoR evidencing the lessor s residence in Hong Kong in order to enjoy a reduction in withholding tax on aircraft rentals under an income tax treaty. DIPN 54 indicates that QALs whose central management and control is exercised in Hong Kong and have substantial activities in Hong Kong should be able to obtain a CoR from the IRD. No tax credit available in Hong Kong where withholding tax is borne by lessee DIPN 54 indicates that a tax credit would generally not be available to a QAL in Hong Kong if the overseas withholding tax on aircraft rentals is borne by the lessee pursuant to the lease arrangement, regardless of whether there is an income tax treaty in force between Hong Kong and the lessee jurisdiction. Endnotes 1. For more information, see EY Global Tax Alert, Hong Kong enacts law to attract aircraft leasing and aircraft leasing management businesses, dated 7 July 2017. 2. DIPN 54 states that qualifying profits include incidental income such as interest income, exchange gains or hedging gains, to the extent that the relevant transactions are ancillary to the qualifying activities. 3. The safe-harbor rules require that both the aggregate amount of the aircraft leasing management profits and the aggregate value of the aircraft leasing management assets are not less than 75% of the total amount of the profits and value of the assets of the corporation concerned.
4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young Tax Services Limited, Hong Kong Tracy Ho tracy.ho@hk.ey.com Florence Chan, Financial Services florence.chan@hk.ey.com Ernst & Young LLP, Hong Kong Tax Desk, New York Charlotte Wong charlotte.wong1@ey.com Ernst & Young LLP, Asia Pacific Business Group, New York Chris Finnerty chris.finnerty@ey.com Kaz Parsch kazuyo.parsch@ey.com Bee Khun Yap bee-khun.yap@ey.com Ernst & Young LLP, Asia Pacific Business Group, Houston Trang Martin trang.martin@ey.com
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