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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
1. Double Taxation Agreement (“DTA”)
The HKSAR concludes DTAs with various other countries/tax jurisdictions. A DTA
provides certainty to investors on the taxing rights of the contracting parties, helps
investors to better assess their overall tax liabilities on their economic activities and
provides a potential incentive for overseas companies to do business in Hong Kong,
and likewise, for Hong Kong companies to do business overseas.
Therefore, Hong Kong has tried to establish a comprehensive DTA network that
minimizes potential double taxation exposure of Hong Kong residents and residents
of the DTA partner. The framework of DTAs are based on the Model Double Taxation
Treaties of the Organization for Economic Co-operation and Development ('OECD')
and the United Nations ('UN').
OECD is an inter-governmental organization. For avoidance of double taxation, many
countries (including members and non-members of the OECD) have entered into tax
treaties that are based on the OECD Model and the UN Model. Broadly speaking, a
tax treaty is to facilitate cross-border trade and investment by eliminating the tax
impediments to these cross-border flows. The operational objectives of a tax treaty
are:
(1) elimination of double taxation; and
(2) prevention of fiscal evasion.
In addition, a tax treaty has the following objectives as well:
(1) elimination of discrimination against foreign nationals and non-residents.
(2) exchange of information between the Contracting States.
(3) provide dispute resolution mechanisms.
2. Double Taxation Agreement between China and HKSAR
The Mainland of China and HKSAR signed two arrangements for the Avoidance of
Double Taxation on Income on 1998 and 2006. The purpose of the two DTA is to
eliminate any situation of double taxation that a Mainland or Hong Kong investor
may face when they carry out cross-border business activities.
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
Article 1 – Persons covered
The DTA is intended to cover “residents of the Mainland” and “residents of Hong
Kong”. The definitions of “residents of the Mainland” and “residents of Hong Kong”
are covered in Article 4 of the DTA.
Article 2 – Taxes covered
This article specifies what taxes are covered in the DTA:
a. Hong Kong (Profits tax, Salaries tax, and Property tax)
b. the Mainland (Individual income tax and Corporate income tax)
Article 3 – General definitions
a. Person
The term “person” is widely defined in the DTA to include an individual, a
company, a trust, a partnership and any other body of persons.
b.
Enterprise
i.
The term “enterprise” applies to the carrying on of business activities of
any form.
ii. An “enterprise of One Side” means “an enterprise carried on by a resident
of One Side”.
iii.
iv.
c.
An “enterprise of the Other Sides” means “an enterprise carried on by a
resident of the Other Side”.
An “enterprise carried on by a resident” includes an enterprise carried on
by a resident company, a resident individual, a resident partnership or a
resident body of person.
Business
The term “business” includes the performance of professional services and
other activities of an independent character.
Article 4 – Residents
a. Resident individual
i.
Definition of “resident individual”
In Hong Kong, a resident individual means:
(a) an individual who ordinarily resides in Hong Kong;
(b) an individual who stays in Hong Kong for
(i) more than 180 days during the relevant year of assessment, or
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
(ii) more than 300 days in two consecutive years of assessment (one
of which is the relevant year of assessment).
ii.
Definition of “ordinarily resides”
An individual is regarded as “ordinarily resides” in Hong Kong if he has a
permanent home in Hong Kong where he or his family lives.
Other relevant factors in considering the status of “ordinarily resides”:
(a) duration of his stay in Hong Kong,
(b) whether he has a permanent place of residence in Hong Kong,
(c) whether he owns any property overseas for residential purposes, and
(d) whether he is primarily resident in Hong Kong or overseas.
If an individual has a permanent home in both Sides (i.e., Hong Kong and the
Mainland) concurrently, it is necessary to ascertain with which of the two Sides
his personal and economic relations are closer. Consideration will be taken into
account of his family and social relations; his occupations; political, cultural and
other activities; his place of business; and the place from which he administers
his property, etc.
b.
Resident company
i.
Definition of “resident company”
In Hong Kong, a resident company is:
(a) a company incorporated in Hong Kong, or
(b) if incorporated outside Hong Kong, a company normally managed or
controlled in Hong Kong.
ii.
Definition of “management”
“Management” refers to management of daily business operations, or
implementation of the decisions made by top management, etc.
iii.
Definition of “control”
“Control” refers to control of the whole business at the top level, including
formulating the central policy of the business, making strategic policies of
the company, choosing business financing, evaluating business
performance, etc. The board of directors usually exercises “control”.
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
Article 5 – Permanent establishment
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a.
Definition of “permanent establishment”
i.
A “permanent establishment” is a fixed place of business through which
the business activities of the enterprise are carried on.
ii.
b.
The term “permanent establishment” includes especially” a place of
management; a branch; an office; a factory; a workshop; a mine, an oil or
gas well, a quarry or any other place of extraction of natural resources”.
Representative office
A genuine “representative office” is not regarded as a permanent establishment
subject to tax. In order to maintain a genuine representative office, the
following have to be observed:
i.
the activities should be for the enterprise itself;
ii.
iii.
c.
the activities should not directly generate profits; and
the function of the place of business should only be of a supportive nature.
Business agent
i.
Dependent agent
A dependent agent is an agent acting under the control and leadership of
an enterprise of One Side.
If a dependent agent in Hong Kong regularly acts on behalf of a Mainland
enterprise and has, or habitually exercises, an authority to conclude
contracts in the name of that enterprise, that Mainland enterprise will be
deemed to have a permanent establishment in Hong Kong.
In Hong Kong, a Mainland enterprise may still be treated as having a
permanent establishment in Hong Kong if a dependent agent (though not a
final signatory to a contract) participates in detailed negotiations and
formulates the contract provisions on behalf of the relevant Mainland
enterprise in Hong Kong.
ii.
Independent agent
In the Mainland, a Hong Kong enterprise is not treated as having a
permanent establishment in the Mainland if its activities in the Mainland
are conducted through an independent agent who is acting in the ordinary
course of its business.
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Article 6 – Income from immovable property
Income derived by an enterprise of One Side from immovable property situated in the
Other Side may be taxed in that Other Side, regardless of whether it has a permanent
establishment in that Other Side.
Article 7 – Business profits
a.
General principle
The profits of an enterprise of One Side shall be taxable only in that Side (i.e.
the Other Side has no right to tax) unless the enterprise carries on business in
the Other Side through a permanent establishment situated therein, in which
case its profits may be taxed in that Other Side, but only so much of them as is
attributable to that permanent establishment.
b.
Definition of “business profits”
“Business profits” does not only include profits derived from business activities,
but also income from immovable property, dividends and interest.
c.
Payments between permanent establishment and its head office
i.
As a permanent establishment and its head office are one and the same
legal entity, the DTA sets out three categories of payments which are not
deductible in determining the profits of a permanent establishment:
(a)
payments such as royalties, remuneration or fee in return for
the use of patents or other rights;
(b)
commissions for specific services performed or for
management; or
(c)
interest on money lent to the permanent establishment (except
in the case of a banking enterprise).
ii.
As the aforesaid three categories of expenses are not deductible in
the permanent establishment on the Other Side, the income derived
from those three categories is not included in the determination of
the profits of the head office.
Article 8 – Shipping, air and land transport
a. DTA exempts shipping, air and land transport income derived from a Hong Kong
company from China tax.
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
Cross-border transportation income
Revenue and profits derived by an enterprise of One Side from the operation of
ships, aircraft or land transport vehicles in shipping, air and land transport
businesses is exempt from tax in that Other Side if that income is derived from
cross-border transport. For example, the income derived by a Hong Kong
company’s Mainland permanent establishment from its cross-border
transportation business is exempt from PRC income tax and business tax.
Article 9 – Associated enterprises
If the taxation authority on One Side finds that transactions done by enterprises at
the Other Side with the associated enterprises on the original One Side are not
carried out at an arm’s length, such as transfer pricing, the taxation authority of the
One Side may make adjustments to profits of the associated enterprises.
Article 10 – Dividends
i.
Double charge on dividend income
Dividends paid by a company which is a resident of One Side to a resident of the
Other Side, may be taxed in the Other Side. Thus, the same dividend income
may be taxed in both Sides.
ii.
Relief in tax liability under DTA
According to the DTA, the tax on dividend income shall not exceed:
a. 5% of the gross amount of the dividend where the beneficial owner is a
company directly owning at least 25% of the capital of the company which
pays the dividends,
b. 10% of the gross amount of the dividend in any other cases.
c. No effect on Hong Kong
As Hong Kong does not tax dividend income, the relevant DTA provisions do not
affect the Hong Kong profits tax liability on the receipt of dividend income.
Article 11 – Interest
a. Source of interest
i.
The DTA is of the view that the source of interest is “the Side in which the
interest arises”.
ii. Interest is deemed to arise in a Side when the payer is the Government of
that Side, a local authority thereof or a resident of that Side.
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
Interest is deemed to arise in the Side in which the permanent
establishment, in connection with which the indebtedness on which the
interest is paid is incurred, is situated. In short, the source of interest is at
the Side in which the payer who effectively bears the interest is situated.
c.
Tax relief on interest received under DTA
i.
The limitations of tax rates in the Side in which the interest arises are in 2
tiers as follows:
(a) The interest will not exceed 7% of the gross amount of the interest,
except in the situation (b) below;
(b) interest is exempt from tax in the Side of source if it is received by the
Government of the Other Side or any other institutions mutually
recognised by the competent authorities of both Sides (for example:
China Development Bank, The Export-Import Bank of China and
Agricultural Development Bank of China and the Hong Kong Monetary
Authority).
ii.
Hong Kong taxes income on a territorial basis, and the limitation of tax
rates does not have any practical application in Hong Kong deposit interest
income. However, the 7% limitation is relevant to the income received by a
Hong Kong enterprise from a Mainland entity.
Article 12 – Royalties
a. Charge of tax on royalty income
Royalties arising in One Side and paid to a resident of the Other Side may be
taxed in that Other Side. However, such royalties may also be taxed in the Side in
which they arise and according to the laws of that Side.
b.
Tax relief on royalty received under DTA
i.
If the beneficial owner of the royalties is a resident of the Other Side, the
tax so charged shall not exceed 7% of the gross amount of the royalties.
ii.
Royalty income chargeable at 30% under sections 15(1)(a),(b) and (ba)
When a Mainland enterprise receives royalties from a Hong Kong company,
and it is chargeable with assessable profits at the rate of 30% on the
royalties received, the effective tax rate in Hong Kong would be as follows:
(a) 4.5 in the case of an individual (30% x 15% = 4.5%).
(b) 4.95% in the case of a corporation (30% x 16.5% = 4.95%)
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As 4.5% and 4.95% are lower than 7%, the Mainland enterprise is taxed on
4.95%, not 7%.
iii.
Royalty income chargeable at 100% under sections 15(1)(a), (b) and (ba)
When a Mainland enterprise receives royalties from a Hong Kong company,
and it is chargeable with assessable profits at the rate of 100% under
Section 21A(1)(a) on the royalties received, the effective tax rate in Hong
Kong would remain to be 15% for an individual or 16.5% for a corporation.
The reason is that it is stated in Article 25 of the DTA that the articles in the
DTA do not apply to tax avoidance provisions in the domestic tax law.
iv.
Royalty income chargeable under section 15(1)(d)
Unlike the royalty income chargeable under section 15(1)(a), (b) or (ba)
where the tax is charged on the gross income, section 15(1)(d) charges tax
on the net income after deduction of the relevant expenses.
Under the Fourth Protocol, the withholding tax on royalties paid to aircraft and ship
leasing business will be capped at 5%.
Example 1
Company A, a resident of the Mainland, derives from Hong Kong royalties (hire
income of machinery) of $900,000 in the year ended 31.3.2018.
After deducting allowable expenses and depreciation allowance in respect of the
equipment:
 Assessable profits is $500,000
 Profits tax payable is $500,000 x 16.5% = $82,500
 The effective tax rate of assessable profits of $82,500 on $900,000 = 9.17%
Applying the DTA, the tax rate charged on Mainland company on the royalty by Hong
Kong profits tax is restricted to 7% of the gross income, i.e. $900,000 x 7% = $63,000
(not $82,500)
The Hong Kong payer is required to deduct $63,000 only from the remittance made
to Company A.
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
Example 2
Company B, a resident of the Mainland, derives from Hong Kong royalties (hire
income of machinery) of $900,000 in the year ended 31.3.2018.
After deducting allowable expenses and depreciation allowance in respect of the
equipment:
 Assessable profits is $350,000
 Profits tax payable is $350,000 x 16.5% = $57,750
 The effective tax rate of assessable profits of $57,750 on $900,000 = 6.42%
As the effective tax rate on gross income is 6.42% which is lower than 7% the tax
payable remains $57,750, and unaffected by the 2007 DTA.
Article 13 – Capital gains
a. General principle
Article 13 states that gains derived by a resident of One Side from the alienation
(“disposal”) of immovable property and situated in the Other Side may be taxed
in that Other Side.
b.
Disposal of ships, aircraft or land transport vehicles
Gains derived by an enterprise of One Side from the disposal of ships or aircraft
or land transport vehicles operated in shipping, air and land transport or
movable property pertaining to the operation of such ship, aircraft or land
transport vehicles, is taxable only in that Side.
c.
Disposal of shares of a company mainly holding immovable property
Gains derived from the disposal of shares in a company the assets of which are
comprised, directly or indirectly, mainly of immovable property situated in One
Side may be taxed in that Side. Paragraph 105 of the DIPN 44 specifies that 50%
is the benchmark in determining whether the assets of a company comprised
“mainly” of immovable property.
d.
Disposal of shares not holding 50% immovable property as its assets
Gains derived from the disposal of shares, other than the shares of a company
the assets of which are comprised, directly or indirectly mainly of immovable
property situated in One Side, of not less than 25% of the entire shareholding of
a company which is a resident of One Side may be taxed in that Side.
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ACY4401 Advanced Taxation Lecture 3
International aspects of current Hong Kong Taxation law and practice
Article 14 – Income from employment
a. General principle
Income derived from an employment by a resident of One Side is taxable only in
that Side unless the employment is exercised in the Other Side. If the
employment is exercised at the Other Side, the remuneration derived from
employment may be taxed in that Other Side.
b.
183-day rule of exemption
Remuneration derived by a resident of One Side in respect of an employment
exercised in the Other Side is taxable only in that One Side if all the following
three conditions are satisfied:
i.
the recipient is present in the Other Side for a period or periods not
exceeding in the aggregate 183 days in any 12-month period
ii.
iii.
commencing or ending in the taxable period concerned; and
the remuneration is paid by, or on behalf of, an employer who is not a
resident of the Other Side; and
the remuneration is not borne by a permanent establishment which the
employer has in the Other Side.
Article 15 – Directors’ fees
Directors’ fee and other similar payments derived by a resident of One Side in his
capacity as a member of the board of directors of a company which is a resident of
the Other Side may be taxed in that Other Side. In other words, directors’ fee is not
chargeable to tax twice. The fee is only chargeable at the place where the company is
a resident.
Article 16 – Artistes and sportspersons
Income derived by a resident of One Side as an entertainer, such as a theatre, motion
picture, radio or television artiste, or a musician, or as a sportsperson, from his
personal activities as such exercised in the Other Side, may be taxable in that Other
Side. The 183-day rule of exemption for employment does not apply to entertainer
or sportsperson.
Article 17 – Pensions
Pensions and other similar remuneration (whether a payment in lump sum or by
instalments) paid to a resident of One Side in consideration of past employment are
taxable only in that Side (unless the pension is a public or a government or a
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International aspects of current Hong Kong Taxation law and practice
government approved or recognised pension). In other words, the pension is taxable
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according to the resident status of the recipient.
Article 20 – Other income
Income of a resident of One Side, wherever arising, not dealt with in the other
Articles of the DTA is taxable only in that Side.
Article 21 – Methods of elimination of double taxation
a. General principle
Amount of tax credit available for set-off
The amount of Hong Kong income tax paid by a Mainland resident is allowed as
a credit against Mainland income tax imposed on that resident. Similarly, the
amount of Mainland income tax paid by a Hong Kong resident is allowed as a
credit against Hong Kong income tax imposed on that resident. However, the
amount of tax credit is not to exceed the amount of home place income tax
payable in respect of such income.
b.
Nature of tax credit
Before a tax credit is allowed, the taxpayer has to prove to the satisfaction of
the IRD that the tax has been paid and the tax so paid is not subject to any
further adjustment.
c.
Time for making a claim for tax credit set-off
A taxpayer may submit a claim for a tax credit within 2 years after the end of the
relevant year of assessment.
Example 3
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International aspects of current Hong Kong Taxation law and practice
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Article 23 – Mutual agreement procedure
Any difficulties or doubts arising as to the interpretation or application of the DTA are
to be resolved by the competent authorities of the Mainland and the HKSAR.
Article 24 – Exchange of information (“EOI”)
Article 24 allows taxation authorities of both Sides to exchange such information as is
necessary for carrying out the provisions of the China-HK DTA or of the domestic laws
of both Sides concerning taxes covered by the China-HK DTA.
This Article requires the contracting parties, upon receiving a request for
information, to exchange tax information foreseeably required for applying the
China-HK DTA or the domestic law, even where the requested party does not need
such information for its own tax purposes. The previous version of the EoI clause only
allowed tax information to be exchanged where it related to the administration of
taxes under the domestic law of the jurisdiction in which it was requested.
Both parties are obliged to keep the information received confidential and can only
disclose the information to persons involved in the assessment and determination of
tax, including courts and state departments of administration.