||Ayesha Macpherson Lau
The Hong Kong government briefed the Legislative Council
Panel on Economic Development on January 23 2017 about a
proposed new tax regime for aircraft leasing in Hong Kong. This
development comes at an opportune time when, for example,
Boeing is forecasting global demand for 39,600 new airplanes
over the next 20 years, with 38% for Asia-based airlines, of
which 17% are for China.
Equity, bank and capital market debt, finance leases and
operating leases all underpin aircraft financing, with the
latter supporting one third of new deliveries globally.
Given the high level of Asia and China demand in the future,
Hong Kong, with its established financial and business
infrastructure, should be a natural venue for aircraft
While the Hong Kong tax regime has needlessly impeded the
development of the aircraft leasing business to-date, the new
proposals, alongside the continued expansion of Hong Kong's
double tax treaty network, have the potential to finally make
Hong Kong truly competitive in the global aircraft leasing
Hong Kong's tax regime
From a Hong Kong profits tax perspective, a lease agreement
will generally either be regarded as a "hire-purchase
agreement" or a "lease", i.e. an operating lease. The
accounting classifications of a finance lease or operating
lease does not determine the tax characterisation.
The Inland Revenue Ordinance (IRO) sets out rules for hire
purchase arrangements, under which the lease payment consists
of an interest component and the repayment in principal of a
deemed loan used to fund the purchase of the aircraft (the
amount of the loan is equivalent to the cost of the aircraft).
A Hong Kong company should be subject to Hong Kong profits tax
on the deemed interest payments to the extent that it is
sourced from Hong Kong and it is from a business carried by
that company in Hong Kong. With appropriate structuring, it
should be possible to ensure the Hong Kong lessor is not
taxable on the interest income.
More important for the leasing industry, however, are the
IRO's specific provisions governing the taxation of income from
an aircraft owning business, which include section 23C for
"resident" aircraft owners and section 23D for "non-resident"
aircraft owners. Resident aircraft owners are, under a complex
calculation termed the maritime formula, subject to tax on all
their rental income from chartering aircraft. In addition,
under section 39E, depreciation allowances are denied where the
aircraft is leased to a "non-Hong Kong operator" (i.e. a
non-Hong Kong headquartered airline).
The tax law in Hong Kong is a major impediment to the
development of aircraft leasing activity because it taxes the
full rental income while denying deductions for aircraft
depreciation. Ironically, Hong Kong has the most competitive
withholding tax rate for aircraft leases into China, but other
jurisdictions such as Ireland and Singapore are much more
attractive options overall with much lower effective tax
To make Hong Kong more competitive for operating leases, a
new set of tax rules for offshore aircraft leasing (i.e.
leasing to non-Hong Kong headquartered airlines) is being
proposed. The main features of the new regime are:
- The tax rate on the profits of "qualifying
aircraft lessors" and "qualifying aircraft leasing managers"
will be only 8.25% (i.e. one half of the normal Hong Kong
profits tax rate); and
- This reduced tax rate for lessors will be
applied to only 20% of the usual tax base (i.e. gross rentals
less deductible expenses, excluding tax depreciation).
Implicitly, this suggests a 1.65% tax rate on gross rental
income before deductions.
The new regime will contain anti-abuse features
- Measures to ensure that the concessions
will not apply where the rental payments are tax-deductible
in Hong Kong to the lessee;
- Requiring qualifying aircraft lessors and
qualifying aircraft leasing managers to be standalone
corporate entities. They must also conduct business
transactions with associated parties on an arm's length
- Imposing a substance requirement, by
stipulating that the central management and control of these
entities, as well as their profit generating activities, must
be located in Hong Kong.
The Hong Kong government proposes to introduce the necessary
legislation into the Legislative Council in April 2017.
The proposal to effectively allow tax depreciation through a
deemed profit of 20% of the net rental income is a simple
solution to what has been an intractable problem. In addition,
the tax rate concession is very attractive to leasing managers.
At face value, these proposals should make the Hong Kong tax
regime competitive globally.
As always, the "devil is in the detail", particularly around
the issue whether the overall economics will make sense
compared to operations in Ireland, Singapore and the special
free trade zone regimes in mainland China. Recent experience
with enhancements to concessionary regimes such as the expanded
offshore funds regime and corporate treasury centres, while
good proposals on paper, have proved to be less useful in
practice due to the overly complex anti-abuse measures.
Nonetheless these proposals are a step in the right
Khoonming Ho (email@example.com)
and Ayesha Macpherson Lau (firstname.lastname@example.org)
Tel: +86 (10) 8508 7082 and +852 2826 7165