Hong Kong: China clarifies beneficial ownership requirements – how this impacts Hong Kong

April 30, 2018

The long awaited Announcement 9 has been released by the State Administration of Taxation of China (SAT). Effective from April 1 2018, Announcement 9 replaces Circular 601 and Announcement 30, both of which are key circulars setting out the rules for foreign investors claiming tax treaty benefits on their Chinese-sourced dividends, interest and royalties (passive income).

Announcement 9 provides additional guidance for taxpayers to determine their beneficial ownership (BO) status for the purpose of obtaining tax treaty benefits under China's double tax agreements (DTA). The issue of Announcement 9 demonstrates the SAT's commitment to preventing tax treaty abuse by implementing BEPS Action 6 recommendations.

The key changes to the BO analysis are:

Extended safe harbour rules (Announcement 30);
Same jurisdiction rules for treaty benefits; and
Changes to the existing negative factors (Circular 601)

The extended safe harbour rules and same jurisdiction rules for treaty benefits applies only to dividends, while the negative factors in determining the BO status apply to passive income.

These changes provide foreign investors who hold investments in Hong Kong via China with more flexibility in obtaining tax treaty benefits on their Chinese-sourced dividend income. However, foreign investors should ensure that any Hong Kong holding companies are not established for the primary purpose of obtaining a tax benefit under the Hong Kong – China DTA, otherwise, the general anti-avoidance rules or DTA principal purpose test could be invoked.

It also remains to be seen whether the Hong Kong tax authorities would issue Hong Kong tax residence certificates to the immediate DTA relief claimant where the commercial and operating substance of other group companies can be 'shared' under the same jurisdiction/same treaty benefit rule.

Hong Kong and India sign a comprehensive double taxation agreement

On March 19 2018, Hong Kong signed a comprehensive DTA with India. The DTA will come into force when both jurisdictions have completed their formal ratification procedures.

The key features of the DTA include:

Interest income will be subject to 10% of the gross interest subject to satisfying beneficial owner requirements. Certain interest income may be exempt from tax if the beneficial owner is a government, political subdivision or a local authority;
Similarly, royalties may be subject to 10% of the gross royalty income, subject to satisfying beneficial owner requirements; and
Any other income derived in India will be subject to tax in India.

For capital gains, the DTA unfortunately does not confer any specific exemption for most capital gains on Hong Kong residents investing in India. Such gains will continue to be taxed in accordance with Indian domestic tax law.

The signing of the Hong Kong – India DTA has been highly anticipated and is a welcome addition to Hong Kong's tax treaty network. Overall, it should provide foreign investors with greater tax certainty on the Indian tax treatment of certain income. However, the limited exemption from Indian tax on capital gains is disappointing.