Hong Kong: Hong Kong’s latest tax updates
In January 2018, a tax bulletin was published on the annual meeting held between the Hong Kong Inland Revenue Department (IRD) and the Hong Kong Institute of Certified Public Accountants (HKICPA). The annual meeting covers a wide range of topics and is a discussion on practical matters raised by practitioners on which the IRD provides clarification. Some of the key Hong Kong tax issues discussed included the following.
Offshore bond funds
Offshore funds, even if they are managed in Hong Kong, are exempt from Hong Kong tax in respect of profits derived from specified transactions, provided that the trading receipts from incidental transactions do not exceed 5% of the total trading receipts from both specified and incidental transactions.
Given that many bond funds' primary source of income in any tax year is interest income, the funds would likely exceed the 5% threshold and the interest income would be subject to tax in Hong Kong.
In order to boost the attractiveness of Hong Kong's fund management industry, the HKICPA expressed concern that many bond funds may be subject to tax in Hong Kong and asked whether the IRD would consider adopting a more liberal interpretation or consider expanding the definition of 'specified transactions'.
The IRD explained that the interpretation has been in line with the law since it was enacted in 2006. Interest on securities was derived from holding the securities rather than from a transaction in securities and interest could only be considered as derived from incidental transactions and not specified transactions. The IRD reiterated that it would be difficult to provide a definition of 'incidental transactions' that could cover all business operations adopted by various offshore funds. Therefore, the buying and selling of a bond was generally treated as a specified transaction while the payment and receipt of interest income from such a bond would be an incidental transaction to a specified transaction. The IRD confirmed that the existing interpretation of specified and incidental transactions would remain unchanged and there were no plans to expand the list of specified transactions.
Offshore private equity (PE) funds exemption
Similar to bond funds, the exemption status of the PE fund can be tainted if they undertake any non-specified transactions in the year of assessment. For example, where an offshore PE fund invests in a number of overseas private companies and one of these companies fails to qualify as an excepted private company (EPC), investing in the shares of that EPC which failed to qualify would taint the investments of that fund's entire investment portfolio.
The HKICPA raised a concern over an uncertainty whether any transactions in an overseas private company that is not an EPC by a special purpose vehicle (SPV) of an offshore fund would taint the exemption of other SPVs owned by the same fund. The IRD explained that an offshore fund would not be tax exempted if it invested in an overseas private company which failed to qualify as an excepted private company, whether held directly or indirectly through an SPV.
Although the HKICPA has expressed concerns over the strict application of the tainting rules in Hong Kong compared to Singapore, the IRD indicated that it would not be relaxing the tainting rules.
The new Hong Kong Financial Reporting Standard (HKFRS) 16 will be effective for annual periods beginning on or after January 1 2019. Entities may apply for early application subject to certain conditions.
Under the new HKFRS 16, depreciation of the leased assets (right-of-use assets) and interest on lease liabilities will be charged to the lessee's profit and loss account. The HKFRS 16 has also eliminated the classification of a lease by the lessee as an operating or finance lease. All leases were treated similar to a finance lease under Hong Kong Accounting Standard (HKAS) 17 and will be also under HKFRS 16.
The IRD confirmed it would review the legal form and substance of the relevant lease agreements in order to determine the tax treatment of the lease payments. Where lease payments are incurred for the use of a leased asset, the lessee should be entitled to tax deductions in respect of the lease payments, irrespective of the accounting treatment.
Hong Kong salaries tax
Certain Hong Kong salaries tax issues were also discussed in the 2017 annual meeting between the IRD and HKICPA. These included:
Conditions for qualifying as a Hong Kong resident individual under a comprehensive double taxation agreement (CDTA); and
Whether the source of locality of an employment would be affected merely by way of employers or employees observing local laws and regulations.
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