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DTAs and Islamic bonds in Hong Kong

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A focus on Hong Kong's network of double taxation agreements (DTAs) and why it wants an Islamic bond market.

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Hong Kong continues to enhance its network of comprehensive double taxation agreements (DTA) with the signing of an agreement with Malaysia in April 2012. Hong Kong has now concluded 24 agreements and is in the process of negotiating agreements with a further 11 countries.

Furthermore, in March 2012, the DTA with Indonesia entered into force and will have effect in Hong Kong for years of assessment commencing on or after December 31 2013. The DTA with Indonesia potentially makes Hong Kong one of the more attractive locations for investing into Indonesia. Hong Kong''s DTA with Indonesia provides for a withholding tax rate of 5% on dividends and royalties and either 5% or 10% for interest. These rates compare favourably with Singapore and the Netherlands.

The DTA between Hong Kong and Indonesia also provides a complete exemption from withholding tax on capital gains derived from private share transfers, subject to certain limitations.

Investors wishing to rely on the agreement will need to ensure that they have sufficient substance in Hong Kong to benefit from the agreement. Furthermore, an area of uncertainty remains on the application of the reduced withholding tax rate for dividend income. For the reduced withholding tax rate of 5% or 10% to apply, Indonesia requires that the income must be subject to tax in the other jurisdiction. As dividends are not subject to tax in Hong Kong, it remains unclear whether the reduced withholding tax could apply to dividends. It is understood that the Hong Kong Inland Revenue Department has sought clarification from their counterparts in Indonesia on this aspect, and we await the outcome of these discussions.

Provided these uncertainties are resolved, Hong Kong should be well placed to become the preferred investment location for investment into Indonesia.

Islamic bonds

In March 2012, the Hong Kong government launched a two month consultation on proposed amendments to the Inland Revenue Ordinance and Stamp Duty Ordinance to promote the development of an Islamic bond market in Hong Kong. This policy initiative was first articulated by the Chief executive, Donald Tsang, in his policy address in 2007 and most recently by the Financial Secretary, John Tsang Chun-wah in the Hong Kong Budget for 2012-13.

The consultation demonstrates Hong Kong''s commitment to ensuring that it has the legal and tax framework required to support the development of Islamic financing in the region. Against a background of an ever increasing demand for Islamic financing products from both investors and borrowers, it is essential that Hong Kong provides an efficient platform to promote the sector in the region. To do this, Islamic financing products have to be treated the same as more conventional forms of financing. Introducing such rules will reinforce Hong Kong''s position as an international finance centre.

Ayesha Lau (ayesha.lau@kpmg.com) & Darren Bowdern (darren.bowdern@kpmg.com)

KPMG

Tel: +852 2826 7166 & +852 2826 7165?

Website: www.kpmg.com

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