Hong Kong: Concessionary tax regimes introduced for ship leasing activities
Lewis Lu and John Timpany of KPMG analyse the proposed concessionary tax regimes for qualifying ship lessors and leasing managers.
The Hong Kong SAR Government gazetted the Inland Revenue (Amendment) (Ship Leasing Concessions) Bill 2020 on January 17 2020, which formally introduces a concessionary tax regime for certain ship leasing activities. The bill is subject to approval by the Legislative Council and is expected to apply to income earned from April 1 2020. The main features of the proposed regime are:
Income from ship leasing and managing a ship leasing business carried on from Hong Kong SAR will be deemed taxable. For ship leasing, the taxable amount will include interest received under a funding or finance lease;
The taxable income for qualifying lessors from operating leases will be calculated as 20% of the gross rentals (including sums payable under residual value guarantee) less deductible expenses, excluding tax depreciation;
The taxable income for qualifying lessors from funding leases will be calculated as gross finance income (i.e. interest) under the lease less deductible expenses;
The tax rate on the profits of “qualifying ship lessors” will be 0%; and
The tax rate on the profits of “qualifying ship leasing managers” conducting “qualifying ship leasing management activities” will be 0% where services are provided to an associate and 8.25% (i.e. half the normal tax rate) where those services are provided to a non-associate.
The rules are closely modelled on the aircraft leasing concession although there are important differences in the scope and application of the two regimes. The regime is designed around a Hong Kong SAR based manager using separate Hong Kong SAR incorporated special purpose companies to own and lease ships for use outside Hong Kong SAR waters. While it should be possible for lessors to adopt a more integrated model with ship ownership and management in one company, it will be important that any corporations looking to take advantage of the new regime take careful note of the qualifying conditions imposed.
“Qualifying ship lessors” and “qualifying ship leasing managers” as defined in the bill must be corporations that conduct only qualifying activities, with some non-qualifying activity allowed for leasing managers. This precludes the regime applying to taxpayers who conducted passenger or cargo shipping businesses. For both the manager and lessors, they are required to be centrally managed and controlled in Hong Kong SAR with all the profit generating activities conducted in Hong Kong SAR and not attributable to any permanent establishment the company may have outside Hong Kong SAR. They must also make an election in writing to apply the regime.
There is a deeming provision that deems a ship to be a capital asset if it is held for three years as part of a qualifying ship leasing business. This is a welcome addition because it provides some clarity to the position when a ship is sold. For a ship sold before the three-year mark, the position will depend on the relevant facts and circumstances.
There is a safe harbour for qualifying ship leasing managers which allows them to carry on certain non-qualifying activities, provided at least 75% of its profits arise from qualifying activities and the value of assets used by the company to carry out qualifying activities are at least 75% of its total assets.
Common with all of Hong Kong SAR’s latest concessionary regimes there are several complex anti-abuse and anti-avoidance measures built into the regime. The key measures include rules to:
Require that any transactions between associated parties are conducted at arm’s length;
Require that certain substance threshold requirements be met;
Ring-fence losses sustained where the qualifying lessor or qualifying lease manager qualify for the 0% tax rate; and
Deny the benefit of the relevant concessions where one of the main purposes of an arrangement is to obtain a tax benefit including a benefit under one of Hong Kong SAR’s double tax treaties.
In order to qualify for the tax concessions, the taxpayer must meet the substance threshold requirement, namely: (a) have an adequate number of full-time employees; and (b) adequate operating expenditure:
For ship leasing activity, the number of full-time employees is two and the minimum operating expenditure is HK$7.8 million ($1 million);
For ship leasing management activities, the number of full-time employees is at least one and the minimum operating expenditure is HK$1 million.
The new regime is a change to Hong Kong SAR tax law in that it now provides a tax concession to ship leasing managers and for finance leasing, which has been potentially uncertain if key activities are conducted in Hong Kong SAR. The proposed tax regimes should bolster Hong Kong SAR’s position as a ship leasing centre in the Asia-Pacific region.
For operating leases, section 23B of the Inland Revenue Ordinance has, for many years, been understood to apply to mean that charter hire income arising from the use of ships solely or mainly outside Hong Kong SAR waters was effectively not taxed. Only a recent change in the Inland Revenue Department’s assessing practice has created uncertainty in this regard. That said, the regime provides certainty going forward.
Given the relative complexity of the regime and the need for sufficient substance in Hong Kong SAR, companies looking to apply the regime should review the rules, their ship ownership structures and business operations carefully.
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