As part of Hong Kong's participation in the OECD's BEPS project, the government plans to implement legislation by the end of 2017 to introduce transfer pricing rules into Hong Kong's tax law. These rules will largely resemble the OECD's transfer pricing guidelines. In addition, Hong Kong has entered into the MLI. This was signed by the China government on behalf of Hong Kong. Local ratification of the MLI is expected in 2018.
Separate from BEPS, the Inland Revenue Department (IRD) has clarified the concessionary tax treatment of corporate treasury centres and regulatory capital securities, following feedback from various industry bodies, by issuing administrative guidance in the form of Departmental Interpretation and Practice Notes (DIPNs).
Towards the end of 2015, the Hong Kong government announced it was looking to enhance Hong Kong as a centre for aircraft leasing. After much consultation with industry bodies and various interest groups, a new tax regime for aircraft leasing legislation was enacted in July 2017. The previous tax rules had effectively blocked any use of Hong Kong as an aircraft leasing centre with respect to foreign airlines.
Multilateral instrument (MLI)
On June 7 2017, with 67 other jurisdictions, Hong Kong joined the MLI. Hong Kong submitted a list of 36 comprehensive double taxation agreements (DTAs) that it designated as its covered tax agreements (CTAs) to be amended through the MLI mechanism. (The tax arrangement between Hong Kong and mainland China was not included and is expected to be updated through bilateral negotiations in due course.)
The positions taken by Hong Kong with respect to the MLI provisions are shown in Table 1.
|Article||Hong Kong’s position|
|Article 3 – Hybrid mismatches||Hong Kong did not apply this to its CTAs|
|Article 4 – Dual resident entities||Hong Kong did not apply this to its CTAs|
|Article 5 – Application of methods for elimination of double tax treaties.||Hong Kong did not apply this to its CTAs.|
|Article 6 – Purpose of a CTA||Hong Kong applied this to its CTAs (with an exception with respect to its CTA with Belarus which already contains the relevant preamble language).|
|Article 7 – Prevention of treaty abuse||Hong Kong specifically opted to apply the principal purpose test (PPT) but not a limitation of benefits test (with exceptions with respect to its CTAs with Belarus and Pakistan that already contain such provisions).|
|Article 8 – Dividend transfer transactions||Hong Kong did not apply this to its CTAs.|
|Article 9 – Capital gains from alienation of shares or interests of entities deriving their value principally from immovable property||Hong Kong did not apply this to its CTAs.|
|Article 10 – Anti-abuse rule for permanent establishments (PEs) situated in third jurisdictions||Hong Kong did not apply this to its CTAs.|
|Article 11 – Application of tax agreements to restrict a party’s right to tax its own residents||Hong Kong did not apply this to its CTAs.|
|Article 12 – Artificial avoidance of PE status through commissionaire arrangements and similar strategies||Hong Kong did not apply this to its CTAs.|
|Article 13 – Artificial avoidance of PE status through the specific activity exemptions||Hong Kong did not apply this to its CTAs.|
|Article 14 – Splitting up of contracts||Hong Kong did not apply this to its CTAs.|
|Article 15 – Definition of a person closely related to an enterprise||Hong Kong did not apply this to its CTAs.|
|Article 16 – Mutual agreement procedures (MAP)||Although Hong Kong’s CTAs already contain MAP provisions, it agreed to supplement these provisions.|
With the global BEPS programme, transfer pricing (TP) has become a key focus. Traditionally, Hong Kong has taken a 'light touch' with respect to transfer pricing regulation, using IRD guidance rather than specific legislation.
The Hong Kong government published a consultation paper on BEPS in October 2016, and subsequently released a consultation report summarising the responses on July 31 2017. Following this process, the government announced that it will introduce comprehensive transfer pricing rules and a TP documentation regime that will be largely based on the OECD's three-tier approach (including a master file and local file) and is likely to be introduced from the 2018/19 year of assessment.
The key points from the latest consultation report include:
- The proposed thresholds for enterprises to prepare master and local files will be based on: (i) the size of business; and (ii) the quantum of related party transactions. This should relieve the administrative burden for smaller taxpayers.
- Purely domestic transactions between Hong Kong entities will be covered by the new transfer pricing regime.
- Penalties for incorrect tax returns prepared using non-arm's-length pricing will be the same as those that apply for under-reporting in other tax contexts. This means that a penalty could amount to up to 300% of the tax undercharged where the taxpayer acted without reasonable excuse.
The government plans to introduce a bill to codify the new TP rules by the end of 2017, with enactment likely in the earlier part of 2018.
Aircraft leasing regime
To put Hong Kong on the global stage as an aircraft leasing jurisdiction, a tax incentive for this industry was enacted on July 7 2017. This became effective on April 1 2017.
The main benefits of the aircraft leasing concessions are as follows:
- An effective tax rate of 1.65% will be levied on profits earned by 'qualifying aircraft lessors'. This rate is achieved by applying one half of the normal tax rate of 16.5% to 20% of the gross rental receipts less deductible expenses, but excluding tax depreciation;
- A concessional 8.25% tax rate will apply to profits from 'qualifying aircraft leasing management' activities.
To be a qualifying lease, the lease should satisfy the following conditions:
- It must be a dry lease (i.e. a lease having a term of more than one year under which the lessor is not responsible for the airworthiness of the aircraft and does not employ any member of the crew);
- It must not be a (i) funding lease, (ii) hire purchase agreement, nor (iii) conditional sale agreement. This means the lease must neither contain a purchase option nor an arrangement under which title to the aircraft might pass to the lessee.
The definition of 'qualifying aircraft leasing management activities' is wide. It includes standard lease management activities such as procuring and leasing aircraft, a range of financing activities such as providing loans to associated companies to acquire the aircraft, providing loans to airlines to acquire the aircraft from qualifying lessors, providing residual value guarantees, etc.
To benefit from these tax concessions, 'qualifying aircraft lessors' and 'qualifying aircraft leasing managers' must not be aircraft operators (e.g. airlines), and must conduct only qualifying activities (although leasing managers can conduct some non-qualifying activities). They must be centrally managed and controlled in Hong Kong, with all of their profit generating activities conducted in Hong Kong.
The IRD will clarify uncertain issues in an upcoming DIPN. These include the ability to obtain a tax residency certificate, utilising foreign tax credits in Hong Kong and other corporate structuring and operational issues.
Regulatory capital securities (RCS)
Amendments enacted on June 3 2016 clarified the tax treatment of RCS. The IRD issued DIPN 53 – Tax Treatment on Regulatory Capital Securities – in February 2017 to provide guidance on the application of these new rules.
To satisfy the revised regulatory capital standards as prescribed by the Third Basel Accord published by the Basel Committee on Banking Supervision, financial institutions may issue qualifying RCSs to meet the requirements for classification as Common Equity Tier 1, Additional Tier 1 and Tier 2 capital under the Banking (Capital) Rules or under the equivalent laws or regulatory requirements of another member jurisdiction of the Basel Committee.
Broadly, RCS that satisfy the prescribed conditions (subject to certain specific anti-avoidance provisions) will be treated as follows for Hong Kong tax purposes:
- RCS will be treated as debt securities;
- Distributions (excluding any paid-up capital) made by the issuer on the RCS will be treated as interest;
- Gains and losses in respect of RCS will not be treated as trading gains/losses (and therefore will not be taxable/deductible); and
- No Hong Kong stamp duty is payable on the purchase and sale of RCS.
Corporate treasury centres
Specific tax concessions were introduced in 2016 for corporate treasury centres. Broadly speaking, this refers to a corporation that is centrally managed and controlled in Hong Kong and which carries on qualifying activities in Hong Kong. Those activities include carrying on an intra-group financing business, providing corporate treasury services or entering into corporate treasury transactions.
Where these conditions are met, the corporate treasury centre will be taxed at a concessional tax rate of 8.25% on its qualifying profits.
Interest deduction relief for intra-group financing activities
New provisions in 2016 provide for interest paid by a corporation that carries on a business of intra-group financing, where the interest is paid to an associated overseas corporation, to be tax deductible in certain circumstances.
To explain this, generally, interest paid to an entity that is not a financial institution is not deductible in Hong Kong (unless the lender is subject to Hong Kong profits tax on such interest). This new provision therefore expands the ability of a corporation, which carries on an intra-group financing business, to obtain a deduction for the interest it pays to offshore related parties.
The condition for deductibility is that the lender must be subject to tax in its own jurisdiction at the statutory tax rate equal to Hong Kong's own 16.5% rate (or 8.25% if the borrower qualifies for the corporate treasury centre concession described in the previous section).
In DIPN 52, the IRD clarified that a corporation will be treated as carrying on an intra-group financing business if it satisfies the following conditions:
- The corporation has four or more borrowing and lending transactions per month;
- Each of these borrowing and lending transactions exceed HK$250,000 ($32,000); and
- Lending and borrowing transactions are conducted with four or more associated corporations during the relevant year.
That being said, failure to meet these benchmarks does not necessarily mean that the corporation is not carrying on an intra-group financing business.
The requirement for the lender to be taxed in its own jurisdiction has been clarified in DIPN 52. The IRD states that this condition will not be satisfied where:
- The gross interest income of the lender is not taxable due to utilisation of tax losses or having direct expenses, ultimately resulting in the interest not being chargeable to tax; or
- The lender has tax losses that partially offset its taxable profits.
While the Hong Kong taxpayer may not be required to provide tax returns or tax computations of the overseas lender to claim this interest deduction, DIPN 52 requires it must have a reasonable degree of certainty that the tax payment has been or will be made by the overseas lender. The IRD may request documentation of the lender if it challenges the interest deduction.
Open-ended fund companies
On June 28 2017, a bill was introduced to provide a tax exemption to privately offered Hong Kong open-ended fund companies (OFCs), which are essentially mutual fund companies. The existing proposal is that three broad conditions will need to be satisfied at all times by the OFC to qualify for the exemption:
- The OFC must be resident in Hong Kong (i.e. its central management and control must be exercised in Hong Kong);
- The OFC must not be closely held; and
- The OFC must predominantly carry out transactions in specific asset classes.
To be regarded as 'not closely held', the requirements are as follows:
- The OFC is required to have a minimum of at least 10 non-qualified investors and the participation interest of each of these investors must exceed HK$20 million; or, if the OFC has one qualified investor, it must have five investors in total (including non-qualified investors). The participation interest of the non-qualified investors must exceed HK$20 million, and of qualified investors must exceed HK$200 million;
- The participation interest of non-qualified investors must not exceed 50% of the OFC's issued capital; and
- The participation interest of the originators and their associates must not exceed 30% of the OFC's issued capital.
The bill is still going through the legislative process.
Direction of Hong Kong's new administration
A new chief executive took office on July 1 2017. She has signalled that tax reform will be a priority in her agenda. Tax policy, and how it can be used to grow Hong Kong's economy, will likely take on a central role in her administration. Some new tax policy initiatives have already been announced, including:
- A two-tier profits tax rate. The first HK$2 million of profits of a group will be taxed at 8.25% (with the remainder subject to tax at 16.5%); and
- A super deduction for research and development expenditure. A 300% deduction will apply for the first HK$2 million of such expenditure, and 200% thereafter.
Harmful tax practices
As part of the OECD's and EU's initiatives regarding harmful tax practices, a number of Hong Kong's tax regimes have been identified as constituting harmful tax practices. These include the concessions for corporate treasury centres, offshore reinsurance and captive insurance. Any necessary changes will likely be implemented during 2018.
|Ayesha Macpherson Lau|
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Ayesha Macpherson Lau is a partner with KPMG China and the managing partner in Hong Kong. She has been a specialist in the tax field for more than 20 years, initially with KPMG in London before joining KPMG in Hong Kong.
Ayesha is a regular speaker and writer on tax matters and is the co-author of "Hong Kong Taxation: Law and Practice" (Chinese University Press), a leading textbook on Hong Kong taxation.
Ayesha is the chairman of International Fiscal Association Hong Kong Branch and a member of the joint liaison committee on taxation. She was the chairperson of the HKICPA's taxation faculty executive committee and its former taxation committee.
Ayesha has been appointed by the Hong Kong SAR government as a member of various advisory bodies. She is the chairman of the joint committee on student finance and a non-executive director of the Mandatory Provident Fund Schemes Authority. She is also a member of the Council of the University of Hong Kong, the Public Service Commission, the Legal Aid Services Council, the financial infrastructure sub-committee of the exchange fund advisory committee and the policy research committee of the Financial Services Development Council.
Ayesha was appointed as a Justice of the Peace on July 1 2013 and an accounting adviser of the Chinese Ministry of Finance in May 2016.
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Darren Bowdern is the head of alternative investments and head of financial services in KPMG's Hong Kong tax practice. For more than 20 years, Darren has been involved in developing appropriate structures for investing into Hong Kong, mainland China and the Asia Pacific region.
Darren's extensive experience includes cross-border buy- and sell-side M&A tax services (e.g. tax due diligence and tax vendor due diligence), tax structuring, tax planning and optimisation and international corporate tax issues, restructuring and optimisation. Many of these projects comprise tax effective regional planning including consideration of direct and indirect taxes, capital and stamp duties, withholding taxes and the effective use of double taxation agreements.
Darren is also a regular speaker and writer on private equity related tax issues, and advises on establishing direct investment, private equity and other investment funds in Hong Kong and in the Asia Pacific region. He also advises on structuring tax efficient performance and co-investment arrangements for private equity funds, as well as effective remuneration and employment arrangements.
Darren is a member of the technical committee of the Hong Kong Venture Capital Association (HKVCA), a member of the tax committee of the Alternative Investment Management Association (AIMA), the chair of the finance, legal and tax committee of the Australian Chamber of Commerce and deputy chair of the Australian Chamber of Commerce in Hong Kong (AustCham).
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Michael Olesnicky is an Australian and US-trained lawyer who left legal practice and joined KPMG in Hong Kong in 2015. Michael's practice focuses on corporate tax and tax dispute work, as well as wealth management and estate planning matters. He has been the chairman of the joint liaison committee on taxation, which is a quasi-governmental committee which interfaces between tax practitioners and the Hong Kong Inland Revenue Department, from 1986 to now. He formerly served on the Hong Kong Inland Revenue Board of Review. He has served on a number of governmental and quasi-governmental tax committees in Hong Kong, and was previously a member of the law faculty at Hong Kong University where he remains as an honorary lecturer in the Department of Professional Legal Education.
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With more than 20 years of experience in KPMG's tax practices in Hong Kong and New Zealand, John Timpany provides the full range of tax assistance and advice to multinational companies across the Asia Pacific region and beyond. A number of John's clients use Hong Kong as the location for their head office and John advises these organisations on managing their tax affairs regionally and globally.
His role involves advising on issues relevant to the establishment and restructuring of investment holding and operating structures for companies operating in diverse industries and countries. John has extensive international merger and acquisition experience and is seasoned in advising clients in a wide variety of industries, including, financial services, consumer markets, telecommunications, real estate, transportation and logistics.
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Curtis Ng is the head of tax in Hong Kong. He joined KPMG's Hong Kong office in 1995 and became a tax partner in 2006. He is also the head of real estate of our Hong Kong office.
Curtis is well versed in the complexities of delivering compliance and advisory services to multinational clients in various sectors. His experience includes a depth of expertise in cross-border business activities, and coordination and liaison with specialists to provide the most efficient and effective services.
Curtis received his BSSc degree in economics. He is an associate member of the Hong Kong Institute of Certified Public Accountants (HKICPA) and the Taxation Institute of Hong Kong. He is the vice chairman of the executive committee of the taxation faculty and a member of the tax specialisation development working group of the HKICPA. Curtis is also a Certified Tax Adviser (Hong Kong).
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