Looking back, Hong Kong ended 2015 with the release of guidance from the Inland Revenue Department (IRD) on the tax treatment of court-free amalgamations in Hong Kong. This release was eagerly anticipated, but while it provided a clearer picture on how the IRD views court-free amalgamations in practice, it also highlighted conflicts in the interpretation of, and reconciliation with, universal succession concepts that are fundamental in amalgamation cases. These would need to be remedied through a formal legislative process.
Around the same time, the Hong Kong government introduced the Inland Revenue (Amendment) (No. 4) Bill 2015, formally introducing a concessionary profits tax rate for qualifying corporate treasury centres. Once enacted, the hope is that the measures will go towards promoting Hong Kong as a favourable location for multinational enterprises (MNEs) to establish their corporate treasury centres.
On a global level, Hong Kong has accepting the OECD's invitation to join in the Base Erosion and Profit Shifting (BEPS) movement, paving the way for the government to introduce legislation to strengthen transfer pricing regulations and curb treaty abuses. At the same time, Hong Kong continues to expand its treaty network with the conclusion of double tax treaties with Latvia and Russia.
Court-free amalgamation guidance
The concept of court-free amalgamations was introduced in March 2014 with the release of the new Companies Ordinance (Cap. 622). This development was welcomed by the business community, which saw these measures as a tool for efficient corporate acquisitions and restructuring exercises. However, two years since the release of the Companies Ordinance, there remains little guidance, legislative or otherwise, on how court-free amalgamations are treated for tax purposes.
The IRD's release in December 2015 of their views on amalgamation provisions was, therefore, eagerly anticipated by the business community and tax professionals alike. Although the guidance did not come in the form of an official departmental interpretation and practice note (DIPN), it is still a useful indication of how the IRD perceives that certain provisions of the Inland Revenue Ordinance (IRO) should apply to court-free amalgamations.
The main take-away from the IRD's guidance on court-free amalgamations is that the tax treatment of these transactions may not be the same as those that were applied in previous merger transactions undertaken in Hong Kong under private merger Ordinances. Further, the IRD also stated that the principles of universal succession will not be applicable for tax purposes. This conflicts with the widely-held belief that, since the court-free amalgamation rules in the Companies Ordinance were largely modelled on the Singapore and New Zealand corporate merger provisions (which are based on universal succession principles) the tax treatment of these transactions should thus follow in the same vein.
A notable example of the IRD's departure from the principles of universal succession is demonstrated in the treatment of carried forward tax losses post-amalgamation. Under the IRD's guidance, tax losses incurred by amalgamating companies before joining the same wholly-owned group as the amalgamated company (that is, the surviving company) cannot be utilised post-amalgamation. This clearly conflicts with the concept of universal succession, which envisages that the amalgamated company should merely "step into the shoes" of the amalgamating company, thus inheriting all of its tax attributes.
In addition to this, it is arguable that some of the rules in the IRD's guidance extend beyond the provisions of the IRO as it stands today. It is clear that the intention behind the tax loss rules in the IRD's guidance is to safeguard against situations where amalgamations are carried out wholly or substantially for the purposes of utilising tax losses. In other words, situations that would otherwise be caught by the anti-avoidance provisions in sections 61A and 61B of the IRO. However, in arbitrarily denying the utilisation of losses merely due to the timing of when the losses were incurred, the IRD's rules become arguably more restrictive than the anti-avoidance provisions, which would still allow the losses if it can be demonstrated that the amalgamation was not carried out for the purpose of utilising tax losses.
Although the guidance released by the IRD provides insight into the direction the authorities are heading towards when it comes to implementing the court-free amalgamation provisions, it also highlights gaps in legislation that would need to be remedied.
In the coming year, we look forward to the government filling in these gaps, either through legislation or formal guidance in a DIPN.
Developing Hong Kong as a treasury centre
Following the government's announcement in 2015 on measures to develop Hong Kong into a corporate treasury centre, draft legislation was introduced in December 2015 setting out the main features of the corporate treasury centre (CTC) rules that included:
- A concessionary rate of tax for qualifying CTCs on certain income;
- A deemed deduction for interest paid on intra-group lending; and
- A deeming provision for interest income and other gains on certain intra-group lending regardless of how the arrangement was entered into or where the loan funds were provided.
A qualifying CTC is a corporation that has either:
- Carried out only corporate treasury activities in Hong Kong during the year of assessment (i.e. a treasury CTC);
- Satisfied defined safe harbour rules (i.e. a safe harbour CTC); or
- Has obtained the Commissioner of Inland Revenue's discretionary consent (i.e. a discretionary CTC).
Corporate treasury activities are defined as, and generally involve, making loans, providing corporate treasury services and undertaking corporate treasury transactions to, and in respect of, associated entities.
The concessionary rate of tax is 8.25%. The effect of the second and third features of the CTC rules is to deem certain interest expenses and income, which would ordinarily be considered non-deductible/no-taxable under the offshore sourcing concepts, as deductible and assessable for Hong Kong tax purposes. Although the deeming provisions on interest deductions is a positive development for Hong Kong taxpayers, given current potential mismatches in the treatment of interest on cross-border lending and borrowing transactions, the deemed interest income rules gives rise to concerns as they may have an impact on financing arrangements already in place.
In addition to concerns regarding the interest deeming provisions, there are also uncertainties as to how the qualifying conditions will be applied. Under the draft legislation, it appears that a separate legal entity must perform qualifying treasury centre activities in order to qualify as a CTC. This would mean that the many existing entities in Hong Kong that operate corporate treasury activities in a separate division may need to restructure their operations in order to qualify as a CTC.
Notwithstanding these uncertainties and concerns, the CTC framework is still a positive step towards drawing corporate treasury centres to Hong Kong, especially in light of the greater scrutiny placed on intragroup financing activities resulting from the OECD's BEPS initiatives.
The rules should be further refined and drafted in consultation with industry and the business experts in order to produce a CTC regime that offers the right levels of incentives.
BEPS plan gains momentum in Hong Kong
On the global stage, the BEPS initiatives are gaining momentum and the movement has hit Hong Kong's shores.
In 2016, the Hong Kong government accepted an invitation from the OECD to join the BEPS project as an "associate", committing itself to the comprehensive package of reforms proposed by the organisation.
As a priority, Hong Kong will be implementing the following four action points with agreed minimum standards:
- Action 5: harmful tax practices and spontaneous exchange of information;
- Action 6: anti-treaty abuse;
- Action 13: country-by-country reporting (CbCR); and
- Action 14: improvements in cross-border tax dispute resolution.
The immediate priorities for the Hong Kong government will be to introduce a more comprehensive transfer pricing regime with specific documentation rules and to increase scrutiny on related-party transactions in IRD audits and investigations. On the treaty shopping front, the simplified limitation of benefits rule and the principle purpose test are likely to be incorporated into all of Hong Kong's future tax treaties.
In line with this, a public consultation paper was released on October 26 2016. Among others, the most significant proposals were to:
- Codify the transfer pricing rules into tax legislation and to extend the transfer pricing regime to cover financial and business arrangements;
- Mandate the preparation of transfer pricing documentation based on Action 13. This means that companies must prepare a master file and a local file where they meet two of the following criteria – annual revenues exceeding HK$100 million ($13 million), assets exceeding HK$100 million and a workforce exceeding 100 employees. Companies with consolidated group revenues of more than €750 million ($795 million) will be required to prepare a country-by-country report;
- Provide for the exchange of country-by-country reports with jurisdictions with which Hong Kong has a double tax treaty in force;
- Implement an OECD-coordinated multilateral instrument and amend double tax treaties to counter the use of hybrid entities and hybrid instruments and to strengthen treaties against the avoidance of tax. Hong Kong will adopt a principal purpose test under which benefits of a tax treaty cannot be obtained if one of the principal purposes of the transaction or arrangement is to obtain the benefit;
- Introduce legislation to formalise mutual agreement procedures and mandatory arbitration to resolve treaty disputes and to provide for the spontaneous exchange of certain information with tax treaty partners; and
- Extend the time period for claiming tax credits from two years to six years.
How all the pieces will fall into place after the implementation of the BEPS recommendations will depend on the details in the resulting legislation, but the Hong Kong government has stated that it will strive to maintain a simple, neutral and highly transparent tax regime. At the very least, for the international taxpayer, this means that robust transfer pricing support and documentation are becoming more important in a climate of increasing scrutiny of related-party transactions.
Structures will need to be reviewed for sustainability and future tax planning structures should be future-proofed as best as possible, taking into consideration the anti-treaty abuse measures.
Expanding the treaty network
Along with adopting the BEPS measures, Hong Kong is continuing to build on its international profile by expanding its tax treaty network. In 2016, it concluded double tax treaties with Latvia and Russia.
The conclusion of the treaty with Latvia is representative of Hong Kong's efforts to build relations with economies along the Belt and Road. Hong Kong was previously listed on Latvia's list of low-taxing jurisdictions. Under the agreement, dividend and interest withholding tax rates are capped at 10% (compared with the maximum Latvian domestic withholding tax rate for dividends at 30% and interest at 15%). In addition, withholding tax on royalties are capped at 3% (compared with the maximum Latvian domestic withholding tax rate of 23%).
Withholding rates under Hong Kong's agreement with Russia are capped at 10% for dividends (compared to the Russian domestic withholding tax rate of 15%), 0% for interest (compared to the Russian domestic withholding tax rate of 20%), and 3% for royalties (compared to the Russian domestic withholding tax rate of 20%).
Negotiations are continuing with India, Pakistan, Turkey, Germany and Cyprus, among other jurisdictions.
In 2015, various announcements were made by the government on Hong Kong's future. In 2016, the future started to become clearer as Hong Kong works towards clarifying and implementing previously announced measures.
Clarifications from the IRD on its view of the court-free amalgamation provisions shed some light on an issue where guidance was previously absent. However, it remains to be seen whether these views will eventually translate into legislation or a DIPN.
Draft legislation introducing the CTC rules is another welcome step towards making Hong Kong an attractive location for corporate treasury centres. For the remainder of 2016 and possibly well into 2017, consultations will continue in order to refine the rules. These rules come at an opportune time as the BEPS movement increases scrutiny on intra-group financing measures.
On the BEPS front, Hong Kong's entry into the BEPS movement is likely to gather momentum in the immediate future. Any future policies and measures enacted by the government are likely to be heavily influenced by BEPS.
Ayesha Macpherson Lau
8th Floor, Prince's Building
Ayesha Macpherson Lau is the partner in charge of tax services in Hong Kong and the partner in charge of the Hong Kong market. 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 has extensive experience advising multinational clients in various industries on local and regional tax implications of international group transactions and structures. She also has extensive experience in tax audit cases.
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 Hong Kong branch of the International Fiscal Association and a member of the joint liaison committee on taxation. She was the chairman of the executive committee of the Hong Kong Institute of Certified Public Accountants' taxation faculty and its former taxation committee.
Ayesha is passionate about community service and has been appointed by the Hong Kong SAR government as a member of various advisory bodies. She is currently a member of the council of the Hong Kong University, Legal Aid Services Council, Public Service Commission, the standing committee on judicial salaries and conditions of service, the policy research committee of the Financial Services Development Council, and the financial infrastructure sub-committee of the exchange fund advisory committee.
Ayesha was appointed as a justice of the peace on July 1 2013. She is a member of the Hong Kong Institute of Certified Public Accountants and the Institute of Chartered Accountants in England and Wales.
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Darren Bowdern is a partner in KPMG's Hong Kong tax practice. For more than 20 years, he has been involved in developing appropriate structures for investing into the Asia Pacific region, tax due diligence reviews in connection with M&A transactions and advising on cross-border transactions. 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. He also advises on establishing direct investment, private equity and other investment funds in Hong Kong.
Senior Adviser, Tax
8th Floor, Prince's Building
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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Curtis Ng joined KPMG's Hong Kong office in 1995 and became a tax partner in 2006. He is the head of real estate of the 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 experience 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 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 committee of the HKICPA. Curtis is also a certified tax adviser (Hong Kong).
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