Double Tax Treaties Between Hong Kong And Mainland China

The development of the global economy would be seriously affected if the profits from cross-border investment were subject to double tax. Treaties between nations aim to avoid double-taxation. There are a plethora of similar agreements in Hong Kong.

These agreements have strengthened Hong Kong’s position as Southeast Asia’s economic center and have aided in removing tax obstacles that restrict cross-border commerce, investment, technological know-how, and expertise between Hong Kong and the rest of the globe.

Hong Kong may use the abbreviation Hong Kong, China to sign its own double taxation treaties with the rest of Mainland China. There are no double taxation treaties that apply to Hong Kong since only mainland taxes are included in these agreements.

The Mainland will not enforce a double taxation agreement between Mainland China and Hong Kong because of the promise in Basic Law sections 106-108 that Hong Kong would be allowed to retain an autonomous taxation system until 2047.

What does the word “Double Taxation” mean?

For example, a person who lives in two different countries may be taxed on the same amount of money by two different taxing authorities – one in their home country and one in the source country. This is known as a source-residence dispute and is the most prevalent cause of double taxation.

To avoid double taxation, most countries have enacted domestic legislation or signed bilateral double taxation agreements (DTAs) that provide for some sort of relief from double taxes.

Do you know about the Double Tax Agreement?

DTAs are bilateral agreements that aim to remove the practice of taxing individuals in two nations on the same source of income. It is the primary goal of a DTA to alter the taxation rights of the two countries that signed it. Domestic law is often overridden by DTAs.

Advantages of Double Tax Agreements

Here are a few of the benefits of double taxation:

• It is evident from DTAs how the money will be divided and how taxes will be levied in each country. Furthermore, the jurisdictional power of transnational commerce is defined by DTAs.
• By obtaining a DTA, taxpayers in one nation are able to determine the extent of their tax liability in the other country.
• DTAs improve the integrity of a country’s tax system and prevent tax evasion by providing a framework for sharing information between revenue authorities.
• If you paid taxes in another country, you might claim a deduction on your DTA return.

The Double Tax Treaty between Hong Kong and China

In order to avoid double taxes on income, the Hong Kong Special Administrative Region and the People’s Republic of China struck an agreement. Trade and commercial ties between the two areas are bolstered by this tax arrangement, which is favorable to international investors.

Treaty sets favorable rates for withholding tax, income tax, and other taxes on earnings. You may rely on attorneys in Hong Kong whether you’re a Chinese investor who wants to launch a Hong Kong enterprise or the other way around.

The Chinese and Hong Kong government reached an agreement to prevent double taxation in August 2006, intending to give investors and taxpayers in both countries confidence regarding their tax liability and tax savings.

The new agreement was signed by State Administration of Taxation Minister Xie Xuren on behalf of the Central Government and by Chief Executive Donald Tsang, Financial Secretary Henry Tang, and Secretary for Financial Services & the Treasury Frederick Ma.

Both sides signed an agreement on business profits and revenue from personal services in 1998, but the agreement has since been expanded to avoid double taxation on earnings.

The new agreement includes both direct and indirect income, such as operating earnings and employee income. As a result, no one’s earnings will be subjected to double taxation.

As a result of the change:

• Mainland dividend withholding tax rates for Hong Kong residents have been reduced from 20% to 10%, while rates for Hong Kong enterprises that receive dividends have been slashed from 10% to 5% for those companies that own at least 25% of the Mainland company’s capital. Foreign investment in Hong Kong will rise as a result of this.
• Top withholding tax rates for interest a Hong Kong resident gets from the Mainland have dropped from 20% to 7%; those for a Hong Kong firm have also dropped from 10% to 7%.
• The top withholding tax rates for Hong Kong residents and businesses that receive royalties from the Mainland were decreased from 20% and 10% to 7%. Both in the industrial sector and Hong Kong’s arts community, this will help foster new ideas and approaches.
• Hong Kong residents and businesses have the unique right to tax any profits they make from selling shares in a Mainland company. For non-trading or non-Hong Kong-based income, no Hong Kong-based profit tax will be imposed in Hong Kong. It is possible to be taxed in two locations if the Mainland company’s assets are mostly immovable property on the Mainland or its transferred shares are equal to or exceed 25% of the Mainland company’s ownership. Tax credits prevent the same income from being taxed more than once.

With this agreement, Hong Kong’s Inland Revenue Department and the State Administration of Taxation may share data and carry out their respective obligations. However, by international norms, communication is restricted to guarantee that taxpayer information is not misused.

Fifth Protocol to Avoid Double Taxation between the Mainland and Hong Kong

To avoid a double taxation arrangement (DTA) between Hong Kong and China’s Mainland, the Fifth Protocol came into force on December 6, 2019. Mainland China’s provisions apply to income earned during a fiscal year beginning or after January 1, 2020, while Hong Kong’s provisions apply to income earned during a fiscal year beginning or after April 1, 2020.

With the Fifth Protocol, many of the key elements of the OECD’s Base Erosion and Profit Shifting (BEPS) effort are formally included in the DTA. Overall, BEPS aims to reduce the potential for aggressive tax avoidance across jurisdictions while also bringing international taxation into line so that, to the greatest extent possible, business profits and other income are taxed in the authority where they were in substance economically generated.

In addition, it includes measures for teachers and researchers, which allow for an explicit taxation scheme for emoluments earned by academics working in both countries.

The DTA’s preamble and beneficiaries’ rights

The Fifth Protocol alters the DTA’s Preamble, which now states that the agreement’s goal is to strengthen economic connections between Hong Kong and the Mainland and to improve tax cooperation.

The Fifth Protocol further indicates that the DTA strives to resist double non-taxation and treaty abuse, reflecting the effect of Hong Kong’s adoption of the Multilateral Convention to Implement Tax Treaty Related Measures to Protect BEPS on June 7, 2017.

The “principal purpose test” (PPT) is a new provision in Article 24A of the DTA that addresses this issue. Suppose all relevant facts and circumstances are taken into account. In that case, it is fair to assume that any arrangement or transaction which results directly or indirectly in the receipt of such advantage had the primary intention of gaining this benefit, which is prohibited under PPT.

That general restriction is subject to proving that giving the treaty benefit in conformity with the goal and purpose of the relevant provisions of the DTA is still permitted.

Readers should keep in mind that the DTA now has a general anti-avoidance, or more precisely, anti-abuse provision. This means that tax planning that relies on the DTA to get treaty advantages may need to be revisited after the Fifth Protocol comes into effect.

Establishment for the long term

The Fifth Protocol has made it easier to have a permanent establishment (PE). If an individual is acting in one jurisdiction on behalf of an organization that is based in another, and in doing so, they regularly make commercially important contracts, or they play the main role in making these contracts happen, and these contracts are:

• in the company’s name; or
• when property held by or authorized for use by that business is being transferred or granted a right to utilize it;
• for the company’s supply of services,

In this case, the company will be considered to be a PE. This is a major shift from the long-held belief that a non-resident firm must have a physical presence in order to qualify as a PE. Consequently, a PE on the Mainland will most likely be a Hong Kong business with mainland agents who are either authorized to bind their Hong Kong principle to commercial contracts or who otherwise do so de facto with limited oversight from the principal.

This is why the Fifth Protocol changed the concept of “independent agent,” which previously did not constitute a PE, to exclude agents that work entirely or mostly exclusively for more than one business if those businesses are closely connected. For the purpose of avoiding being considered a PE, this clause is an anti-fragmentation measure.

Resident

For non-individuals who are treaty residents of both China and Hong Kong, the DTA previously stated that the location where its effective management is located constituted a tiebreaker. The current position is that both countries must agree on how to apply the tiebreaker, taking into account variables such as where a taxpayer’s place of effective management is, where it was incorporated or formed, and any other relevant considerations.

Taxpayers are not eligible for any treaty benefit unless and until the competent authorities of both countries have agreed on how and to what degree they are entitled. The absence of an automatic tiebreaker means that the administrative practices of both the Hong Kong Inland Revenue Department (IRD) and the Chinese State Taxation Administration (STA) would play a more significant role in the provision of treaty relief.

There has been no publication of detailed processes or specifics about how the mutual agreement will function in practice by either the IRD or the STA as of this publication.

Teachers and researchers

Teaching or research is defined as someone who works for a university or college in Hong Kong or China as well as for a government-recognized academic research institution in both jurisdictions under Article 18A of the Fifth Protocol.

During the first three years following the date of their initial arrival in the other jurisdiction for the purpose of teaching or conducting research at a university or other government-recognized institution, a teacher or researcher who is a resident of one authority but travels to another for these purposes is exempt from taxation in the other jurisdiction.

Suppose his compensation is paid by the school, university, or institution where he worked in his jurisdiction of origin and is liable to taxation there. A Hong Kong resident teacher who is hired by a Hong Kong school and goes to Guangzhou to teach will not be subject to Chinese tax if the following conditions are met:

• This person can receive their salary from the Hong Kong school, and
• They are subject to Hong Kong taxation on that salary.

Teachers, professors, and researchers in the Great Bay Area should be encouraged to move about more freely, thanks to Article 18A and other local tax advantages. Although Hong Kong taxes on wages are territorial, a Hong Kong resident teacher who only lives on the Mainland may have trouble proving that they are still taxed in Hong Kong in certain cases.

It is also not possible to profit from Article 18A if the study or teaching being done is largely for the private advantage of an individual or individuals rather than in the general public’s interest.

Capital Gains

When a partnership or trust’s interests are sold, the DTA now treats them as “interests equivalent to shares” for purposes of Article 13’s applicability (Capital Gains). Because more than 50% of partnership assets are attributable directly or indirectly to Mainland property at any time prior to the transfer, Hong Kong tax residents who sell their partnership interest in an English partnership will be taxed on any gains they make from selling their interest, regardless of where they are located.

DTAs are beneficial to whom?

Under the DTAs, people who are both Hong Kong residents and non-residents of the contracting nations are eligible for income tax reduction. To qualify for relief, a company must be registered in Hong Kong and have its management and control based in Hong Kong.

The phrase “Hong Kong resident person” applies to the following individuals:

• It is defined as a person who lives in Hong Kong most of the time, i.e. (s)he has an ancestral home or habitual abode there.
• A person who spends more than 180 days in Hong Kong during the relevant year of evaluation.

If a firm meets the following criteria, it is considered a Hong Kong resident:

• It is based there or has its headquarters in Hong Kong.
• Even though it is based outside of Hong Kong, its operations are overseen and managed from Hong Kong.

Contents of Hong Kong’s DTAs

Despite the fact that Hong Kong’s DTAs are individually negotiated and have particular conditions that may change from one nation to another, there are certain common characteristics that a typical DTA would address:

DTA’s Purpose:

Only Hong Kong residents and the treaty countries may benefit from this arrangement. In most cases, proof of residency is necessary. Residents of any nation are not subject to DTAs.

Taxes that are included in the DTA:

Income and property taxes are often subject to the DTA.

Permanent Establishment (PE) definition:

Determining what constitutes a “PE” is critical since company earnings attributed to a PE as defined in domestic law are subject to taxation in that jurisdiction. Profits may be traced back to the presence of a PE, which serves as an indicator of corporate success.

A PE is a physical location where a company’s operations are conducted in whole or in part. Included in this are a company’s main office and all of its branches and sub-branch locations, as well as any of these locations’ individual buildings or parts of a building’s physical structure that will take more than a year to complete.

Dividend income:

According to domestic tax laws, dividend income might be taxed in the source nation (i.e., where the firm that paid the dividend is based). In addition, the income is subject to taxation in the nation of residence (i.e., the country in which the recipient receives the dividend income). Generally, dividend withholding taxes are lower in the nation of origin.

As long as a country’s domestic tax law levies dividend income, the government has the power to tax the distribution of those funds. Even though the DTA authorizes Hong Kong to apply a dividend tax, no duty is payable since the city-state does not tax dividends.

The domestic tax rules of the treaty countries and what the treaty states will determine whether the dividend income is taxable in that country.

Interest:

A lower withholding tax rate for interest is common in the nation where the interest income is generated (source country). The lower tax rate relies on the agreement between the two jurisdictions.

Royalties:

Royalty income is taxed differently in various nations due to the diversity of the DTAs that have been signed.

Employment-related income:

Employees in Hong Kong can get taxed on their income from work if they work there. But if they don’t work there for more than 180 days in a tax year, if their employer is from the contracting country, or if they don’t work for an employer from the contracting country, they can’t get taxed on their income.

Directors’ fees:

Suppose a resident of one nation receives directors’ fees from a business based in another country while serving as the director of that company. In that case, the directors’ fees are subject to taxation in the country where the company providing the payments is located. In the case of domestic taxes, there is no tax exemption or reduction in the standard deduction. Thus the full domestic tax rate would apply.

Profits from flights or shipments:

Profits made by a firm in one nation that originate in another country are normally free from taxation. Only the nation in which the company has its primary place of business will impose a tax on it. Any profit generated by a Hong Kong-based airline or shipping business in China will be taxed only in Hong Kong. It is not subject to Chinese taxation.

Business profits:

Only the nation in which a business has a physical presence is allowed to tax the company’s earnings. The company is also subject to tax in the contractual nation if it does business there via a PE located in that country. Taxes are only levied by contracting countries on profits made by a PE-based in the contracting nation itself.

Right to tax gains:

The right to tax earnings from the transfer of immovable property and gains from the sale of shares differs depending on DTAs signed with various nations.

Government payments:

In Hong Kong, the government of a contracting country does not have to tax any compensation for personal services given to individuals who work in Hong Kong on behalf of that state and only has to pay taxes in the country where the compensation was provided.

Immovable property income:

Taxes are often levied on income generated by real estate in the nation where the property is located.

Tax credit:

As part of the credit system, the international tax paid by a taxpayer is credited against his domestic tax on that income.

Methods for reducing Hong Kong’s double taxation

There are two ways to alleviate double taxation agreements: via the country’s internal tax legislation or through a particular DTA agreement. Double taxation agreements may be avoided in four different ways.

Tax credit relief:

A taxpayer’s international tax is credited against his domestic tax under the credit system. The home jurisdiction is obligated to award a tax credit for taxes paid in the source jurisdiction under the credit method. That is to say, the tax paid in the place of origin must be deducted from the tax due on the same income in the place of residency. The credit may only be used to offset the tax owed on such income in the jurisdiction where you live.

Tax exemption:

Foreign income is free from domestic taxation under the tax exemption method. The foreign income might be excluded in whole or in part. This kind of tax relief lowers the tax rate on income such as interest, dividends, and royalties.

Relief by deduction:

• After the foreign tax has been deducted, domestic tax is applied to the foreign income.
• By allowing for a tax credit, Hong Kong has been able to avoid paying taxes twice.

Tax Treaties in Hong Kong

40 double taxation agreements have been signed by Hong Kong, which are divided into the following groups:

• A bilateral agreement that gives protection from double taxation for all kinds of income. Hong Kong has signed DTAs with Belgium, China, Thailand, Vietnam, and Luxembourg at this time.
• Airlines and shipping revenues are covered under DTAs. Currently, Hong Kong has agreements in place with Sri Lanka and Singapore about airline and shipping profits.
• DTAs that exclusively cover airline income. In addition to the countries listed above, Hong Kong has also signed agreements with countries such as Belgium and Canada, as well as countries such as Bangladesh, Croatia, Denmark, Estonia, Ethiopia, Korea, Fiji, Finland, Iceland, Germany, Israel, Jordan, Kenya, Sweden, Kuwait, Laos, Mainland of China, Maldives, Mauritius, New Zealand, Mexico, Netherlands, Macau SAR, Norway, Seychelles, Switzerland, Russian Federation, and the United Kingdom.
• DTAs simply cover the revenue from shipment. Shipping income treaties have been signed between Hong Kong and Denmark, Germany, Holland, Norway, and the United Kingdom.
• Hong Kong has signed agreements to share tax information with Denmark, the Faroe Islands, Greenland, other Nordic countries, and the United States.

Conclusion

The Fifth Protocol brings new obstacles and possibilities for cross-border tax planning for both corporations and individuals. As a result, it is recommended that you speak with your tax and legal professionals to learn more about the consequences of your present arrangements in Hong Kong and the Mainland.