Issue 23 - November 2008
Tax notes

On 21 August 2006 the Hong Kong Special Administrative Region (HKSAR) and Mainland China (the Mainland) signed an Arrangement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (DTA). The DTA entered into force on 8 December 2006.

Second Protocol to the DTA – After the DTA became effective a number of  areas were identified where the possibility existed for the authorities in the HKSAR and the Mainland to  have conflicting interpretations. Accordingly, in September 2007 the Tax Authorities of the two jurisdictions entered into successful negotiations to resolve a number of these issues. These changes are set out in the Second Protocol to the DTA which was formally signed on 30 January 2008 and which came into effect on 11 June 2008. The Second Protocol deals with interpretations regarding a permanent establishment under Article 5 of the DTA and Capital Gains under Article 13 of the DTA. The Second Protocol includes  transitional arrangements to facilitate the alignment of the interpretations, and detailed advice should be taken on the implications of the Second Protocol and the DTA.

The main provisions of the DTA are set out below.

In the HKSAR the DTA applies to Profits Tax, Property Tax and Salaries Tax, whether or not charged under Personal Assessment. 

The DTA applies to persons who are residents in either or both of Hong Kong and the Mainland. For Hong Kong this means that it applies to any person who is resident in Hong Kong for the purposes of Hong Kong taxation. A "person" for this purpose includes a company.

Article 4 of the DTA contains the following definitions of a Hong Kong resident:

Individual – (a) any individual who ordinarily resides in the HKSAR in any year of assessment; or (b) any individual who stays in the HKSAR for more than 180 days in a year of assessment or more than 300 days in two consecutive years of assessment, one of which is the relevant year of assessment.

Company – a company incorporated in the HKSAR or, if incorporated outside the HKSAR, is "normally managed or controlled" in the HKSAR.

Resident of mainland China is defined in Article 4 as any person who under the laws of the Mainland is liable to tax in the Mainland by reason of his domicile, residence, place of head office, place of effective management or any other criteria of a similar nature. "This term, however, does not include any person who is liable to tax in the Mainland China in respect only of income from sources in the Mainland."

A Permanent Establishment (PE) is defined in Article 5 as a "fixed place of business through which the business of an enterprise is wholly or partly carried on". Under Paragraph 3(2) of Article 5 the provision of services in the Mainland by an employee for a period or periods of more than "six months within any twelve month period" would constitute the establishment of a PE in the Mainland. Prior to the implementation of the Second Protocol the Mainland Tax Authorities treated months as the counting unit and counted any month in which services were rendered as a full month for this purpose, even if
services were provided for only one day. Following the adoption of the Second Protocol, the Mainland Authorities will follow the internationally accepted test of "183 days in any twelve month period".

This is a significant change and detailed advice should be sought in this area as previously a PE could be deemed to have been established in the Mainland through the provision of limited services by an employee of a Hong Kong resident company.

The main provisions regarding the taxation of income under the DTA are:

	Income from immovable property will be taxed in the jurisdiction in which the property is situated.
	Business profits – A Hong Kong company which derives profits in the Mainland will be subject to tax only in the HKSAR unless it carries on business in the Mainland through a permanent establishment on the Mainland, in which case it may be subject to tax in the Mainland on the profits attributable to the permanent establishment.
	Shipping, air and land transport – Income or profits derived by a Hong Kong enterprise from the operation of ships, aircraft or land transport vehicles in shipping and land transport in the Mainland shall be exempt from tax in the Mainland (including Business Tax).
	Interest income will be taxable in the country in which it is received. Under Hong Kong's territorial system interest income with a Mainland source will not be subject to tax in Hong Kong. However, such income suffers Mainland withholding tax on the payment. Under the DTA this withholding tax will be reduced from 10% to 7% of the gross interest.
	Royalties are taxed in the recipient country. Under the DTA the rate of withholding tax in the Mainland on royalties paid from the Mainland to a Hong Kong recipient will be reduced from 10% to 7% of gross royalties.
	Under the DTA the maximum rate of withholding tax on royalties paid by a Hong Kong company to a recipient in the Mainland is 7% of the gross amount of the royalty.
	Dividends – Where a Mainland company pays dividends to a Hong Kong resident the Mainland may apply a withholding tax on the payment of such dividends as follows:
	i.	where the beneficial owner is a company owning directly at least 25% of the Mainland company which pays dividends the withholding tax is 5% of the gross amount of the dividends
	ii.	in any other case the withholding tax is 10% of the gross amount of the dividends.
	Employment income received by a HKSAR resident may be subject to tax in the Mainland if the employment is exercised in the Mainland unless the employee is not present in the Mainland for periods of more than 183 days in a twelve month period and the remuneration is paid by or on behalf of an employer who is not a Mainland resident and the remuneration is not borne by a PE of the  employer in the Mainland.
	Director's fees will be taxed in the jurisdiction in which the company paying the director's fees is resident.
	Capital Gains – a HKSAR resident may be subject to tax in the Mainland in respect of gains received in respect of:
	(a)	the alienation of moveable business property of a permanent establishment in the Mainland
	(b)	the alienation of shares in a company where the assets are composed, directly or indirectly, mainly of immoveable property situated in the Mainland.
	(c)	The alienation of shares (other than (b) above) of not less than 25% of the entire shareholding of a company resident in the Mainland.
	The Second Protocol has clarified that, with respect to (b) above, from 11 June 2008, in considering whether a company's assets are composed mainly of immovable property the tax authorities will refer to the accounts of the company for the three financial years before the sale of shares took place. If the value of immoveable property did not represent 50% of the assets at any time in those three years the gain on the alienation of the shares is not subject to tax in the Mainland under this classification. For the alienation of shares prior to 11 June 2008 the test is whether immoveable property composed 50% or more of the assets of the company at any time prior to the alienation.
	The Second Protocol also clarifies the calculation of the 25% shareholding in (c) above. Previously the Mainland Tax Authorities had interpreted the reference to a 25% shareholding to mean that, if a Hong Kong resident held 25% or more of the shares in a Mainland Company at any time, the alienation of any part of the shareholding was taxable in the Mainland. For alienation of shares after 11 June 2008 the Second Protocol will mean that the Mainland Authorities accept that a Hong Kong resident will only be subject to Mainland tax if he held 25% or more of the shares of the company at any time during the twelve months prior to alienation.
	Elimination of Double Taxation – where income is subject to tax in both the Mainland and the HKSAR, the DTA provides for relief to reduce or eliminate the double taxation. Hong Kong residents may use any Mainland tax paid on income as a credit to offset their Hong Kong tax liabilities on the same income. However the tax credit may not exceed the Hong Kong tax on that income.

There are exchange of information provisions in the DTA. Any information provided to the Authorities in the Mainland by the HKSAR Authorities under Article 24 of the DTA can only be used by the Mainland Authorities and cannot be disclosed to any other jurisdiction without the prior approval of 
the HKSAR Authorities.

The DTA offers a number of potential tax savings and, with the implementation of the Second Protocol, provides a greater degree of certainty for Hong Kong residents doing business in the Mainland, and 
should therefore be an important factor in considering investments in the Mainland by Hong Kong  residents.

　

Contact Information

Paul Chow
T  +852 2218 3188
E  paul.chow@gthk.com.hk　

Gary James
T  +852 2218 3137
E  gary.james@gthk.com.hk

David Southwood
T  +852 2218 3103
E  david.southwood@gthk.com.hk

Brenda Cheung
T  +852 2218 3136
E  brenda.cheung@gthk.com.hk

Mary Ho
T  +852 2218 3040
E  mary.ho@gthk.com.hk

Daisy Ip
T  +852 2218 3168
E  daisy.ip@gthk.com.hk

Winnie Tsui
T  +852 2218 3280
E  winnie.wy.tsui@gthk.com.hk

　

About Tax notes
Tax notes are issued in summary form exclusively for the information of clients and staff of Grant Thornton and should not be used or relied upon as a substitute for detailed advice. Accordingly Grant Thornton accepts no responsibility for any loss that occurs to any party who acts on the information contained herein without further consultation with ourselves.

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