The Fourth Protocol has clarified five areas of the China- HK Tax Treaty, which we will summarize in the following sections. We will also highlight the corresponding impact to Hong Kong, where applicable.
CLARIFICATION BY THE FOURTH PROTOCOL
1. Value Added Tax (“VAT”) exemption
The tax exemption application to income derived by a HK company from the provision of air, land and sea transport services in China has now expanded to cover VAT.
2. Withholding tax rate applicable to aircraft and shipping rentals
The withholding tax rate for rentals derived from business of aircraft or ship leasing is reduced from the current rate of 7% to 5%, which is the lowest withholding tax rate on royalties among China’s existing tax treaties.
This amendment may help in promoting the subject leasing business in Hong Kong and provide Hong Kong with another competitive edge.
3. Exemptions for capital gains
Gains derived by a Hong Kong resident from disposal of shares listed in a recognized stock exchange in China will be exempted from China tax, and vice versa, on condition that the shares are purchased and sold on the same stock exchange. Additionally, this exemption is still applicable to the Hong Kong resident under the situations where, within the stipulated time period, the disposed company’s assets comprise mainly (i.e. more than 50%) of immovable property in China, or the Hong Kong resident’s share-holding is greater than 25% of the disposed China company’s total equity. Without this exemption, the gain derived by the Hong Kong resident under either of these two situations will be liable to China tax.
The Fourth Protocol also clarifies that an investment fund established in Hong Kong can be treated as a Hong Kong resident eligible for the above relief treatment. Hong Kong resident investment fund is a fund which fulfills the following criteria:
- A fund established under the laws of Hong Kong, which is registered with and monitored by the Hong Kong Securities and Futures Commission (“SFC”);
- The fund manager should be a Hong Kong incorporated company and the fund is managed pursuant to the SFC regulations; and
- More than 85% of the fund’s capital should be raised through the Hong Kong market. (Note)
Note: A fund’s capital will be regarded as being raised through the Hong Kong market if its capital is raised through the following ways:
- Listed and traded in the Hong Kong Stock Exchange;
- Sold or allotted via financial institutions with operating substance in Hong Kong;
- Sold or allotted directly to investors in Hong Kong; or
- Other arrangements mutually agreed by the China and Hong Kong in-charge authorities.
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Readers may recall that in November 2014, China offered similar exemption benefits in connection with the Shanghai-Hong Kong Stock Connect Programme (“the Programme”). After all, the above clarification may be viewed as a reinforcement of the special tax treatments offered for the Programme, and also strengthen the status of Hong Kong as the gateway for investing in PRC A-Shares.
4. Main objective test
The Articles in relation to the dividend, interest, royalties and capital gains in the China-HK Tax Treaty will not be applicable if the main objective for entering into the arrangement is to obtain the benefits in relation to these Articles.
Apparently, both China and Hong Kong are committed to fulfill their international obligation to meet global standards of enhancing tax transparency.
5. Exchange of information
The coverage of PRC taxes under the exchange of information Article in the China-HK Tax Treaty is now extended to VAT, Consumption Tax, Business Tax, Land Value Added Tax, and Real Estate Tax.
The Fourth Protocol will be effective upon completion of the ratification procedures and mutual notifications in writing of both China and Hong Kong.
The Fourth Protocol has offered unique tax treaty treatments which are not yet available in tax treaties between China and other countries meanwhile. Such benefits may reinforce Hong Kong’s position as the gateway of investing in China to a certain extent. On the other hand, investors should also bear in mind the main objective test therein before entering into cross border transactions between China and Hong Kong, or else the planned tax treaty benefits may not be achievable.