Hong Kong has adopted the territorial source principle of taxation – that is, only profits that have a source in Hong Kong are taxable in Hong Kong. Profits sourced elsewhere are in general not subject to tax.
Several countries that implement the principle of levying tax on income earned worldwide offer unilateral tax exemptions to citizens who operate a business in Hong Kong, and if they have paid taxes on their profits or income sourced in Hong Kong, these taxes can be set off against their taxes payable in their home country. With respect to profit on which tax is payable in Hong Kong, the government of the Hong Kong Special Administrative Region (SAR) also allows, based on the turnover principle, tax reductions or exemptions for profits on which tax has been paid in another country.
In short, companies operating in Hong Kong basically need not worry about double taxation, although in certain circumstances some may run into trouble. Uncertainty in taxation is, and has always been, an obstacle to business expansion.
Benefits of tax agreements
“For investors, double taxation agreements clearly define the taxation rights of the parties to the agreement,” said Simon Galpin, director-general of investment promotion at Invest Hong Kong. “With a double taxation agreement, investors can better evaluate the potential tax burden for any economic activity and it is conducive to encouraging foreign companies to develop their business in Hong Kong – and it benefits Hong Kong companies that wish to develop abroad.”
A consistent policy of the Hong Kong SAR government has been to develop a network of double taxation agreements with other economic jurisdictions so as to reduce the possibility of Hong Kong residents, and residents of contracting parties, having to bear a double tax burden.
In general, double taxation agreements are formulated with reference to the Organisation for Economic Co-operation and Development’s Model Double Taxation Convention on Income and on Capital, and clearly set out the allocation of taxing rights between the two jurisdictions, as well as the relief on tax rates on different types of income.
When executing double taxation agreements, Hong Kong adopts the internationally recognised data exchange principle, which also helps to emphasise Hong Kong principles of transparency in taxation, as well as the SAR’s support for the international community’s efforts in increasing transparency in taxation.
The 24 trading partners that have executed double taxation agreements and arrangements with Hong Kong, as at 30 April 30, are: mainland China, Austria, Belgium, Brunei, the Czech Republic, France, Hungary, Indonesia, Ireland, Japan, Liechtenstein, Luxembourg, the Netherlands, New Zealand, Spain, Thailand, the UK, Vietnam, Jersey*, Kuwait*, Malaysia*, Malta*, Portugal* and Switzerland (* denotes agreements that were not yet effective). Countries and regions currently negotiating such agreements include: Bangladesh, Canada, Finland, Guernsey, India, Italy, South Korea, Macau, Mexico, Saudi Arabia and the United Arab Emirates.
Understanding tax burden
Hong Kong’s double taxation agreements with the Netherlands and Luxembourg attracted Benelux law firm Loyens & Loeff to set up an office in Hong Kong to look after its businesses in the Greater China region.
“The bilateral treaties between the jurisdictions bring certainty in taxation issues, which is an important factor in investment decision making, and an important consideration for our clients,” Carola van den Bruinhorst, a partner at Loyens & Loeff, said. “Outside Benelux, we have 12 offices worldwide … The Hong Kong office’s role is to look after the Greater China region.”
Forms of transport
Section 8 of the Inland Revenue Department’s Double Taxation Arrangement between Hong Kong and mainland China expressly provides that the income and profits derived by an enterprise of one side (i.e. a mainland enterprise or a Hong Kong enterprise) from the operation of ships, aircraft or land transport vehicles in shipping, air and land transport may be exempted from tax by the other side, except when the ship, aircraft or land transport vehicle is operated solely between places within the other side. The terms income and profits refer to the income and profits derived by an enterprise from engaging in cross-border shipping, air or land transport. If the cross-border services provided in the other side, from which the income and profits are derived, are provided by a permanent establishment established in the other side, no tax exemption will be available from the other side. This provision also applies to income and profits derived from participation in partnership businesses, joint venture businesses or international business agencies.
Problems for airlines
As the operations of airline companies are international, they face more double taxation issues than other industries. As the negotiation and execution of comprehensive double taxation agreements require a considerable amount of time, the Hong Kong government and other airline partner countries will frequently strive, when negotiating and executing bilateral air services agreements, to add the conditions under which airline profits can avoid being subject to double taxation in the agreement.
As to the shipping industry, Hong Kong has amended its ordinances and implemented mutual tax exemptions on shipping income since 1 April 1998, enabling shipping enterprises to benefit from the tax relief offered under similar laws of other countries. Furthermore, Hong Kong is actively seeking to execute double taxation agreements that address shipping income with two types of countries: countries that have not implemented mutual tax exemptions on shipping income; and countries that have passed relevant legislation but wish to have a bilateral agreement to define the right of taxing shipping income. Additionally, there are other agreements that address the airline and shipping industries.
Matt Hu is the head of North China investment promotion at InvestHK, a department of the Hong Kong SAR Government
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