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SEPTEMBER 2007

New Double Taxation Arrangement between Hong Kong and Mainland China

On 21 August 2006, the Mainland government and the Hong Kong SAR government signed an "Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income" (the "New Arrangement").  The New Arrangement has strengthened Hong Kong's position as the best base for investments into China with agreement on no capital gain tax or no or reduced withholding tax on dividend, royalties and interest payments from Mainland China to Hong Kong.
 
The New Arrangement became effective on 8 December 2006 and will apply in the Mainland, to income derived in taxable years beginning on or after 1 January 2007, and in Hong Kong, in years of assessment beginning on or after 1 April 2007, in line with the respective taxable year of the Mainland and Hong Kong.

Main Differences between the New Arrangement and the 1998 Arrangement

The New Arrangement replaced the previous double taxation arrangement between the two jurisdictions in 1998 (the "1998 Arrangement").
 
It extended the 1998 Arrangement by broadening the coverage of income to include income from immovable property, transactions between associated enterprises, dividends, interest, royalties, capital gains, pensions and government services etc. The New Arrangement also has broader administrative provisions, e.g. exchange of information. 

Key New Provisions and Changes

Some key changes of the New Arrangement are :-

1. New Provisions regarding Capital Gains

If a Hong Kong resident company disposes of less than 25% of shareholding in a Mainland company, and the assets of the Mainland company are not comprised of mainly immovable property situated in the Mainland, any gain derived from the disposal will be tax exempt. Without such preferential treatment, the gain would be subject to a 10% withholding tax. 
 
It is noted that according to the PRC SAT Rules, as long as the Hong Kong seller has ever owned 25% or more interest in the Chinese company, any amount or percentage of gain will still be taxable in the Mainland.
 
Paragraph 2 of Protocol to the New Arrangement provides that the term "assets" shall mean the value of the assets, and the term "mainly" shall mean not less than 50%.
 
The PRC SAT Rules however have a broader interpretation : as long as there has ever been 50% or more of immovable property on the book value of the company, it will be deemed to be a company comprising of mainly immovable property in the Mainland; in which case, the preferential rate will not apply.
 
Nevertheless, the timeframe for "ever been" may be further discussed and agreed to between the Mainland and Hong Kong.

2. Withholding Tax
 
The New Arrangement also covers indirect income such as interest, dividends and royalties as follows :-

	Dividend	Royalty	Interest
China normal rate	0% or 20%	10%	10%
Hong Kong normal rate	Nil	5.25%	Nil
New Arrangement rate	5% or 10%	7%	0% or 7%

In general, Hong Kong investors are provided with preferential treatments through reduced withholding tax rates or a tax exemption.  For instance, interest and royalties income under the New Arrangement is subject to a 7% withholding tax as opposed to 10% for others not within the New Arrangement.
 
Article 9 of the New Arrangement defines "Associated Enterprises".  Related profits derived from any associated enterprises would not be treated differently from those obtained between independent enterprises.  Profits which, but for the association, would have been accrued, will be included in the enterprise for taxation purpose, hence, addressing the transfer pricing issue.

3. Income from Employment : the 183-days tax exemption rule

Under the New Arrangement, remuneration derived by a resident of one place (i.e. Hong Kong or Mainland) in respect of an employment exercised in the other place shall be taxable only in the first-mentioned place if all the following 3 conditions are met :-

It is noted that the "any 12-month period" basis has replaced the old "calendar year" basis provided in the 1998 Arrangement. With this change, it may be more difficult for tax resident of one place to claim tax exemption from the other place.

4.     Exchange of Information and others 

The Hong Kong Inland Revenue Department Practice Notes and the PRC SAT Rules
 
The Hong Kong Inland Revenue Department ("IRD") issued its Interpretation and Practice Notes No 44 ("DIPN No 44") on 29 December 2006 (and the DIPN No 44 (revised) on 26 April 2007) in relation to the New Arrangement. The DIPN No 44 states that if any inconsistency between the New Arrangement and the Inland Revenue Ordinance ("IRO") arises, the IRD will resolve the issue without violating the New Arrangement. If the New Arrangement and the IRO provide different benefits to a taxpayer, the one that provides a greater benefit to the taxpayer will prevail.
 
Similarly, the rules issued by the State Administration of Taxation of PRC on 4 April 2007 [Guoshuihan [2007] No.403] ("PRC SAT Rules") also offer the preferential treatment to taxpayer in case there is difference in the New Arrangement and Chinese domestic tax law.

Our Services
 
If you have any question about the above Double Taxation arrangement or issues relating to structuring investments or mergers and acquisitions in Mainland China, experienced lawyers in our China Business Department will be happy to assist you.

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