I. Introduction.
It is well known that the big movement of capital in the next decade is going to be to Eastern Asia, the People's Republic of China (PRC) and India being the two world's most preferred targets due to the size of their consumer martkets. This article will only focus on the PRC, and Hong Kong due to its proximity to the Chinese Mainland. As it will be further explained, although foreign capitals may be invested in the PRC directly; the Hong Kong tax system is lower and simpler than the Chinese one, and therefore, frow a taxation view point it makes sense to manage assets located in the PRC through a Hong Kong, SAR entity. Hong Kong became a Special Administrative Region (SAR) of the PRC on July 1, 1997. However, it has a high degree of autonomy, except in the areas of defense and foreign policy, and retains its own currency, laws, and border controls.
II. Investing in the Chinese Mainland directly vs. Investing in China through a Hong Kong entity.
Even though, the United States has not entered into a comprehensive double-taxation avoidance agreement with Hong Kong [1] this jurisdiction is still attractive for investors to incorporate a company to manage assets in the PRC. Indeed, Hong Kong has a tax regime different and completely separate to the Mainland of China. It even has its own independent tax authority known as the Inland Revenue Department. [2] As it will be explained later it has a low tax structure which imposes tax liability separately on different types of income. [3] Moreover, tax rate is the same for foreign and local companies. [4]
As opposed to the PRC, [5] Hong Kong does not have any capital gains tax, sales tax, withholding tax in dividends and interest, inheritance tax, value-added tax, and it only levies on very few items (e.g. tobacco). [6] Moreover, unlike the U.S. and Mainland China, Hong Kong operates a territorial basis of taxation under which only income sourced in or from Hong Kong is taxable. [7] Therefore, foreign income is not taxable even if remitted to Hong Kong. In contrast, under the Chinese Law, individuals and/or companies who are Chinese residents are also taxed on their income outside China and receive a credit for overseas taxes. [8]
III. Hong Kong tax system.
There are three direct taxes imposed in Hong Kong: i.e. profit tax on business profits, salaries tax on income from employment and pensions, and a property tax on income from real estate. [9] Profit tax for individuals is at the standard rate of 16% since 2004-2005, [10] Corporate Tax is at a rate of 17.5% on assessable profits, [11] and business other than corporate entities pay a rate of 16.5%.[12] With respect to the shipping business, shipping profits meeting the conditions of the double taxation agreement with the USA are exempt from profits tax in Hong Kong. [13]
In Hong Kong, personal income tax is known as Salaries tax and it is governed by the provisions of the Inland Revenue Ordinance (IRO). Salaries tax of 15% (calculated after deduction of expenses and personal allowances) is imposed on income arising in or from a Hong Kong employment. [14] This tax is demanded on a yearly basis.
Property tax is also governed by the provisions of the IRO. Under these provisions, tax is only chargeable on rental income from owned property situated in Hong Kong, and the rate ranges from 16% of the assessed annual rental income from owned property situated in Hong Kong. [15] Likewise, the rate ranges from 16% of the assessed annual rental income from the land or buildings and an allowance of 20% for repairs and maintenance. [16]
Hong kong does not levy a general consumption tax. However, it has several indirect taxes including rates on property, betting duty and various other selective taxes and charges (e.g. hotel accomodation tax and aiport tax). [17] Besides, a stamp duty is levies on documents relating to transfers of real estate and Hong Kong stocks and shares. [18]
IV. Double Taxation Agreement between the PRC and Hong Kong.
On August 21, 2006, the Hong Kong and PRC tax authorities signed a comprehensive double tax "arrangement" which deals with dividends, interest and royalties, transfers pricing, tax credits, and exchage of information (the Arrangement). [19] Under this new Arrangement, foreigners investing into the Chinese mainland should seriously consider using Hong Kong-based structures. The most relevant provisions of the Arrangement are commented as follows:
- There is no limitation of benefits or anti-conduit provision. Thus, non-Hong Kong investors can utlize the arrangement by establishing entitites in Hong Kong, or outside Hong Kong if they are permanently established (i.e. managed and controlled) from/in Hong Kong. [20] It should be kept in mind that even if the legal entity is managed and controlled in Hong Kong, this does not necessarily mean that the company will be subject to Hong Kong tax. This is because Hong Kong does not impose tax based on incorporation or residency criteria.
- The Arrangement limits PRC withholding tax on dividends to 5% if the Hong Kong resident legal entity holds at least 25% of the capital of the Mainland enterprise, and 10% in all cases. [21] Hong Kong is an attractive location in which to base a holding company because it does not imporse a withholding tax on dividends or interest, or on profits remitted by a branch.
- There Arrangement recognizes the taxing right of both the Mainland and Hong Kong. But, it limits PRC withholding tax on interest to 7% (whether paid to a financial institution or other lender). [22] Again, Hong Kong does not tax interest if the borrower first received the loan funds outside Hong Kong, thus, it is a good business to base a lending operation in Hong Kong.
- The Arrangement limits PRC withholding tax on royalties to 7% of the gross amount of the royalties in all cases. [23]
- the Arrangement specifically exempts capital gains tax from the sale of shares in a mainland company when a foreign investor disposes of shareholdings and other assets in China, so long as the holding is less than 25%. [24] Gains realized by a Hong Kong resident from the disposal of a shareholding of 25% or more in a foreign invested enterprise will remain subject to capital gains tax in the mainland. [25] Since Hong Kong does not tax capital gains, good tax planning strategy could result in gains not taxed in either jurisdiction.
- Other taxes, such as Stamp duty, business tax, land appreciation tax, and other indirect taxes are not convered by the arrangement, and therefore, the liability for those mainland taxes still remain enforced. [26]
V. Conclusion.
From a tax perspective, Hong Kong is an attractive jurisdiction for investments in the PRC. It provides reduced taxes and a simpler tax regime compared to the Chinese one. Moreover, Hong Kong provides a double-taxation avoidance arrangement with the Mainland. Therefore, it is highly advisable for foreign capitals to explore alternatives in the Hong Kong jurisdiction as a vehicle to manage assets in the Chinese Mainland.
[1] http://www.legislation.gov.hk/table6ti.htm (last visited Feb 27, 2009) The U.S.A. and Hong Kong only have signed a Double Taxation Relief with respect to income from shipping operations.
[2] http://www.ird.gov.hk/eng/abo/mis.htm (last visited Feb 27, 2009).
[3] http://www.lowtax.net/lowtax/html/hongkong/jhktax.html (last visited Feb 27, 2009).
[4] http://www.hketo.ca/invest/tax.html (last visited Feb 27, 2009).
[5] http://www.worldwide-tax.com/china/china_tax.asp.m (last visited Jan 27, 2009).
[6] http://www.ird.gov.Hong Kong/eng/pdf/tax_guide_e.pdf (last visited Jan 27, 2009).
[7] Supra note 4, at 1.
[8] http://www.worldwide-tax.com/china/china_tax.asp.m (last visited Jan 27, 2009).
[9] Supra note 4, at 1.
[10] Id.
[11] http://www.doingbusiness.org/ExploreTopics/PayingTaxes/Details.aspx?economyid=43 (last visited Feb 27, 2009).
[12] Supra note 4, at 1.
[13] http://www.legislation.gov.hk/table6ti.htm (last visited Feb 12, 2009).
[14] http://www.gov.hk/en/residents/taxes/taxfiling/taxrates/salariesrates.htm#sr (tax rate for the period 2008-2009) (last visited Feb 27, 2009).
[15] http://www.ird.gov.hk/eng/tax/ind_ppt.htm (last visited Feb 27, 2009).
[16] Id.
[17] http://www.hketo.ca/invest/tax.html (last visited Feb 27, 2009).
[18] http://www.ird.gov.hk/eng/tax/sdu.htm (last visited Feb 27, 2009).
[19] http://www.ird.gov.Hong Kong/eng/pdf/pam71e.pdf at page 2. (last visited Jan 27, 2009). The arrangement took effect after the completion of certain formalities in both jurisdictions. With respect to income derived on the mainland on or after January 1, 2007, and income derived in Hong Kong on or after April 1, 2007.
[19] Id.
[20] Ibid. at page 7.
[21] Id.
[22] Id.
[23] Id. at page 6-7.
[24] Id.
[25] Id.
[26] Id.