This country-specific Q&A provides an overview to tax laws and regulations that may occur in Hong Kong.
It will cover witholding tax, transfer pricing, the OECD model, GAAR, tax disputes and an overview of the jurisdictional regulatory authorities.
This Q&A is part of the global guide to Tax. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/tax
How often is tax law amended and what are the processes for such amendments?
Generally, the quantum of certain deductions and allowances changes annually based on the Budget for the year. The Budget is usually delivered in February and the revised amounts will apply in the next taxation year (beginning on 1 April) even if the Budget implementation legislation is passed after 1 April. Preparation of the Budget always involves broad consultation with the public.
Substantive changes such as amendments to the law or introduction of new measures are occasional but have been more frequent in recent times. Generally, a proposed change will be foreshadowed in the Budget and then followed by a policy paper and a public consultation. In due course, a draft legislation will be submitted to the Hong Kong Legislative Council for enactment. Application date can vary but would usually be subsequent to the coming into force of the relevant implementation legislation.
This process was followed for the recent introduction of the offshore fund profits tax exemption (2006), expanded information exchange in tax agreements (2010), profits tax deduction relating to the purchase of patent rights, rights to know-how, copyrights, registered designs and registered trademarks (2011), profits tax offshore private equity funds (2015), taxation of corporate treasury activity (2016), automatic exchange of information in Hong Kong (2016) and is currently on going for various changes in connection with the OECD Base Erosion and Profits Shifting initiative.
Exceptionally, Hong Kong will proceed to changes of immediate application but it would only do so to deal with an urgent problem. For instance, in the last several years and indeed as recently as November 2016, Hong Kong has introduced with little or no warning various stamp duty measures to rein in an overly buoyant property market. Thankfully the latter are exceptions and, normally, there is ample warning of new tax measure.
Tax legislation have to be passed by the Legislative Council. Bills are then published in the Gazette of the Hong Kong Special Administrative Region and will have to go through three readings before they are adopted. Bills must be voted by simple majority of the members of the Legislative Council and they become law once signed and promulgated by the Chief Executive through a publication in the Gazette (even if the tax measures addressed in a particular legislation may have an earlier application date).
What are the principal procedural obligations of a taxpayer, that is, the maintenance of records over what period and how regularly must it file a return or accounts?
Hong Kong applies a schedular tax system with three types of taxes: profits tax, salaries tax and property tax. The taxation year is referred to as the year of assessment and runs from 1 April to 31 March.
Generally, taxpayers are required to file for tax only when the tax authorities prompt them to do so by issuing them a return. Filing is required at the time specified in the return (usually a month for individuals). For a business, the taxpayer will be expected to include with the return (audited) financial statements as well as a tax computation. For individuals involved in employment, or property owners, no other document is required to be included with the tax return at the time of filing.
All taxpayers are required to maintain records relevant to any year of assessment for a period of seven years after the year of assessment. Records should be maintained in English or Chinese (if not, the taxpayer may have to translate his records in English or Chinese if they are ever requested). Failure to retain adequate records can lead to penalties or criminal prosecution in particularly egregious circumstances.
Who are the key regulatory authorities? How easy is it to deal with them and how long does it take to resolve standard issues?
The Inland Revenue Department (IRD) is responsible for administering the tax system in Hong Kong. Their motto is: ‘Tax by the Law, Service from the Heart’(!)
The IRD recently published a report analysing its performance against self-defined targets for various types of services or issues. The exercise will eventually be annual but for now the one report is found at: http://www.ird.gov.hk/eng/abo/per_tcp.htm. Please note that the gaudy numbers do not reflect how lengthy and complicated certain issues can become (particularly as it pertains to audits and investigations).
Are tax disputes capable of adjudication by a court, tribunal or body independent of the tax authority, and how long should a taxpayer expect such proceedings to take?
Appeals of tax cases usually start in front of an administrative, independent board called the Board of Review. The Board of Review hears the case, including witnesses as needed, and renders a decision in the matter. Appeals from its decisions then move to the Hong Kong judicial system starting with the Court of First Instance and then up the chain to the Court of Appeal and the Court of Final Appeal. Appeals to the Court of First Instance and Court of Appeal are as of right but they are by permission for the Court of Final Appeal.
Resolution of a litigation case is likely to take several years, particularly since the IRD is known for engaging in lengthy exchanges of correspondence with taxpayers before a case is even ready for an appeal.
Are there set dates for payment of tax, provisionally or in arrears, and what happens with amounts of tax in dispute with the regulatory authority?
Tax is payable in accordance with the schedule set out in the notice of assessment issued to the taxpayer. Once in the system, tax payable in a given year will include any remaining tax payable/refundable for that year as well as a provisional tax purporting to be an estimate of the tax payable by the taxpayer in the coming year.
Once an assessment is issued, it is deemed to be a debt payable immediately to the government, irrespective of any objection or appeal against the assessment. Nevertheless, once an objection or appeal has been filed, the IRD has discretion to hold over part or all of the amounts in dispute as well as agree to other arrangements to secure the debt. It is common for the IRD to request taxpayers to purchase so called ‘tax reserve certificates’ (TRC), which are effectively certificates for funds placed on deposit with the IRD. The purchase of TRCs stops interest from accruing against the taxpayer in the event that the objection or appeal is rejected and it pays the taxpayers interest if the objection or appeal is successful and the money is repaid to the taxpayer.
Is taxpayer data recognised as highly confidential and adequately safeguarded against disclosure to third parties, including other parts of the Government?
Yes, there are strict safeguards in the tax legislation against disclosure of any tax information to anyone. However, in recent years, the government has expanded the ability of the IRD to obtain and reveal tax information to other jurisdictions. Hong Kong is now a party to 35 Comprehensive Double Taxation Agreements/Arrangement with another 14 at different stages of negotiations as well as 7 Tax Information Exchange Agreements (TIEAs) with another 3 in progress under which it has committed to provide various tax information to other jurisdictions. Furthermore, Hong Kong has recently adopted the legislative framework authorising it to enter into automatic exchange of tax information. It has already announced that Japan and the UK would be its first partners for automatic exchange of information and it will gradually continue to build its network.
Is it a signatory (or does it propose to become a signatory) to the Common Reporting Standard? And/or does it maintain (or intend to maintain) a public Register of beneficial ownership?
Yes, Hong Kong is a signatory to the Common Reporting Standard and has recently adopted the legislative framework to implement Automatic Exchange of Information. Hong Kong expects that its first exchanges will take place in 2018.
Are there any plans for the implementation of the OECD BEPs recommendations and if so, which ones?
On 26 October 2016, Hong Kong published a public consultation paper seeking views and comments on the implementation of the BEPS package in Hong Kong. It aims to introduce new measures into the Legislative Council by mid-2017. While Hong Kong intends to preserve its simple and low tax regime, it will focus on codifying the international standard of transfer pricing legislation and transfer pricing documentation requirements : (i) countering harmful tax practices by spontaneous exchange of information on tax rulings (Action 5), (ii) anti-treaty abuse rules (Action 6), (iii) transfer pricing rules in light of the Organization for Economic Co-operation and Development's (OECD) Model Tax Convention and transfer pricing Guidelines (Action 8 to 10), (iv) transfer pricing documentation and country-by-country (CbC) reporting whose exchange will rely on current CDTAs and TIEAs (Action 13) , (v) statutory cross-border dispute resolution mechanism (Action 14), (vii) implement of Multilateral Instrument (MLI) in early 2017 to prevent treaty-shopping (Action 15) and (viii) enhancement of the Hong Kong credit tax system.
Is there a GAAR and, if so, how is it applied?
Yes, Hong Kong has a GAAR allowing the tax authorities to disregard or review as they see fit any arrangement entered into for the sole or dominant purpose of enabling a person to obtain a tax benefit in Hong Kong. It also has specific anti-avoidance provisions dealing with specific circumstances (for instance, restrictions on interest deductions or on using losses in certain transfers of companies).
The tax authorities have no hesitation arguing that an arrangement is subject to the GAAR or specific anti avoidance provisions in its discussions with taxpayers and thereafter in court. In fact, in many cases, GAAR is an automatic fall back position in the event all else fails.
Does the tax system broadly follow the recognised OECD Model?
Does it have taxation of; a) business profits, b) employment income and pensions, c) VAT (or other indirect tax), d) savings income and royalties, e) income from land, f) capital gains, g) stamp and/or capital duties.
If so, what are the current rates and are they flat or graduated?
Hong Kong’s tax system is schedular and territorial where income can be subject only to profits tax, salaries tax or property tax and only to the extent that such profits arise in or are derived from Hong Kong.
a. Taxation of business profits
Business profits arising in or derived from Hong Kong are subject to tax pursuant to Profits Tax at a basic rate 16.5%. Whether or not profits arise in or derive from Hong Kong can be quite controversial and has been the topic of many reported cases.
b. Taxation of employment income and pensions
Employment remuneration (including pensions) is taxed pursuant to Salaries Tax at the lower of (i) 15% of net chargeable income or (ii) a graduated rate schedule ranging from 2% to 17% of the net chargeable income.
c. VAT (or other indirect tax)
There is no VAT or other indirect tax in Hong Kong. There are echoes from time to time of introducing some form of VAT but there are currently no plans to do so.
d.Taxation of savings income and royalties
Bank interest is usually exempt from tax while royalty arising in or derived from Hong Kong may be taxable when received in the form of business income subject to tax pursuant to Profits Tax. Of note is that payments made to a non-resident for the use of right to use in Hong Kong various forms of intellectual properties can be subject to withholding tax, the only instance of withholding tax in Hong Kong.
e. Taxation of income from land
Income from real property can be subject to Property Tax at a rate of 15% or 16.5% depending on the taxpayer (the lower rate applies to individuals).
f. Taxation of capital gains
Hong Kong does not tax capital gains.
g. Stamp and/or Capital duties:
Stamp duties apply at various rates on real property as well as on Hong Kong shares. Stamp duty on real property has been a focus of attention in recent years with significantly higher stamp duty applying to what are perceived to be speculative transactions (such as purchases by non residents or purchases of flats for purposes other than self residence). The measures have so far had little effect on price increases of properties in Hong Kong. There is no capital duty in Hong Kong.
Is the charge to business tax levied on, broadly, the revenue profits of a business as computed according to the principles of commercial accountancy?
Generally yes. The starting point for Profits Tax purposes is the profits as per the (audited) financial statements of the taxpayer prepared in accordance with generally accepted accounting principles. Profits as per financial statements are then adjusted to calculate assessable profits with the main adjustments being: (i) differences between depreciation for accounting purposes and statutory rates of depreciation allowances for taxation purposes; (ii) exclusion of dividends, most interest-like payments, certain non-Hong Kong source profits and capital profits; (iii) adjustments where accounting and taxation principles conflict in relation to capital and revenue expenditures; and (iv) specific exemptions and deductions under the tax legislation.
Are different vehicles for carrying on business, such as companies, partnerships, trusts, etc, recognised as taxable entities?
Yes, Hong Kong will recognise any form of entities (including companies, partnerships, trustees, other bodies corporate, etc.) carrying on a trade, a profession or a business in Hong Kong as taxable entities. Any entity established in Hong Kong or carrying on business in Hong Kong through an establishment is required to obtain a business registration certificate. The registration is administered by the tax authorities and becomes the linchpin to integrate the entity within the tax system. Once registered, in due course, a return will be issued to the entity to test whether its income is subject to tax in Hong Kong.
Is liability to business taxation based upon a concepts of fiscal residence or registration?
Generally, residence is not particularly relevant from a Hong Kong tax perspective and rather the basic test for taxation purposes is whether or not a person carries on a trade profession or business in Hong Kong.
Nevertheless, to the extent that residence is relevant (say, for the offshore funds profits tax exemption or for tax treaty purposes), Hong Kong would apply the traditional common law test of central management and control. Under that test, a company (or other entity) will be considered resident in Hong Kong if it is effectively managed and controlled from Hong Kong.
Also, Hong Kong’s tax arrangements usually refer to ‘a company incorporated in Hong Kong’ as being a resident of Hong Kong for the purposes of the arrangements but, in practice, the IRD will expect that a company incorporated in Hong Kong has substance in Hong Kong before it will issue to it a Certificate of Residency for the purposes of its tax agreements. Substance is usually understood as referring to staff and premises in Hong Kong.
Are there any special taxation regimes, such as enterprise zones or favourable tax regimes for financial services or co-ordination centres, etc?
Generally, Hong Kong is of the view that its low rate, simple tax system is incentive enough for businesses to want to settle in Hong Kong. However, in recent years, it has introduced amendments targeting specific activities. The offshore fund profits tax exemption, the profits tax offshore private equity funds and the corporate treasury centres incentive are examples of special regimes that have found their way to the tax legislation in recent years.
Are there any particular tax regimes applicable to intellectual property, such as patent box?
No, Hong Kong does not have a patent box regime. Payment made out of the Hong Kong for the right to use in Hong Kong, and outside in certain circumstances, can be subject to withholding tax.
Is fiscal consolidation employed or a recognition of groups of corporates for tax purposes and are there any jurisdictional limitations on what can constitute a group for tax purposes? Is a group contribution system employed or how can losses be relieved across group companies otherwise?
There is no tax consolidation in Hong Kong and no group contribution system. Each entity of a group is required to deal individually with its own tax affairs.
Is there a CFC or Thin Cap regime?
There is no CFC and Thin Cap Regime in Hong Kong. However, the deduction of interest expenses in Hong Kong is generally restricted to interest paid to (i) a local or offshore financial institution, or (ii) an entity who is liable to tax in Hong Kong on the receipt of the interest.
Is there a transfer pricing regime and is it possible to obtain an advance pricing agreement?
There is currently no formal transfer pricing regime in Hong Kong but the tax authorities take the view that various provisions of the Inland Revenue Ordinance, alone or together in any combination, allow them to proceed to transfer pricing adjustments. Hong Kong has recently announced that it would introduce a formal transfer pricing regime in complying with the OECD BEPS initiative.
The tax authorities encourage APAs but they have not been particularly popular and it is now proposed to strengthen APA regime by providing a formal statutory basis to (i) allow for transfer pricing issues in an APA, (ii) provide better legal certainty, (iii) clarify the rights and obligations of the tax authorities and taxpayers in relation to an APA, (iv) extend existing penalties to APA application or post-APA audits and investigations, (v) charge a fee upon APA application.
Are there any withholding taxes?
Payments to a non-resident for the use or right to use in Hong Kong various types of intellectual properties (i.e. patent, design, trademark, copyright material, secret process or formula or other property of a similar nature) are subject to withholding tax. For companies, generally the rate is 4.95% but it can increase to 16.5% where the payments are made to a non-resident associated company for the use or right to use in Hong Kong intellectual property that was, at any time, partly or wholly owned by a person carrying on business in Hong Kong.
Are there any recognised environmental taxes payable by businesses?
There are no environmental taxes.
Is dividend income received from resident and/or non-resident companies exempt from tax? If not how is it taxed?
Dividends are not taxed in Hong Kong.