Double taxation agreement for Hong Kong and mainland China in effect for 2007 tax year

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By Stefanie Knirsch and Richard Hoffmann/Dezan Shira & Associates

In August 2006, China and Hong Kong signed an arrangement that provides certainty and preferential tax treatment between the two tax jurisdictions, known as the “Arrangement for the Avoidance of Double Taxation on Income and Prevention of Fiscal Evasion”.

Since 1995, Hong Kong has been seeking to negotiate a comprehensive double taxation treaty with China in order to clarify the tax rules and ease the tax burden for the growing number of companies based in the territory that are doing business with the mainland. An agreement signed in 1998 permitted Hong Kong based companies that maintain manufacturing operations in China to split their profits equally between the two jurisdictions. However, the rules did not apply to companies in the service industry and excluded regulations on withholding taxes on interest, royalties and dividends.

The August 2006 agreement extends the scope of the original agreement and came into effect with respect to Hong Kong taxes from the year of assessment beginning on or after April 1, 2007. With respect to mainland taxes, it will apply to the taxable year beginning on or after January 1, 2007.

The agreement basically covers the taxation of direct income earned by businesses and individuals – such as operating profits and employment income – and indirect income, such as dividends, interest and royalties. It ensures that the same income will not be taxed in two places. The arrangement provides added incentives for international investors to enter the mainland market via Hong Kong and improves the close economic ties between the two. It enhances cross-border financing arrangements and the transfer of technical know-how and patent rights. Hong Kong’s competitiveness will be improved further and it becomes a more attractive place for overseas capital.

The tax treaties include that Hong Kong enterprises are only taxable in China if they are active on the mainland for more than six out of 12 months. Hong Kong based shipping, aviation and land transport operations as source of income for Chinese companies are exempt from tax on the mainland. Furthermore, Hong Kong will give a tax credit for any tax paid in mainland China.

New regulations on capital gains include that if a Hong Kong resident company disposes less than 25 percent of shareholding in a mainland company and the assets of the mainland company are not comprised of at least 50 percent immovable property situated in the mainland, any gain derived from the disposal are tax exempt. Otherwise the rate would be 10 percent. Under the new arrangement top rates for withholding tax for dividends a Hong Kong business receives from mainland investments are halved from 10 percent to 5 percent if the Hong Kong business holds at least 25 percent of the capital of the mainland enterprise.

The rates for withholding tax for interest a Hong Kong business receives from the mainland fall from 10 percent to 7 percent. Additionally the arrangement contains an “Exchange of Information” article which allows the exchange of certain information between the mainland and Hong Kong tax authorities to help them in their tax collection and enforcement activities. However, the exchange is limited to information that is necessary for carrying out the provisions of the domestic laws concerning taxes covered by the new arrangement.

For business advisory services, assistance establishing, structuring or operating a business and contract drafting in Hong Kong, please contact Eve Ng in the Hong Kong office of Dezan Shira & Associates at, tel. [852] 2376 0339.