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New Double Taxation Arrangement between Hong Kong and Mainland China

New Double Taxation Arrangement between Hong Kong and Mainland China

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 :-

(a) the recipient is present in the other place for a period or periods not exceeding in the aggregate 183 days in any 12-month period commencing or ending in the taxable period concerned;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other place; and

(c) the remuneration is not borne by a permanent establishment of the employer in the other place.

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

Article 24 of the New Arrangement allows the authorities of the both sides to exchange information necessary for carrying out the provision of the New Arrangement or of the domestic laws concerning double taxation. It is also stated that any such information exchanged shall be treated as confidential and only be disclosed to persons or relevant authorities or officials. This provision aims to protect the taxpayers?information from being misused.

It is noted that the PRC SAT Rules stipulate that the information requested may be those prior to the effective date of the New Arrangement but it should only be used for purpose of tax implementation after the effective date.

Further, Article 25 of the New Arrangement provides that nothing in the New Arrangement shall prejudice the right of the parties to apply its domestic laws and measures against tax avoidance.

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.

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