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22 February 2022

Hong Kong is famous for its simple taxation system and low tax rate, so would most probably be the first set-up to consider when investors enter the Asian market (particularly the Mainland China market). However, without a better understanding of the benefits, investors may not realise just how attractive Hong Kong is. Cheng & Cheng Taxation Services Limited (Cheng & Cheng Taxation) provides 10 quick facts about the taxation system investors need to know before deciding to move to Hong Kong.

Benefits of setting up a Hong Kong intermediate holding company:

1.Hong Kong does not have withholding tax in most circumstances

Most countries impose withholding tax when money is transferred out of the country. This tax could be even higher than the local corporate income tax rates. However, Hong Kong is the complete opposite. In general, there is no withholding tax on dividend and interest, or on services, while only a low withholding tax will be imposed on royalties. When a Hong Kong company has to pay royalties to an overseas entity, it has to withhold tax on behalf of the overseas entity. The general tax rate is between 2.475% and 4.95%, but under some circumstances the tax rate could be as high as 16.5%.

The fact that Hong Kong does not charge withholding tax on dividend and interest makes it an ideal place for setting up an intermediate holding company.

2.Hong Kong does not tax on capital gains

Capital gains tax planning is common in Hong Kong, because there are huge differences between tax rates on long-term capital gains and short-term trading gains. While short-term trading gains are subject to normal tax rates of 16.5%, long-term capital gains are subject to a tax rate of 0%.

There is no clear definition that distinguishes between long-term and short-term investments. There are six “badges of trade” tests that are generally used to judge the difference, which leaves room for tax planning opportunities before the investment decision is made. Investments in securities and immovable properties for long-term investment purposes are also eligible for the non-taxable capital gain claim.

From a group structure perspective, the non-taxable capital gain claim provides more flexibility in the exit of an underlying investment or subsidiary. This adds to the benefits of setting up an intermediate holding company in Hong Kong.

3.Hong Kong does not tax on dividend income

Dividend income from both Hong Kong and foreign investments are non-taxable under Hong Kong Profits Tax. Hong Kong–sourced dividend income is exempted under Section 26 of the Inland Revenue Ordinance to avoid double taxation on the same profits, while foreign-sourced income is generally non-taxable in Hong Kong.

Fund distribution income is generally exempt from Hong Kong Profits Tax under the same logic.

4.      Hong Kong has already entered into DTAs with 45 tax jurisdictions

Hong Kong has been rapidly expanding its Comprehensive Double Taxation Agreement (DTA) network in recent years to facilitate the use of Hong Kong entities to carry out cross-border business and investment. The number of DTAs has already reached 45. Please refer to the following website for a detailed list of DTA partners [https://henrykwongtax.com/home/hong-kong-tax-treaty-network/].

The expanded DTA network will effectively reduce the overseas withholding tax when a Hong Kong company sets up an overseas subsidiary or does business with overseas business partners.

It has become a global practice that a taxpayer has to apply for a Certificate of Resident Status in order to utilise the tax benefits under a DTA. As an international city, located in the central part of Asia and being so close to Mainland China, Hong Kong is in a good position to attract multinational corporations to build up economic substance (including personnel and an office) here. For more details on the requirements for obtaining Hong Kong tax resident status, please visit the "Tax Residency Certificate Video" section of the following website [https://henrykwongtax.com/home/trc-videos/].

Benefits as a trading company:

5.      Hong Kong does not have GST or VAT

To facilitate the development of the trading industry in Hong Kong, Hong Kong does not impose goods and services tax (GST) or value-added tax (VAT). Only certain specific items, such as like liquor and tobacco, are subject to tax.

More pertinently, while digital services tax (DST) has become a global trend, Hong Kong does not currently plan to introduce DST, a fact that will attract corporations working in the digital economy arena.

As such, multinational corporations tend to set up a Hong Kong office as their Asian trading hub and sales office. They first sell the products to the Hong Kong group company, which will subsequently sell the products to customers in other Asian countries.

6.      Hong Kong does not adopt the worldwide taxation system

Unlike many developed countries, Hong Kong adopts a territorial taxation system. Regardless of whether a company is a Hong Kong resident or non-resident, only Hong Kong–sourced profits are subject to Hong Kong Profits Tax, in most circumstances. In other words, if a Hong Kong company carries out its operations outside Hong Kong, it will have the technical basis to pursue an offshore claim, even when the relevant profits are deposited with the bank accounts in Hong Kong.

The Inland Revenue Department (the IRD) issues an enquiry letter to taxpayers that pursue an offshore non-taxable claim in Hong Kong to ensure their operations are carried out outside Hong Kong. As such, it is important for taxpayers to plan their inter-company arrangements and operational flow in advance, so as to defend against any challenge by the IRD. Sufficient trade transaction documents should be in place as the burden of proof is on the taxpayer.

On the other hand, under the Common Reporting Standard (CRS) and Automatic Exchange of Information (AEOI), taxpayers that pursue an offshore claim in Hong Kong should be aware of their foreign tax risk. Double non-taxation is not encouraged under the OECD's base erosion and profit shifting (BEPS) framework. Nevertheless, an offshore claim is one of the effective ways of avoiding double taxation issues, particularly with countries without a DTA with Hong Kong.

7.      Hong Kong is well known for its low corporate income tax rate

The corporate income tax rate in Hong Kong is 16.5%, which is among the lowest across the globe. For the first HK$2 million of profits, the tax rate is reduced by half, to 8.25%. The low tax rate has attracted a lot of Mainland China enterprises and multinational corporations to set up companies and operations in Hong Kong.

Taxpayers in certain specified industries (such as insurance, shipping and corporate treasury centres) can enjoy a special tax rate of 8.25%, while taxpayers carrying out R&D activities in Hong Kong can enjoy an enhanced tax deduction of 200% or 300%.  Please visit the following website for more details on the tax benefits: https://henrykwongtax.com/newsletter/inland-revenue-ordinance-section-15f-double-taxation-risk-on-mnc-with-research-development-rd-functions-in-hong-kong/

By setting up operations in Hong Kong to enjoy the low tax rate, the group / company could certainly benefit from a lower group effective tax rate to reduce the tax burden.

 Employer obligations:

8.      Hong Kong employers have no obligation to withhold tax for employees

Unlike many other tax jurisdictions, Hong Kong employers in general do not have an obligation to withhold tax on behalf of their employees when the remuneration is paid. The employees are under their own obligation to settle their Hong Kong Salaries Tax position.

A withholding tax obligation only arises when an employee will permanently leave Hong Kong. In such a case, the employer has to notify the IRD at least one month before the expected date of departure. The employer is also required to temporarily withhold payment of salaries until receipt of the "letter of release" from the IRD. 

9.      Employers have to report salaries paid to employees, even when they work outside Hong Kong

Every April, employers are required to file an Employer's Return (BIR56A and IR56B) with the IRD to report the remuneration paid to its directors and staff, regardless of whether the work was carried out in or outside Hong Kong. It is a common misconception that filing the Employer's Return is not required if the employees work outside Hong Kong.

The mismatch between salary expenses incurred by a corporation and the Employer's Return is one of the catalysts that will trigger a field audit and investigation by the IRD. As such, employers should also report remuneration paid to both Hong Kong and non-Hong Kong employees. Employees are under their own obligation to lodge a non-taxable offshore claim to the IRD if they work outside Hong Kong.

Having said that, it is worthwhile for the employers to make a note in the IR56B that the employee did not perform his or her job duties in Hong Kong. Meanwhile, all employment contracts should be well structured to avoid any challenge by the IRD.

Transfer pricing rule:

10.  Hong Kong already has its own transfer pricing rule

Large corporations in Hong Kong are now required to file transfer pricing documentation in Hong Kong, which comprises Master File, Local File and Country-by-Country (CbC) reporting. Since the implementation of the transfer pricing rule on 13 July 2018, we are also seeing an increased trend by the IRD to carry out transfer pricing audits on taxpayers.

Hong Kong follows the international threshold for CbC reporting. Multinational groups with consolidated revenue of EUR750 million (HK$6.8 billion) are required to file a CbC notification and report in Hong Kong. An important point to highlight is that, even though a multinational group has already submitted a CbC report in another tax jurisdiction, they must submit their CbC notification in Hong Kong, even when there is an information exchange mechanism.

Below is the specific threshold for transfer pricing Master File and Local File in Hong Kong:

A

Criteria (A): Based on size of business (any two out of three of the below)

Threshold

(i)

Total annual revenue

≥ HK$400 million

(ii)

Total assets

≥ HK$300 million

(iii)

Employees

≥ 100


B

Criteria (B): Based on related party transactions
(any one out of four of the below)

Threshold (HK$)

(i)

Transfers of properties (excludes financial assets / intangibles)

≥ $220 million

(ii)

Transactions in financial assets

≥ $110 million

(iii)

Transfers of intangibles

≥ $110 million

(iv)

Any other transactions (e.g. service income / royalty income)

≥ $44 million

 

Taxpayers above the threshold are required to prepare a Master File and Local File on an annual basis.

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