Tax System and BEPS Issues in Hong Kong

Practitioner Forum on BEPS Issues Focus - Hong Kong Thomas Lee President Asia Oceania Tax Consultants Association 24 October 2014 24/10/2014

Tax System in HK Hong Kong operates a territorial tax system Profits is only taxable in HK if a business is carried on in Hong Kong and the profit is sourced in HK. 24/10/2014 2

Permanent Establishment Permanent establishment (PE) not defined in domestic tax law only as a result of the signing of Double Treaty Treaties becomes important to decide the taxing rights with treaty partners 24/10/2014 3

Withholding Taxes Hong Kong does not levy withholding taxes on payment of interest or dividend to a non- resident Dividend income is not taxable to a recipient under domestic law 24/10/2014 4

Withholding Taxes Domestic law creates restrictive conditions for interest expense to be deductible Almost all interest expenses paid to non- Financial Institutions are not tax deductible 24/10/2014 5

Withholding Taxes Special provisions to tax royalty payments to non-residents Deem a non-resident company receiving royalty to be chargeable to profits tax under domestic law 24/10/2014 6

Thin Capitalization Not legislated under domestic law No prescribed ratio of capital and debt Most HK companies have very small paid up capital The restrictive provisions for interest deduction help to deal with most of the problems created by thin capitalization 24/10/2014 7

Anti-treating shopping provisions Absent in most of the DTA s signed between HK and its treaty partners. By reason of the domestic tax system, many foreign companies use HK companies to gain access to benefits under a DTA signed between HK and its treaty partners 24/10/2014 8

Controlled Foreign Companies Dividend income derived by a HK holding company from its foreign subsidiary NOT TAXABLE Offshore profits of the foreign subsidiary NOT TAXABLE IN HK There is no domestic legislation on CFC, since it is a non-issue 24/10/2014 9

Corporate tax residence A company is not taxed in respect of its profits by reason that it is incorporated in Hong Kong Even if a company is resident in Hong Kong by reason that it is incorporated in HK (DTA definition) or the central management and control of which is in Hong Kong (common law concept), the profit of which is only taxable in HK if it is sourced in Hong Kong. As a result, a company incorporated in HK may not be taxable in HK in respect of its profits 24/10/2014 10

Transfer Pricing No domestic transfer pricing rules or contemporaneous documentation requirement Tax department relies on tax avoidance and evasion provisions, rules on source of profits, general provisions of deduction of expenses and common law tax principles to challenge transfer pricing. It seeks to apply the principles in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, if not in conflict with domestic laws. 24/10/2014 11

BEPS The 2014 Deliverables Action Main Ideas Prediction of HK Actions 1 - Digital Economy Permanent Establishment Will follow CFC Rules N/A Withholding tax Might have to reconsider domestic rules on royalty payments to non- residents Transfer pricing Will consider 24/10/2014 12

BEPS The 2014 Deliverables Action Main Ideas Prediction of HK Actions 2 - Hybrid mismatch 1. Domestic laws to address arrangements that result in double non- taxation or long term tax deferral Seems not a HK issue, and yet will follow recommendations and adopt new Model Tax Treaty 2. Changes to OECD Model Tax Treaty 24/10/2014 13

BEPS The 2014 Deliverables Action Main Ideas Prediction of HK Actions 5 - Counter Harmful Tax Practice Consideration of revisions or additions to the existing framework for analysing whether regimes are harmful Will try its best to avoid being labelled a harmful tax jurisdiction 6 - Prevent treaty abuse Limitation of benefit Will adopt latest OECD Model Tax Treaty clause Withholding tax Might have to reconsider domestic rules on royalty payments to non- residents 24/10/2014 14

BEPS The 2014 Deliverables Action Main Ideas Prediction of HK Actions 8 - Transfer Pricing aspects of Intangibles Allocation of profits in accordance with value creation of intangibles Will follow the guidelines 13 - Guideline on transfer pricing documentation and country by country reporting Revised standards for transfer pricing documentation and CbC reporting, to be included in OECD Transfer Pricing Guidelines Will follow the guidelines 15 - Multilateral Instrument To modify bilateral tax treaties Ditto 24/10/2014 15

Thank You! 24/10/2014 16