IRD’s overseas tax minimization requirements for DTA benefits

Highlights:

  • HK IRD explains latest requirement for obtaining benefits under Double Tax Treaties
  • Requirement for Certificate of Residence is clearly stated – to qualify “Economic Substance” in Hong Kong must be demonstrated.

 

At the 2019  Annual Meeting between Hong Kong’s Inland Revenue Department (IRD) and the Hong Kong Institute of Certified Public Accountants (HKICPA), the IRD stated that all local tax-resident enterprises seeking a Certificate of Residence (CoR) in order to apply for treaty benefits under Double Tax Agreements will have to demonstrate economic substance in Hong Kong.

 

Hong Kong taxpayers will be required to reduce their overseas tax liabilities in treaty jurisdictions under the relevant Double Tax Agreement in order to claim those payments as tax credits in Hong Kong. Companies that apply for a Certificate of Residence have to demonstrate economic activity in Hong Kong even if they are registered and incorporated locally and legally considered to be tax resident in the SAR under the China-Hong Kong Comprehensive Avoidance of Double Taxation Agreement.

 

According to Section 50 of the Inland Revenue Ordinance (IRO) Hong Kong residents paying income taxes in treaty jurisdictions are eligible for tax relief by obtaining tax credits for the amount paid overseas. The amount of applicable tax credit must be the same as the amount of Hong Kong tax payable on that income. Under the IRO’s new amendment, section 50AA(2), the extent of double taxation relief obtained in Hong Kong should not be in excess of the amount that would have resulted from overseas tax reduction measures taken by the taxpayer.

 

In cases where a Hong Kong tax resident enterprise was unable to apply for its CoR to claim treaty benefits before the deadline, the withholding tax on the royalties would be assessed at the higher rate of 10% instead of the 7% reduced rate designated by the Hong Kong-China double taxation agreement if the IRD concludes, after reviewing the individual circumstances of the case, that the company did not take sufficient measures in terms of “time, amount and expense” in order to reduce the extent of taxation in the overseas jurisdiction.  However, in cases where the Hong Kong taxpayer claims DTA benefits in Mainland China specifically, tax credit would be available up to a maximum of 7% of the royalty income even if the CoR was not obtained before the deadline.

 

In cases where a Hong Kong Certificate of Residence has been rejected by the IRD, the 10% withholding tax rate applies even if the Mainland China treaty benefit is invoked. The taxpayer would not be eligible for treaty benefit rates because they would not be considered tax-resident in Hong Kong.

 

Under the Circular of the State Taxation Administration on Matters Concerning “Beneficial Owners” in Tax Treaties (PN No. 9), Hong Kong tax resident enterprises can be considered the Beneficial Owner of dividends received from Mainland China under some circumstances. These circumstances include holding 100% equity in a layered holding structure if all shareholders are tax residents in a jurisdiction with a DTA that offers the same benefits for Mainland China sourced dividends. If the Hong Kong based enterprise does not have Beneficial Owner status over the dividends, they could invoke the same-treaty-benefit rule in order to reduce the withholding tax requirement.

 

Invoking the same-treaty-benefit rule requires the submission of supporting evidence of the Beneficial Owner status of another enterprise within the layered holding structure in another DTA treaty jurisdiction, as well as that enterprise’s tax-residence status in their jurisdiction. This documentation, along with certification of Hong Kong tax residency for the Hong Kong enterprise should suffice to enjoy the same-treaty-benefit.

 

However, the IRD has emphasized that Hong Kong entities will be assessed individually in order to determine the extent of their economic substance in Hong Kong, because the purpose of Cross Border Double Taxation agreements, in addition to expediting the free flow of trade between regions, is to encourage compliance with tax laws across jurisdictions. Therefore, the concerns of tax authorities in other jurisdictions are taken into account when reviewing applications for tax treaty benefits.

 

Applicants seeking tax treaty benefits will have to include documentation of all pertinent factors when applying for their CoR from the IRD. The IRD is currently consulting with China’s State Administration of Taxation on a standardized form to be released for this purpose in the future.

 

Should you have any concerns regarding your tax residence status in Hong Kong, or if you are interested in reconfiguring your international tax structure, our tax professionals can assess your individual circumstances and help you streamline your strategy. With over 50 years of experience serving the Hong Kong business community and our extensive presence in Guangzhou, Shanghai, Beijing and Europe, we are uniquely equipped to assist clients with cross border enterprises.

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