How to avoid double tax on income of Hong Kong and Mainland?
Following the fusion of the economy of the Mainland and Hong Kong,
enterprises have operations in both sides should know more about
the impact of doubt tax on income and its avoidance. The following
only serves as a brief introduction. For more detailed information,
please consult your accountant, Inland Revenue Department ("IRD")
or APEX Accountants.
All information stated here refer to the Arrangement between the
Mainland of China and the Hong Kong Special Administrative Region
for the Avoidance of Double Taxation on Income ("ADTI")
as detailed in IRD's Departmental Interpretation & Practice
Note No 32. ADTI applies to income derived from Hong Kong in any
year of assessment commencing on or after 1 April 1998 and to income
derived from the Mainland on or after 1 July 1998.
1. The territorial source principle of taxation
Hong Kong adopts a territorial source principle of taxation. Only
profits, which arise in or are derived from Hong Kong are subject
to Profits Tax. Profits, which are sourced outside Hong Kong are
not taxable.
2. Resident
ADTI applies to a person who is a resident of either the Mainland
or Hong Kong or is a resident of both. According to Article 6 of
ADTI, the term "resident" means any "person"
who is liable to tax of One Side by reason of his residence, domicile,
place of effective management, place of head office or any other
criterion of a similar nature in accordance with the laws of the
respective Sides. The term "person" is defined to include
an individual, a company, and any other body of persons. Our discussion
will concentrate on company instead of Individual.
(1) Resident "company"
The term "company" means any body corporate or any entity
which is treated as a body corporate for tax purposes. Neither ADTI
nor the Inland Revenue Ordinance (Cap.112) ("IRO") contains
a definition of a "resident company". Case law has established
that a company is resident in Hong Kong if its central management
and control is in Hong Kong, i.e., the place where business is being
carried on. The issue is purely a question of fact.
(2) Resident "body of persons"
The term "person" in Article 7 also refers to "any
other body of persons". The Inland Revenue Department ("IRD")
regards this as a reference to separate taxing entities such as
partnership. IRD considers a partnership is resident where is effective
management and control is located.
(3) Certification of resident status
When applying for benefits under ADTI, an applicant may be required
to substantiate his resident status. In such a situation he may
apply for a certificate of resident status from the competent authority
of the Side where he is resident. If he is unable to produce such
a certificate he will be denied the benefits of ADTI.
In the case of a Hong Kong resident who is required to substantiate
his resident status, the Mainland tax authority will first issue
a referral letter to the applicant for forwarding to IRD. This,
together with a properly completed "Application for Certification
of Resident Status", is to be submitted to IRD. The latter
form can be obtained from IRD.
IRD will examine the information supplied and if it is sufficient,
issue a "Certificate of Hong Kong Resident Status". If
the application is rejected, the applicant will be notified accordingly.
3. Taxes covered
Mainland |
Hong Kong |
ADTI applies to
- Individual Income Tax;
- Foreign Investment Enterprises
Income Tax;
- Foreign Enterprises Income Tax;
and
- Business Tax (for shipping, air and land transport
only)
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ADTI applies to
- Profits Tax;
- Salaries Tax; and
- tax charged under Personal Assessment.
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4. Enterprise
ADTI does not define the term "enterprise" and it is
to be interpreted in accordance with the domestic laws of Hong
Kong and Mainland.
Mainland |
Hong Kong |
ADTI applies to
- An enterprise is an economic organization formulated in
accordance with the law, and is engaged in production, trading,
or other activity for the purposes of gain.
- It also practices independent business accounting and
takes full responsibility for its profits and losses.
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ADTI applies to
- An enterprise is any activity carried on for business
or commercial purposes, such as manufacturing and trading.
- IRD would regard the term to include a company and any
other body of persons.
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5. Procedures for applying for benefits under ADTI
A Hong Kong resident who wishes to obtain the benefits of ADTI,
including claiming a tax credit, can do so at the time he submits
his Profits Tax Return for the relevant year of assessment, or in
writing not later than two years after the end of the relevant year
of assessment. Details should be provided of the income on which
relief is being sought, the nature of the tax paid in the Mainland
and the amount of tax credit claimed a copy of the Mainland notice
of assessment and documentary evidence that the tax has been paid
and is not subject to further adjustment are required to be submitted
with application. In addition, the applicant must be resident in
Hong Kong for that year of assessment.
Any adjustment to the amount of the income doubly assessed or the
amount of tax paid subsequent to the lodgment of the claim must
be notified in writing to IRD so that corresponding revision can
be made.
6. Permanent establishment
A permanent establishment is a fixed place of business of a permanent
nature where an enterprise carries on the whole or a part of its
business activities. The Mainland authority may impose tax on the
enterprise if it is held to have a permanent establishment in the
Mainland. However, the enterprise will only be subject to tax on
only so much of the profit as is attributable to the permanent establishment.
(1) A permanent establishment normally has the following features:
(a) it is a place of business for the carrying out of business
activities;
(b) it is a fixed place of business of a permanent nature; and
(c) the enterprise carries on the whole or a part of its business
activities at the place of business.
(2) Activities that do not constitute a permanent establishment
Activities of a preparatory or auxiliary nature carried out at
a fixed place of business that do not of themselves produce profits
will generally not be considered to constitute a permanent establishment.
Such activities include:
(a) the use of facilities solely for the purpose of storage, display
or delivery of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging
to the enterprise solely for the purpose of
(i) storage, display or delivery; and
(ii) processing by another enterprise;
(c) the maintenance of a fixed place of business solely for
(i) the purpose of purchasing goods or merchandise, or of advertising,
or of collecting information, for the enterprise;
(ii) the purpose of carrying on, for the enterprise, any other activity
of a preparatory or auxiliary character; or
(iii) any combination of the activities mentioned in items (a),
(b), (c)(i) and (c)(ii) above, provided that the overall activity
of the fixed place of business resulting from this combination is
of a preparatory or auxiliary character.
7. Representative office
A representative office will not be regarded as a permanent establishment
and subject to tax if the following conditions are satisfied:
(1) the activities are for the enterprise itself;
(2) the activities do not directly generate profits; and
(3) the functions of the representative office are only of a supportive
nature. If the representative office conducts supervisory management
functions or manages business operations for the enterprise, its
activities would not be regarded as being of the required character.
In this event, the representative office would be regarded as a
permanent establishment.
8. Processing or assembly ADTI with a Mainland entity
When a Hong Kong manufacturing enterprise enters into a processing
or assembling ADTI with a Mainland entity, ADTI any take one of
the following forms :
(1) A co-operative processing unit
The Hong Kong enterprise provides the raw materials, technical
know-how, design, training, management and supervision, etc, and
the Mainland entity provides the factory premises, the land and
labour and is responsible for processing, manufacturing and assembling
the good. In law, the Mainland processing unit is a contractor separate
and distinct from the Hong Kong manufacturing enterprise. Profits
arising from the sale of processed goods to the latter are subject
to tax in Hong Kong, and the question of apportionment does not
arise. However, IRD is prepared to concede that the profits in question
can, generally, be apportioned on a 50:50 basis (see Point 15 for
the relevant tax credit).
(2) An independent sub-contractor
A Hong Kong manufacturing enterprise, who contracts the processing
work to an independent Mainland sub-contractor and pays for the
processing on an arm's length basis, is not regarded as having been
involved in the processing work. The sub-contracting charges payable
to the Mainland sub-contractor will be subject to Enterprises Income
Tax in the Mainland. Profits arising from the sale of goods to the
Hong Kong manufacturing enterprise are chargeable to Profits Tax.
9. A building sit, a construction, assembly or installation project
The IRO imposes tax on profits derived from contracting work carried
out in Hong Kong without regard to the duration of the work. However,
ADTI provides that the profits from such projects will only be subject
to tax if the project lasts for more than 6 months. Profits from
a project that does not last for more than 6 months will not be
regarded as constituting a permanent establishment in Hong Kong
and profits derived therefrom will not be subject to tax in Hong
Kong. A Hong Kong resident with a project in the Mainland will be
accorded similar treatment. Calculation of the duration of a project:
(a) The period for which a project is carried out is counted from
the date the contractor commences work (including all preparatory
activities) up until the date of completion of the work and the
hand over of the work completed.
(b) If the period covers two years, the period is counted on a continuous
basis over the years in question.
(c) In a case where two or more sub-projects are contracted for
at the same site or for the same project, the period is counted
from the date of commencement of the first sub-project to the date
of completion of the last sub-project. In other words the sub-projects
are part of a single project.
(d) Where the sub-projects are situated at different localities
and are contracted for different projects, the respective periods
may be counted separately.
10. Provision of services by an enterprise
A Hong Kong enterprise is regarded as having a permanent establishment
in the Mainland if it provides services, including consultancy services,
through employees or other personnel situated therein. The services
have to be furnished for the same project or a connected project
for a period or periods exceeding in the aggregate 6 months in any
12-month period.
The scope of consultancy services includes:
(1) improvement of production facilities and products, selection
of technical know-how, or enhancement of supervisory and management
skills, etc; and
(2) the feasibility analysis of investment projects and the selection
of design plans.
11. Business agent
Dependent agent |
Independent agent |
An agent (acting under the control and leadership of a
Hong Kong enterprise) who regularly acts on behalf of
that resident in the Mainland and has an authority to
conclude contracts (including participation and decision
making in the negotiation of the contract terms), will
be regarded as a permanent establishment of the Hong Kong
enterprise in the Mainland. This is the case even though
the agent is not the final signatory to the contract.
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An agent who does not act wholly or almost wholly on behalf
of a Hong Kong resident in the Mainland will not be considered
to be a permanent establishment of that resident in the
Mainland. |
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12. Business profits
Mainland |
Hong Kong |
All profits derived by an enterprise directly from its
business activities. |
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The business profits derived by an enterprise and are
computed in accordance with generally accepted accounting
principles and the provisions of the IRO. |
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13. Passive income
With permanent establishment
in Mainland |
Without permanent establishment
in Mainland |
The chargeability of certain items of passive income,
such as gains from immovable property, rent and gains
of a capital nature, will depend on whether the income
is derived from a business carried on through a permanent
establishment or a fixed base. Thus, if the derivation
of the above items of income is substantially connected
with a permanent establishment or a fixed base situated
in the Mainland, they would be regarded as part of the
business profits of the permanent establishment and be
subject to Enterprises Income Tax. |
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If this is not the case, the income will be subject to
Withholding Tax. |
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14. Shipping, air and land transport
(1) Shipping Transport
(a) ADTI provides that Hong Kong has the right to tax a Hong Kong
resident on profits derived from its shipping business and will
be exempt from Enterprises Income Tax and Business Tax in the Mainland.
(b) It should be noted that in calculating the assessable profits
of a ship-owner carrying on business in Hong Kong, section 23B of
the IRO already provides that sums derived from relevant carriage
shipped aboard a Hong Kong registered ship and towage operation
undertaken by it at or from any location within the waters of Hong
Kong and proceeding to sea are exempt from Profits Tax.
(c) One half of any sums derived from charter hire in respect of
the operation of a ship navigating between any location within the
waters of Hong Kong and any location within river trade waters are
also tax exempt. These exemptions still apply after ADTI has come
into effect.
(2) Air Transport
(a) ADTI provides that Hong Kong has the right to tax a Hong Kong
resident on profits derived from its air transport business and
will be exempt from Enterprises Income Tax and Business Tax in the
Mainland.
(b) In accordance with section 23C(2A) of the IRO sums derived from
any relevant carriage and charter hire from the Mainland derived
by a Hong Kong resident, that are exempt from tax in the Mainland
under ADTI, are included as "relevant sums" in calculating
profits chargeable to tax in Hong Kong.
(3) Land Transport
(a) ADTI provides that Hong Kong has the right to tax a Hong Kong
resident on profits derived from its cross-border land transport
business and will be exempt from Enterprises Income Tax and Business
Tax in the Mainland.
(b) A cross-border land transport business between the Mainland
and Hong Kong usually takes the form of a co-operative enterprise.
Typically the Hong Kong resident will make his investment in the
form of vehicles and capital. The Mainland resident will be responsible
for the application of permits and licenses, tax compliance and
other management services. This kind of co-operative enterprise
is regarded as a joint business of cross-border transport operated
by a resident of the Mainland and of Hong Kong. The share of revenues
and profits derived by the Hong Kong resident will be exempt from
tax in the Mainland and subject of Profits Tax in Hong Kong.
15. Tax credit
(1) In case of a Hong Kong resident deriving income that is subject
to tax in Hong Kong, except the following:
(a) Any tax paid in the Mainland in respect of that income shall
be allowed as a credit against the Hong Kong tax payable on that
income. The amount of the tax credit cannot exceed the amount of
tax payable in respect of that income, computed in accordance with
the provisions of the IRO.
(b) The total amount of the tax credit to be allowed for a year
of assessment cannot exceed the total Hong Kong tax payable for
that year of assessment.
(c) In the case where the Hong Kong tax payable for a year of assessment
is "NIL", e.g. in a loss situation, a tax credit is not
allowable for any Mainland tax paid nor can the Mainland tax be
carried forward and allowed as a tax credit in a subsequent year
of assessment.
(2) In the case of a Hong Kong manufacturing enterprise whose profits
are apportioned on a 50:50 basis and where the Mainland regards
more than one-half of such profits as derived from the Mainland,
a tax credit will only be allowed in respect of the tax paid in
the Mainland on those profits in excess of one half of the total
profits.
16. An assessment issued by the Mainland authority is not in conformity
with the provisions of ADTI
Hong Kong resident considers that an assessment issued by the Mainland
authority is not in conformity with the provisions of ADTI, he should:
(1) First lodge his objection with the Mainland authority in accordance
with the procedures and time limits provided by the Mainland tax
laws.
(2) In the event that the claim cannot be settled unilaterally or
is not dealt with expeditiously through normal procedures, the taxpayer
may apply through IRD to have the problem dealt with through mutual
consultation.
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