China's New Five-Year Plan and Hong Kong

China’s 12th Five-Year Plan (“the Plan”), which was promulgated in March 2011, has special significance to Hong Kong. This is the first time that a chapter on Hong Kong has been included. This paper outlines how Hong Kong should consider modifying its tax regime to complement the Plan and consolidate its position as an international financial, trade and shipping centre.

 
To allow Hong Kong to take full advantage of the macroeconomic opportunities supported in the Plan, it is recommended that it consider modifying its tax laws in the following areas:
 
  • Further expanding the network of comprehensive double taxation agreements (DTAs)
  • Loss relief
  • Providing a level playing field for Islamic finance
  • Tax incentives for asset management
  • Tax incentives for research & development
  • Tax deduction for intellectual property rights
  • Depreciation allowances for manufacturing plant and machinery utilised in certain cross-border activities
  • Principles for determining the source of profits
  • Facilitating the maintenance of substance in investment holding companies
 
Comprehensive DTAs
A broad network of DTAs will provide Hong Kong companies conducting business overseas with a number of tax benefits. It will also facilitate the restructuring by Mainland investors of their overseas investments through Hong Kong and by overseas businesses investing in the Mainland using Hong Kong as a spring-board.
 
Overseas jurisdictions typically impose withholding taxes on various forms of income, such as dividends, interest, royalties and capital gains, derived from the jurisdiction. Where a DTA has been concluded, withholding taxes on payments made to a Hong Kong enterprise are usually substantially reduced or in some instances eliminated.
 
DTAs typically contain rules that prevent an agreement country from imposing tax on the business profits of a Hong Kong enterprise unless the enterprise maintains a “permanent establishment” (PE) in that country and the business profits are attributable to that PE.
 
The DTA defines what constitutes a PE and whilst the definition varies from country to country, certain activities are commonly excluded from the definition. For instance, facilities maintained only for the purpose of storage, display or delivery of stock do not normally constitute a PE. Therefore, a well-negotiated DTA can, through its definition of a PE, provide significant savings for Hong Kong enterprises operating overseas.
 
For individuals, a DTA normally allows a Hong Kong resident to perform employment services in the agreement country without being subject to tax in that country (normally where they are present in that country for less than 183 days in the year of income).
 
Moreover, a DTA provides investors with certainty. This is achieved, firstly, by placing a ceiling on withholding tax rates and, secondly, by providing investors with procedures to settle disputes that may arise from time to time.
 
Prior to 2010, when Hong Kong amended its legislation to allow it to incorporate in its DTAs the latest international standard on exchange of information of the Organisation of Economic Co-operation and Development (OECD), Hong Kong had only concluded five DTAs. In order to be deemed to have substantially implemented the internationally agreed standard by the OECD, Hong Kong needed to conclude 12 DTAs containing the latest exchange of information article.
 
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