|
Interpretation and implementation notice for double tax arrangement between Mainland China and Hong Kong
The comprehensive tax arrangement for the avoidance of double taxation ("New DTA") between the Mainland China and the Hong Kong Special Administrative Region ("HKSAR") was concluded in August 2006. On 4 April 2007, the State Administration of Taxation of China ("SAT") has released a notice, entitled Guo Shui Han [2007] 403 ("Circular 403") to provide interpretation and implementation guidelines on the New DTA on the side of China.
Despite that it is the interpretation and implementation guidelines for the New DTA between the Mainland China and HKSAR, Circular 403 states that they shall be applicable to other tax treaties that the Mainland China has concluded with other countries/regions if the contents of the relevant articles are the same and no other interpretation and implementation guidelines have been provided before. In light of such widespread and far-reaching implications, Circular 403 is of great interest to not only the tax residents in HKSAR, but also tax residents of other tax treaty countries/regions. Amongst various points raised in Circular 403, we believe the following are the most important ones:
Permanent Establishment ("PE")
Similar to many other tax treaties concluded by the Mainland China, the New DTA contains a clause for determining PE by reference to the length of time for the services rendered by a HKSAR enterprise in China. The New DTA defines that a HKSAR enterprise shall be regarded as having a PE in China if it has provided services in China for more than 6 consecutive or cumulative months in any 12-month period. As such, the definition of "a month" is of prime importance when determining PE cases.
In this regard, the SAT and HK Inland Revenue Department ("IRD") did not reach consensus when the IRD issued its Departmental Interpretation & Practice Notice on the New DTA in December 2006. Now, the SAT's Circular 403 stipulates that when determining "6 consecutive or cumulative months in any 12-month period", the entire period starting from the first month when the first employee arrives China till the last month when the last employee leaves China should be counted. For example, where a HKSAR enterprise may send the first staff into China to provide services on 16 April 2007 and pull out the last staff from China on 15 November 2007, it would be regarded as providing services in China for more than 6 consecutive or cumulative months in a 12-month period in China. In other words, even if the employees are present in China for 1 day in a particular month, that would still be regarded as "a month".
On the other hand, Circular 403 allows exclusion of a period or periods of absence from China for the purpose of determining the "6 consecutive or cumulative months in any 12-month period". Specifically, it provides that any period of 30 consecutive days without any employee working in China can be excluded as "a month". By applying the previous example, if there is no employee of the HKSAR enterprise working in China during the periods from 16 June to 15 July 2007 (30 days consecutively) and from 1 October to 31 October 2007 (31 days consecutively), "two" months can be excluded for the purpose of determining the "6 consecutive or cumulative months in any 12-month period". As a result, the HKSAR enterprise should not be regarded as having a PE in China.
Circular 403 also stipulates that, for projects lasting for periods of more than 12 months, similar treatments should be applied on a rolling 12-month basis.
Capital gain
The interpretation of 25% threshold for China tax exemption in relation to disposal of shares in a Chinese enterprise (whose assets are not primarily comprised of immovable property) under the New DTA is another area drawing much attention. Again, the views of the SAT and IRD were diverged. Now the SAT's Circular 403 provides a more stringent interpretation and implementation on the exemption condition. That is, China tax exemption would not be granted in the case where the HKSAR seller of the shares in a Chinese enterprise has held 25% or more of the total shares in that Chinese enterprise during a prescribed period of time, even if the shares in that particular disposal being less than 25% of the total shares. In other words, the Mainland China has the taxing right on the capital gain derived by the HKSAR seller, no matter how much proportion of the shares the HKSAR seller disposed in one transaction.
Circular 403 does not define the "prescribed period of time" of owning the shares before disposal, but only defers it to further discussion with the IRD. Reference may be made to a similar clause laid down in the recently published Protocol to China/Mauritius tax treaty. That Protocol states that "gains derived by a resident of a Contracting State [Mauritius] from the alienation of shares, participation, or other rights in the capital of a company which is a resident of the other Contracting State [China] may be taxed in that other Contracting State [China] if the recipient of the gain [Mauritius], during the 12-month period preceding such alienation, had a participation, directly or indirectly, of at least 25 percent in the capital of that company". It is the first treaty in which China and the treaty country [Mauritius] lays down a 12-month grace period, during which if the shares held by a Mauritius seller is not more than 25%, China would not impose tax on the capital gain for any disposal. However, it is not certain at the stage if similar consideration would be applied to the New DTA.
Income from employment
The New DTA has changed the basis period for counting the number of days of presence of individual employees for the 183-day threshold from a calendar year to any 12-month period commencing or ending in the tax year concerned. Circular 403 clarifies that in the first year when this clause applies (in the tax year 2007 in the Mainland China), the 12-month period shall start from 1 January 2007. In other words the 12-month period will not claw back to the previous year.
Circular 403 also clarifies that if the commencement date and cessation date of 12-month period fall into two tax years, the employment income derived in China during all the months within those two tax years shall be subject to Chinese Individual Income Tax ("IIT"). It provides an illustration to explain it: where a HKSAR employee provided services in China in the months of February, April, November, December of 2007, and the months of March, April, May, October and December of 2008, and the total number of days of services in China between the months from November 2007 and October 2008 exceeded 183 days in aggregate; then this HKSAR employee shall be subject to IIT not only in respect of the remuneration for these months, but also for the other months in 2007 and 2008, i.e. February and April of 2007 and December of 2008.
HKSAR employees should now plan their trips to China very carefully in order not to expose to IIT as far as practical situation allows.
Toll processing trade arrangement
Circular 403 has reconfirmed the technical position laid down in a previous tax circular which stipulated that where a HKSAR enterprise has toll processing trade arrangement in China and involves in the production, supervision, management or sale functions for the arrangement, then the HKSAR enterprise should be regarded as having a PE in China. However, as a temporary measure to relieve the HKSAR enterprises having such arrangement in China from China tax burden, the HKSAR enterprise would not be so treated as far as the Chinese toll factory has reported taxes in relation to the processing fee and the HKSAR enterprise has reported 50% of its profits in HKSAR following the IRD's common practice.
However, Circular 403 does not provide a clear timeline for such temporary measure to continue. So HKSAR enterprises having such arrangement may still need to review their business model to prepare for the withdrawal of such temporary measure.
Anti-treaty abuse provision
Circular 403 indicates that there could be anti-treaty abuse measures. While the New DTA between the Mainland China and HKSAR is seen to be one of the most favorable amongst the double tax treaties/arrangements that the Mainland China has concluded so far, it is doubtless that the two governments are very careful to avoid the New DTA to be abused. It is important to closely monitor the development in this aspect if multinational corporations are using HKSAR subsidiaries to make investments in China, provide services in China or conduct business with China. Of course, we believe that reasonable business substance is always a strong foundation for enjoying treaty benefits in any circumstances.
Conclusion
While Circular 403 seeks to provide clarification on various issues arising from the practical application of the New DTA, it does not eliminate all uncertainties as there are still a few areas in which consensus between the SAT and IRD has yet to be reached. We hope that their future discussions could resolve those inconsistent views.
|
