tax-relief

Introduction of Double Taxation Relief

This section aims to explain how to allocate tax liability on the taxpayer’s profits from operating business and all income derived from immovable property, investment and alienation of property between Hong Kong and China in relation to “Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income” (“the Comprehensive Arrangement”). The Comprehensive Arrangement was signed on 21 August 2006 and came into effect in Hong Kong on or after 1 April 2007 whereas in China on or after 1 January 2007.

Taxpayers from the two regions are still required to comply with the tax regulations in their respective area. The enterprises in China should be taxed in China, yet, for those carrying business in Hong Kong for a permanent establishment, they may be taxed in Hong Kong but it has to depend on how attributable they are in the region. The same case applies in Hong Kong. The enterprises in Hong Kong should be taxed in Hong Kong, yet, for those carrying business in China for a permanent establishment, they may be taxed in China but it has to depend on how attributable they are in the region. In Hong Kong, the assessable profits of a corporation will be calculated in line with the generally accepted accounting principles (GAAP) under the Inland Revenue Ordinance.

For further inquiry, the taxpayers may refer to Certification of Resident Status and Income from Personal Services.

Definition of Permanent Establishment

Permanent establishment is defined as a place of business, a fixed place of business with a certain degree of permanence and carrying on the whole or a part of its business through this fixed place of business. It can be a place of management; a branch; an office; a factory; a workshop; a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

For Building, Construction, Assembly or Installation Sector

The tax liability relies on the length of time of the contracting work. Only if the company on one side performs the contracting work not less than six months, will it be considered as having permanent establishment on another side so its profits would be liable to tax on the other side. If the duration is less than six months, then the profits of the corporation should be subject to tax on their own side.

For Service Sector

If the company of one side provides services, including consultancy service, directly or through employees or other personnel to another side for more than 6 months in a 12-month period, then will it be considered as having permanent establishment on another side so its profits would be liable to tax on the other side. If not, their profits only will be subject to tax on their own side.

For Preparatory or Auxiliary Sector

The following services would not be treated as permanent establishment even if they are implemented in a fixed place of business. The facilities which are only used for storing, displaying or delivering goods or merchandise of the enterprise would not be perceived as permanent establishment. Neither would the maintenance for a stocking goods or merchandise of their own company for the purpose of storage, display or delivery be counted as permanent establishment. For the maintenance which stocks goods for processing by another company, it cannot be treated as permanent establishment as well. In addition, the maintenance for purchasing goods or merchandise, gathering information, implementing any kinds of activities on a preparatory or auxiliary purpose, for the enterprise is not a permanent establishment either.

For Business Agent

A dependent agent is defined as the one’s act is under the control and authority of the company. If a dependent agent of one side acts on behalf of his or her company on the other side, and have the right to sign the contract in the name of the company very often, then the company would be considered as having the permanent establishment on the other side, and vice versa. However, even if the dependent agent is not the final signatory of the contract, but he or she represents the company and takes an important role in negotiating details, formulating the contract arrangements, the company is still viewed as enjoying permanent establishment on the other side.

Beneficial Owner

Beneficial owner is defined as the one who actually has the entitlement and control to the benefits received. It could be an individual, a company or a trust. For instance, for a unit trust, the beneficial owner would be the unit trust itself, instead of the individual beneficiary. If the recipient is the one who only acts as a representative but has no entitlement to the money received under a contract or law given, then the recipient would not be considered as the beneficial owner of the income. However, if the beneficial owner on one side performs business through a permanent establishment there, and the right and property that paid the investment has direct connection to that establishment, the investment income would be treated as the profits of the establishment and be subject to tax under business profits. In this case, the limitation of tax rates in the Comprehensive Arrangement is no longer available.

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Type of Income

Computation of Income

From Immovable Property

The income derived from directly using or using in any forms or letting out the immovable property on the other side may be subject to tax on the other side. The income from immovable property comprises those from agriculture or forestry.

From Shipping, Air and Land Transport

Companies on one side operating shipping, air and land transport can be exempt from tax on the other side, except for those operate the transport business solely between places on the other side. Business in China can exempt Enterprises Income Tax and Business Tax.

Computation of Investment

The investment income from one side by an investor on the other side would be subject to tax in both one side and the other side, and vice versa. The Comprehensive Arrangement imposes a maximum limit on the tax on the investment income by an investor from the other side.

Computation of Dividends

Dividends paid by a company in China to a Hong Kong resident may be subject to tax in both China and Hong Kong. However, the tax should not charge more than 5% of the gross amount of dividends if the resident is a Hong Kong company directly owns not less than 25% of the capital of the company in China and not more than 10% of the dividends under any other circumstances. In addition, dividends in Hong Kong are not tax liable.

Computation of Interests

Interest paid by a company in China to a Hong Kong resident may be subject to tax in both China and Hong Kong. However, the tax should not charge more than 7% of the gross amount of interest unless the recipient is Hong Kong Government or any other government bodies that are recognized by the authority, then the tax would be exempt in the Mainland. In addition, only interest derived from business in Hong Kong are obligated to pay tax. If so, the limitation of tax rates in the Comprehensive Arrangement is no longer available.

Computation of Royalties

Royalties paid by a company in China to a Hong Kong resident may be subject to tax in both China and Hong Kong. However, the tax should not charge more than 7% of the gross amount of royalties unless the recipient is Hong Kong Government or any other government bodies that are recognized by the authority, then the tax would be exempt in the Mainland. In addition, only royalties derived from business in Hong Kong are obligated to pay tax. If so, the limitation of tax rates in the Comprehensive Arrangement is no longer available.

Nonetheless, under section 15 (1) of the Inland Revenue Ordinance, the Mainland resident should comply with the tax rate under section 21A (1)(b). Thus, they are taxed at 17.5% on 30% of the gross amount for corporations and 16% on 30% of the gross amount for persons, that are 5.25% and 4.8% of the gross amount respectively. Since the tax limit of 7% under the Comprehensive Arrangement is higher than the tax rate stated under the Ordinance, thus the Mainland resident is only required to pay the prescribed tax rate under the Ordinance, that is 5.25% for corporations and 4.8% for persons.

Case Study

  • Case (1): A company in China receives $800000 of royalties from Hong Kong in the year of assessment 2013/14. The assessable profit of the company is $600000 after subtracting the allowable expenses and depreciation of expenses of $200000.
    • The tax payable would be $105000 [($600000 X 17.5%)]. Under the Comprehensive Assessment, the company is only required to pay tax of $ 56000 [($800000 X 7%)]. Thus, the tax payable of the company would be reduced to $56000.
  • Case (2): A company in China receives $700000 of royalties from Hong Kong in the year of assessment 2013/14. The assessable profit of the company is $300000 after subtracting the allowable expenses and depreciation of expenses of $400000.
    • The tax payable would be $35000 [($300000 X 17.5%)]. However, under the Comprehensive Assessment, the company is required to pay tax of $ 49000 [($700000 X 7%)]. Thus, the tax payable of the company would remain at $35000 instead of the higher amount under the Comprehensive Assessment.

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For Business Gains

From Alienation of Property

Gains earned by a resident of one side from the alienation of immovable property located on the other side may be taxed on the other side. Besides, gains arising from alienation of movable property of a permanent establishment on the other side may be taxed on the other side.

From Movable Property from Transport Business

Including Gains of Ships, Aircraft or Land Transport Vehicles, gains obtained by the corporation on one side from alienation of shipping, air and land transport or movable property should only be taxable on that side.

From Shares

If the company chiefly comprises of immovable property in Hong Kong, then the gains from alienation of shares would be taxed in Hong Kong. The case is the same in China. If the company chiefly comprises of immovable property in China, then the gains from alienation of shares would be taxed in China. Both China and Hong Kong take 50% as the definition of “chief”. If the company comprises of more than 50% immovable property, then it would be considered as a company chiefly comprises of immovable property.

If the portion of alienation of shares is not less than 25% of the entire shareholdings of the company which is a resident of Hong Kong, then the gains derived from the alienation may be taxed in Hong Kong and vice versa.

The gains arising from alienation of other kinds of property apart from those specified above should be liable to tax on the side of which the alienator is a resident.

Under section 21 of the Departmental Interpretation & Practice Notes, the Manufacturer in Hong Kong who has a contract processing arrangement with a company in China can report 50% of its profits as the earnings outside Hong Kong and not subject to Profits Tax in Hong Kong. Under the Comprehensive Arrangement, this 50:50 division is still applicable.

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For Person Incomes

Resident “Individual”

An individual who is viewed as a Hong Kong resident if he or she is subject to tax in Hong Kong and he or she ages 18 or above or ages under if both parents are deceased, and is a permanent or temporary resident. The word “permanent” refers to an individual whose origin is Hong Kong. The word “temporary” means an individual who stays in Hong Kong exceeding 180 days in the related year of assessment or exceeding 300 days in 2 successive taxable years and one of that is the related year of assessment.

“Personal Services”

This divides into two categories: independent personal service and dependent personal service.

  • Independent Personal Service: Independent personal service refers to those service or activities performed by an individual independently. The examples include scientific, literary, artistic, educational and teaching activities, as well as the professional activities of physicians, lawyers, engineers, architects and accountants. Yet, the service does not include those services exercised as an employee.
  • Dependent Personal Service: It refers to an employment exercised by an individual with an employer.

Professional Services in Hong Kong and Mainland

Under the Inland Revenue Ordinance, the income of a resident arising from trade, business or profession in Hong Kong is liable to Profits Tax in Hong Kong. However, if a Hong Kong resident performs his or her service regularly on a fixed base in Mainland or stays in Mainland in a total of 183 days in a relevant calendar year, then his or her income will be liable to Individual Income Tax in Mainland, and vice versa.

Personal Services from Employment

Any remuneration derived from Hong Kong employment by a Mainland resident is subject to Salaries Tax in Hong Kong. If the Mainland residents do not stay in Hong Kong for 183 days consecutively during a year of assessment and they do not receive salaries from Hong Kong employer or his or her representative and their salaries are not borne by the permanent establishment that the employer set up in Hong Kong, they are not liable to Salaries Tax in Hong Kong. Additionally, if they are employed in Hong Kong, but they do not stay in Hong Kong for more than 60 days, then they are exempt from paying Salaries Tax.

“Present for not exceeding 183 days” exemption condition

Since the year of assessment in China and Hong Kong is different, thus their condition towards this requirement is not the same. For China, its year of assessment runs from 1 January of a year to 31 December of that specific year, whilst Hong Kong’s year of assessment is from 1 April of a year to 31 March of the following year. During the relevant year of assessment of that side, as long as the residents of one side do not stay on the other side for more than 183 days consecutively, they are not liable to pay salaries tax. In computing the days of staying, the authority adopts “days of physical presence”, which states that even the day of arrival or departure would be counted as one day.

Under the Inland Revenue Ordinance, the income of a resident arising from trade, business or profession in Hong Kong is liable to Profits Tax in Hong Kong. However, if a Hong Kong resident performs his or her service regularly on a fixed base in Mainland or stays in Mainland in a total of 183 days in a relevant calendar year, then his or her income will be liable to Individual Income Tax in Mainland, and vice versa.

Mainland residents receive income derived from employment in Hong Kong

The income arising from being employed in Hong Kong by Mainland residents is subject to Salaries Tax in Hong Kong. However, they can be exempt from the tax if they stay in Hong Kong exceeding 183 days in the concerned calendar year and their income is not paid by a Hong Kong resident and the remuneration is not borne by a permanent establishment or a fixed base that the employer has in Hong Kong.

Income derived from employment in China by a Hong Kong company by Hong Kong residents
If the Hong Kong residents stay in Mainland for more than 183 days in the concerned calendar year, then they are also subject to Individual Income Tax in Mainland. Since the Hong Kong residents are employed in Hong Kong, their salaries are liable to Salaries Tax in Hong Kong. Yet, they may apply for tax credit or tax relief for the portion of income that has paid tax in Mainland.

Case Study

  • Case (1): Ms. Wan, A Mainland resident, has offered services in Hong Kong and she stays in Hong Kong for 256 days in the calendar year of 1 January 2014 to 31 December 2014, is her income subject to Profits Tax?
    • As long as Ms. Wan has provided professional service in Hong Kong and she has stayed in Hong Kong more than 186 days, her income is liable to Profits Tax. The income of Ms. Wan from 1 January to 31 March 2014 should be assessed to Profits Tax for 2013/14 taxable year whereas the income from 1 April 2014 to 31 December should be assessed to 2014/15 taxable year.
  • Case (2): Following Case (1), if Ms. Wan adopts an accounting date that is within a year of assessment.
    • Then the basis period will be the year from the accounting date.

Hong Kong residents working across the Mainland border

Tax liabilities in Hong Kong

Any income arising from Hong Kong employment to a Hong Kong resident is obligated for paying Salaries Tax in Hong Kong, no matter the remuneration is paid by Hong Kong employer or a Mainland permanent establishment. Nonetheless, if the taxpayer has paid the income tax for the service he performed in China, he may request for tax exemption for that portion of income under section 8(1A)(c) of the Inland Revenue Ordinance or for a tax credit under section 21 of the Comprehensive Arrangement.

Under normal circumstances, tax exemption gives the taxpayer a greater tax relief than tax credit. The authority may require the taxpayer to provide the proof of Mainland tax payment and will handle the case in respect of the year of assessment concerned. If the taxpayer has settled the income tax payment on all of his or her income earned in Mainland, he or she may apply for tax revision under section 70A of the Inland Revenue Ordinance.

Given that a Hong Kong resident stays more than 60 days in Hong Kong and provides service during the time, Income arising for him or her from non Hong Kong employment will be evaluated for Salaries Tax on a days-in-days-out basis (the number of days the taxpayer were in Hong Kong during the year of assessment), no matter the remuneration is paid by the overseas employer or a Mainland permanent establishment. Yet, provided he or she stays less than 60 days in Hong Kong and provides service during the time, if his or her trip to Hong Kong is recognized as a “visit”, then he or she is not subject to Salaries Tax in Hong Kong. The trip is recognized as a “visit” or not relies on the situation of each case.

Case Study

  • Case (1): I am a permanent worker that offers services in China and my work is based in China. If I have stayed in Hong Kong for 52 days in a year of assessment, and rendered services during the time, am I liable to Salaries Tax in Hong Kong?
    • No, your occasional trips to Hong Kong would be considered as “visits”. In this case, you do not need to pay Salaries Tax in Hong Kong as long as you stay in Hong Kong for less than 60 days in a year of assessment.
  • Case (2): I am a Hong Kong resident who works in an overseas corporation. I have returned Hong Kong for 85 days in a year of assessment. During the time, I attended a meeting and reported my working progress to my boss. Am I liable to Salaries Tax in Hong Kong?
    • Yes. Since you have stayed in Hong Kong more than 60 days and have rendered services here, your earnings will be subject to Hong Kong Salaries Tax according to the days you have stayed in Hong Kong. The calculation of your assessable income on a days-in-days-out basis would be: Full income of the year of assessment X (No. of days in Hong Kong / 365 days).

Tax liabilities in the Mainland

Any remuneration derived from employment in China by a Hong Kong resident is subject to Individual Income Tax in China. If Hong Kong residents do not stay in China for 183 days consecutively during a year of assessment and they do not receive salaries from employer of China or his or her representative and their salaries are not borne by the permanent establishment that the employer set up in China, they are not liable to Individual Income Tax in China.

For the Hong Kong residents providing services in both China and Hong Kong, if he does not stay in China for more than a total of 183 days in a year of assessment, then he is only required to pay Individual Income Tax in China apportioned on time basis for the portion he earned there. Income from foreign employers including Hong Kong employer is not subject to Individual Income Tax in China. Notwithstanding, if he stays in China for more than a total of 183 days in a year of assessment, then he is required to pay Individual Income Tax in China apportioned on time basis for all income derived from employment, including both China and overseas.

Counting of days of stay for tax liabilities calculation

The State Administration of Taxation and the Hong Kong Inland Revenue Department has a particular regulation towards this counting. Since China and Hong Kong are approximate to each other in terms of geographic, travelers can provide services in both locations within a single day. If a taxpayer travels between China and Hong Kong in one day and render services in both areas, then he would be viewed as staying in Mainland for half a day and in Hong Kong for half a day. Nonetheless, if he only performs services on either side on that specific day, then he would be counted as staying on the side where he renders services for one day.

Case Study

  • Case (1): I am a Hong Kong resident, who works in a Hong Kong company. A year ago, the company sent me to the Mainland company as a manager. My monthly salary is $25000 and of that $15000 was obligated to be paid by the Mainland company. I would return to Hong Kong in my vacations and perform services in Hong Kong occasionally. I have spent a sum of 290 days in China in the taxable year 2013/14. How should I be taxed?
    • A: For Mainland tax liability, since you rendered services in both China and Hong Kong and you have stayed in China more than 183 days, according to the tax liabilities condition in China, all of your income is subject to Individual Income Tax in China. You should make a sum of your salary income on both sides as you total taxable salary and then apportion on time basis. For Hong Kong tax system, as you are under Hong Kong employment and have carried out services in Hong Kong, you are liable to pay Salaries Tax on your whole sum of income in Hong Kong. However, since your income from Mainland company is liable to pay tax in China, you could apply for exemption from Hong Kong Salaries Tax on that portion of income or claim a tax credit by declaring the situation in the related section of your tax return and providing a proof for it.
  • Case (2): At the same situation in case study (1), but I only stayed in Mainland for a total of 93 days in the year of assessment 2013/14. How should I be taxed?
    • A: Since you did not spend more than 183 days in China, so only the part of income that arising from your services in China would be subject to Individual Income Tax in China. Your tax liability would be computed on time basis. For Hong Kong taxability, as you are under Hong Kong employment and have carried out services in Hong Kong, you are liable to pay Salaries Tax on your whole sum of income in Hong Kong. However, since your income from Mainland company is liable to pay tax in China, you could apply for exemption from Hong Kong Salaries Tax on that portion of income or claim a tax credit by declaring the situation in the related section of your tax return and providing a proof for it.
  • Case (3): I am a Hong Kong resident, who works in a Hong Kong company. However, I am responsible for managing both the business in Hong Kong and the Mainland. Therefore, I had to travel to Mainland and Hong Kong and provide services on both sides every day. My monthly salary is $25000 and of that $15000 was obligated to be paid by the company in Mainland. How should I be taxed?
    • A: For Mainland tax liability, as you have supplied services on both sides and were present in China exceed 183 days, your entire salary is subject to Individual Income Tax in China. You should make a sum of your salary income on both sides as you total taxable salary and then apportion on time basis. Regarding to the consensus made by the State Administration of Taxation and the Hong Kong Inland Revenue
      Department, any days you performed services in both China and Hong Kong would be perceived as staying half day on each side.
    • For Hong Kong taxability, as you are under Hong Kong employment and have carried out services in Hong Kong, you are liable to pay Salaries Tax on your whole sum of income in Hong Kong. However, since your income from a company in China is liable to pay tax there, you could apply for exemption from Hong Kong Salaries Tax on that portion of income or claim a tax credit by declaring the situation in the related section of your tax return and providing a proof for it.

Hong Kong residents rendering services in the Mainland only

Tax liabilities in Hong Kong

Even though the taxpayer is a Hong Kong resident, as long as he or she has not rendered any services in Hong Kong, he or she is not required to pay Salaries Tax in Hong Kong, regardless he or she is under Hong Kong employment or not. This regulation does not apply to civil servants or crew members of a ship or an airplane.

Tax liabilities in Mainland

If the taxpayer performs services in China only, his or her entire sum of income would only be taxable in China, regardless he or she is under Hong Kong employment or not. The only exceptional case would be the taxpayers do not stay in China for 183 days consecutively during a year of assessment and they do not receive salaries from employer of China or his or her representative and their salaries are not borne by the permanent establishment that the employer set up in China.

Case Study

  • I am a Hong Kong resident, who works in a Hong Kong company. A year ago, the company sent me to the Mainland company as a manager. My monthly salary is $25000. I did not supply any services in Hong Kong. I came back to Hong Kong on my holidays whereas I stayed in China for a total of 238 days in the year of assessment 2013/14.
    • A: For Mainland tax liability, since you were present in China more than 183 days, and you supplied services therein, so his whole amount of monthly income $25000 would be subject to tax in China. For Hong Kong tax liability, owing to no services performed, you are not obligated to pay any Salaries Tax in Hong Kong.

Taxation of Directors’ Remuneration

Directors’ fees and other relevant remuneration received by either a Mainland resident or a Hong Kong resident is taxed by the side where the company is a resident, regardless of the side that he or she performed services. For instance, a Hong Kong resident who receives director’s fees in a Mainland company, then his or her director’s fees would be subject to the Individual Income tax in China, and vice versa.

Directors’ fees and other relevant benefits include share options, the use of a residence or car, health or life insurance coverage and club memberships, but not comprises of wages, salaries and other remuneration paid to a director on account of his other functions with the company, which would be assessable under income from employment or business profits.

Taxation of Artistes and Sportspeople

If a Hong Kong artist or sportspeople offer services in Mainland, then his or her income from these events would be chargeable to Individual Income Tax in China. On the other hand, if a Mainland artist or sportsman receives income from events in Hong Kong, then his or her income would be subject to Profits Tax in Hong Kong. The tax could accrue to the relevant artist or sportsman or a company.

Taxation of Pensions

If pensions and other resembling fees that are paid by the taxpayer in a public scheme is sort of social security system in Mainland, then the amount should be subject to tax in Mainland only; whereas if pensions and other resembling fees in a recognized retirement scheme in Hong Kong, then the amount should be liable to tax in Hong Kong only. A recognized retirement scheme refers to a “Recognized Occupational Retirement (ROR) scheme” and a “Mandatory Provident Fund (MPF) scheme”.

Pensions and other resembling fees refers to annuities paid regarding past employment, lump sum payments in place of pensions received at or after employment, sums received by commutating pensions and pensions received by widows and orphans. Yet, the one-off payment when ending the employment or the contract is not applicable to this requirement. That one-off payment would be taxed as income from employment.

Taxation of Government Service

Remuneration and retirement fund to one individual by government on one side for his or her service for the government should be taxed on one side only. However, if the resident is from the other side and provides service on the other side, then the above principle is not applicable.

Taxation of Students

In order to nurture the gifts of students, the government offers restricted exemption of tax to them. Any payments arising outside Hong Kong and collected by a Mainland student would not be taxed in Hong Kong so as to minimize his or her living expenses, and vice versa.

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Certification of Resident Status

Introduction

The Comprehensive Arrangement applies to an individual, a company, a partnership, a trust or any other body of persons that qualifies as a Hong Kong resident or a Mainland resident.

Definition of a resident of Hong Kong

First, it could be defined as an individual whose origin is Hong Kong. Next, it could be an individual who stays in Hong Kong exceeding 180 days in the related year of assessment or exceeding 300 days in 2 successive taxable years and one of that is the related year of assessment. In addition, the resident of Hong Kong could be a company operated in Hong Kong or the one who does not operate in Hong Kong but be controlled or managed by Hong Kong. Last, any other body of persons constituted under the laws of Hong Kong, or if the one who is not constituted in Hong Kong, but managed or controlled by Hong Kong.

An individual

The China Government has several considerations for determining whether an individual holds a resident status of Hong Kong. The authority would look into his or her place of residence, employment exercised or services rendered or investment made in the Mainland, tax liabilities in Hong Kong, identity card and re-entry permit.

Only if the authority is not certain about the resident status of a taxpayer, will it ask him or her to provide the Certificate of Hong Kong Resident Status. The cases could be a person is not ascertained as a resident of Hong Kong from the reporting and verification process under normal circumstances or where an individual of a third State or Region applies for treatment under the Comprehensive Arrangement.

For those who qualify as a Hong Kong resident regarding the number of days he or she stays in Hong Kong while he or she has a permanent resident status of a third country, if they make investment or operates business in China, the authority will take into the treaty signed with the relevant country. If there is no such treaty, then the authority will apply domestic law regarding the case.

A company, a partnership, a trust or any other body of persons

The Hong Kong resident status of a company could be proved by a copy of the Certificate of Incorporation of the company or a Certified Extract of Information on the Business Register. The company could apply for Certified Extract of Information the Inland Revenue Department Homepage. The process of application will take 2 working days under normal circumstances.

For those company operated outside Hong Kong and partnership, trust or any other body of persons constituted in or outside Hong Kong, the authority may request for their ”Certificate of Hong Kong Resident Status” issued by the Hong Kong Inland Revenue Department if necessary.

“An individual who ordinarily resides in Hong Kong”

This could be defined as an individual who has a permanent home in Hong Kong where he or she or his or her family lives. The other considerations towards whether an individual ordinarily resides in Hong Kong include the number of days he stays in Hong Kong, whether he has a permanent place of residence in Hong Kong, whether he owns any property overseas for residential purpose, and whether he is chiefly resident in Hong Kong or overseas. Even though an employee who is from Hong Kong generally but is sent to work in Mainland for considerably long time before coming back to Hong Kong, he or she would still be viewed as a Hong Kong resident.

A company, a partnership, a trust or any other body of persons “normally managed or controlled in Hong Kong”

The word “Managed” refers to the management of daily operation and execution of decisions by top management. “Control” means control over the entire business at the top level, normally the board of directors, including formulating the central policy, making strategic policies, deciding business financing and evaluating business performance.

If the company, partnership, trust or any other body of persons normally managed or controlled in Hong Kong would then be treated as Hong Kong resident. When authority considers whether it is managed or controlled in Hong Kong, it will examine the nature of business operated, mode of operation, whether Hong Kong is the place it has a permanent office or employs staff and whether the board of directors meets to formulate policy in Hong Kong.
Verification of Hong Kong resident status by the Mainland tax authorities

The Hong Kong resident can apply for tax relief directly in Mainland by showing documentary evidence such as identity card, re-entry permit, Certificate of Incorporation and Certified Extract of Information on the Business Register. However, if the authority holds doubt, it may issue a referral letter to the applicant for applying a “Certificate of Hong Kong Resident Status” from the Hong Kong Inland Revenue Department.

The referral letter should be submitted along with a filled in application form for certifying the resident status of the applicant. An individual should complete form I.R.1314A whilst a company, a partnership, a trust or any other body of persons should complete form I.R.1313A. The relevant party can download the application forms from the Department website (www.ird.gov.hk) or acquire the forms from the department. The department may require the applicant to submit additional information for reference if necessary. The Inland Revenue Department will issue a Certificate of Hong Kong Resident Status to the applicant who qualifies to be a Hong Kong resident only if the Mainland tax authority requests so.

Definition of a resident of the Mainland

This is defined as any person who, according to the laws in China, is subject to tax there owing to his residence, place of effective management etc, but does not take in any person who is tax chargeable in China only due to his or her sources of income in China.

Verification of Mainland resident status by the Inland Revenue Department

Upon claims for tax relief by a Mainland resident, the Inland Revenue Department will confirm his or her resident status regarding his or her information for tax purposes comprising his or her copy of passport or copy of certificate of incorporation in Mainland. In case of uncertainty about his or her resident status, the department will issue a letter (I.R.1338A) so as to refer the applicant to the Mainland tax authority to issue a certificate of resident status for him or her. Only if the applicant is eligible for the proof by the Mainland tax authority, will he or she be successful in obtaining tax relief in Hong Kong.

  • For Enterprises: The territorial source principle of taxation is applied. Hong Kong follows the principle of territorial source of taxation. Solely profits arising in or derived from Hong Kong are tax chargeable in Hong Kong. Any profits arising outside Hong Kong are not subject to tax in Hong Kong.
  • For Personal scope: The Comprehensive Arrangement is applicable to any residents from either Hong Kong or China or both.

Taxes liability

In China, the arrangement covers Individual Income Tax, Foreign Investment Enterprises Income Tax, Foreign Enterprises Income Tax and Business Tax (for shipping, air and land transport only). In Hong Kong, the Arrangement covers Salaries Tax and tax charged under Personal Assessment.

  • Enterprise: In China, enterprise is defined as an economic organization established in line with the law, and is engaged in production, trading or other activity for gaining profits as its purposes. In addition, it practices independent business accounting and be fully responsible for its own profits and losses. In Hong Kong, enterprise is defined as activity operated for business or commercial purposes, including manufacturing and trading. The definition of it includes a company and any other body of persons.
  • Resident: The term is interpreted as any “person” who is tax chargeable on one side because of his or her residence, address, place of effective management, place of head office or any other criterion of a similar nature in line with the laws of the respective side. The person could be an individual, a company or any other body of persons.

Resident “individual”

An individual who is viewed as a Hong Kong resident if he or she is subject to tax in Hong Kong and he or she ages 18 or above or ages under if both parents are deceased, and is a permanent or temporary resident. The word “permanent” refers to an individual whose origin is Hong Kong. The word “temporary” means an individual who stays in Hong Kong exceeding 180 days in the related year of assessment or exceeding 300 days in 2 successive taxable years and one of that is the related year of assessment.

Resident “company”

The term “company” refers to any body corporate or any legal entity which is regarded as a body corporate for tax purposes. Case law regards a company is a resident of Hong Kong if Hong Kong is the place where control and management are carried out therein.

Resident “body of persons”

The authority views the term as a reference to separate taxing entities like partnerships. The Department considers a partnership is a Hong Kong resident or not by where its effective management and control is located.

Certification of resident status

If the taxpayer wish to apply for benefits in the Arrangement, then he or she has to apply for a Certification of Residence Status on his own side of residence for proof. If no evidence can be shown to the authority, no tax relief could then be granted.

For a Hong Kong resident applying for a tax relief in Mainland, the Mainland tax authority will issue a referral letter to the applicant for forwarding to the Inland Revenue Department. The referral letter should be submitted along with a filled in application form for certifying the resident status of the applicant. An individual should complete form I.R.1314A whilst a company, a partnership, a trust or any other body of persons should complete form I.R.1313A. The relevant party can download the application forms from the Department or acquire the forms from the department.

Applying for benefits under the Arrangement

If Hong Kong residents wish to apply for the benefits in the Arrangement, they may do so when they return their Profits Tax Return in that taxable year or in writing no later than 2 years after the end of that taxable year. The applicant should provide relevant details of the income regarding the tax relief, the nature of the tax paid in the Mainland and the amount of tax credit claimed, along with a copy of the notice of assessment in Mainland and other documentary proof of the tax that has been paid and has no further adjustment are required. The applicant must be a Hong Kong resident for that taxable year. If the income related to the tax relief applied is subject to any amendments, the applicant must write to the authority in order to make any adjustments on the amount.

Permanent establishment or Representative office

This term refers to a fixed business place where an enterprise operates a part of or the whole of the business. The enterprises on one side should be taxed on that respective side, yet, for those carrying business on the other side for a permanent establishment, they may be taxed on the other side. It depends on how attributable they are in the region.

There are three features of a permanent establishment. First, it has to be a business place for conducting business activities. Second, it is a fixed business place with a permanent nature. Third, the enterprise operates a part of or the whole of business at the business place.

The following services would not be treated as permanent establishment even if they are implemented in a fixed place of business. The facilities which are only used for storing, displaying or delivering goods or merchandise of the enterprise would not be perceived as permanent establishment. Neither would the maintenance for a stocking goods or merchandise of their own company for the purpose of storage, display or delivery be counted as permanent establishment. For the maintenance which stocks goods for processing by another company, it cannot be treated as permanent establishment as well. In addition, the maintenance for purchasing goods or merchandise, gathering information, implementing any kinds of activities on a preparatory or auxiliary purpose, for the enterprise is not a permanent establishment either.

For the Representative Office, if the following conditions are fulfilled, then the representative office would not be perceived as a permanent establishment and be liable to tax. If the activities are done for the corporation itself and the activities do not produce profits directly and the representative office only acts as a supportive nature, then it can be exempt from tax. However, if the representative office is responsible for supervisory or management functions, then its activities are no longer supportive. In this case, the representative office would be regarded as a permanent establishment and be tax chargeable.

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Processing or assembly arrangement with a Mainland entity

  • A co-operative processing unit: In case a Hong Kong enterprise is accountable for offering raw materials, technical knowledge, design, training, management and supervision, while enterprise in China is accountable for offering factory facilities, land and labour for processing and manufacturing and assembling goods, the Mainland enterprise would be considered as a contractor and separate from the Hong Kong enterprise. Profits derived from selling the processed goods are taxable in Hong Kong. However, the department will only compromise the profits on a 50:50 basis. The arrangement will have no effect towards this apportionment.
  • An independent sub-contractor: In case a Hong Kong enterprise contracts the processing work to an independent sub-contractor in Mainland and pays them on arm’s length, then the sub-contractor would not be perceived as engaging in the processing work. Thus, the sub-contracting fees are chargeable to Enterprise Income Tax in Mainland only whilst the profits derived from selling the goods by Hong Kong enterprise would be subject to Profits Tax in Hong Kong.

A building site, a construction, assembly or installation project

According to the Inland Revenue Ordinance, any gains from the contracting work implemented in Hong Kong, despite the duration of the work, are liable to Profits Tax therein. However, under the Comprehensive Arrangement, the profit of any project, which lasts for more than 6 months, in Hong Kong by a Mainland resident is tax chargeable. Otherwise, the projects would not be perceived as a permanent resident and the profit of it is not liable to tax. The same case applies to a Hong Kong resident in Mainland project.

Calculation of the duration of a project

The project is calculated for the period from the start of the work, including the preparation work, until the completion of the work and the handover of the work. If the project covers two year, then it should be calculated on a consecutive basis over the years. Sub-projects are considered to be a part of a single project. If the same site or the same project consists of two or more sub-projects, the duration is counted from the start of the first sub-project till the end of the last sub-project. On the other hand, if the sub-projects are for different working sites or different projects, then they would be computed separately.

Provision of services by an enterprise

Only if the Hong Kong enterprise renders services, including consultancy services, via employee or any other staff located in China, would it be perceived as having permanent establishment there. The services provided should be for the same project or a related project more than 6 months in any 12-month period. The consultancy service involves the enhancement of production facilities and projects, selection of technology knowledge or boosting the skills of supervisor and management skills and analyzing the practicability of the investment projects and selecting the design plans.

Provision of services by Business agent

  • Dependent agent: A dependent agent is defined as the one’s act is under the control and authority of the company. If a dependent agent of one side acts on behalf of his or her company on the other side, and have the right to sign the contract in the name of the company very often, then the company would be considered as having the permanent establishment on the other side, and vice versa. However, even if the dependent agent is not the final signatory of the contract, but he or she represents the company and takes an important role in negotiating details, formulating the contract arrangements, the company is still viewed as enjoying permanent establishment on the other side.
  • Independent agent: An independent agent does not wholly or almost wholly represent the resident on one side on the other side. He or she would not be viewed as a permanent establishment of that specific resident on the other side.

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Business profits in Mainland

In Mainland, business profit is defined as all profits arising from engaging in business activities. In Hong Kong, the assessable profits of a corporation will be calculated in line with the generally accepted accounting principles (GAAP) under the Inland Revenue Ordinance.

Passive income

Whether the passive income such as gains from immovable property, rent and gains of a capital nature is liable to tax relies on arising from a business carried on through a permanent establishment or a fixed base or not. If the passive income is obtained directly or mostly directly from the permanent establishment or fixed base in Mainland, then those income would be liable to Enterprises Income Tax. If not, the passive income would be chargeable to Withholding Tax.

Shipping Transport

According to the Arrangement, the profit from shipping business of a Hong Kong resident is taxable in Hong Kong and can be exempt from Enterprises Income Tax and Business Tax in China. Under section 23B of Inland Revenue Ordinance, the 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 the sea is exempt from Profits Tax in Hong Kong. In addition, 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 not tax chargeable. The procedure remains the same under the Arrangement.

Air Transport

According to the Arrangement, the profit from the air transport business of a Hong Kong resident is taxable in Hong Kong and can be exempt from Enterprises Income Tax and Business Tax in China. Under section 23C(2A) of Inland Revenue Ordinance, sums of any relevant carriage and charter hire from the Mainland by a Hong Kong resident are not subject to tax in Mainland. However, the respective sum should be calculated in profits liable to tax in Hong Kong.

Land Transport

According to the Arrangement, the profit from land transport business of a Hong Kong resident is taxable in Hong Kong and can be exempt from Enterprises Income Tax and Business Tax in China. The cross-border land transport business between Hong Kong and Mainland is usually operated in the form of a co-operative enterprise. The business is viewed as a joint business between a Hong Kong resident and a Mainland resident. It implies that in most cases, Hong Kong resident will be investing in capital and vehicles whilst Mainland resident will offer services in applying for permits, licenses, tax compliance and management. The profits arising by the Hong Kong resident is liable to Profits Tax in Hong Kong but exempt from tax in Mainland.

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Tax credit

If the income arising is tax chargeable in Hong Kong, that particular portion of income can be exempt from tax in Mainland as a tax credit. According to the Inland Revenue Ordinance, the amount of tax credit shall not be greater than the amount of tax payable regarding that portion of income. In other words, the total amount of tax credit shall not be greater than the total amount of tax payable in the year of assessment.

In case of the tax payable for that year of assessment is NIL, for instance a loss situation, any tax paid in Mainland in that year or the tax paid in Mainland from the previous year carried forward to next year of assessment is no longer subject to tax credit.

If the Hong Kong enterprise apportions its profits on a 50:50 basis, the portion of profits that is subject to tax in Mainland cannot claim any tax credit in Hong Kong. Provided that the profits in Mainland occupies more than a half of the total profits, the tax paid in Mainland will be qualified to apply for tax credit.

Disputes and Doubts

In case of misinterpretation or misapplication of the Arrangement, the authorities of the Mainland or Hong Kong should try to settle the disputes and doubts. When a Hong Kong resident holds any confusion towards the assessment, he or she should first sends objection to the Mainland authority regarding the procedures and time limits stated in the corresponding laws in Mainland. If the disputes cannot be settled in a normal way, then he or she may apply for mutual consultation through the department.

 

Case Study

If a Mainland resident, Ms. Wan, has offered services in Hong Kong and she stays in Hong Kong for 256 days in the calendar year of 1 January 2014 to 31 December 2014, is her income subject to Profits Tax?

As long as Ms. Wan has provided professional service in Hong Kong and she has stayed in Hong Kong more than 186 days, her income is liable to Profits Tax. The income of Ms. Wan from 1 January to 31 March 2014 should be assessed to Profits Tax for 2013/14 taxable year whereas the income from 1 April 2014 to 31 December should be assessed to 2014/15 taxable year.

However, if she adopts an accounting date that is within a year of assessment, then the basis period will be the year from the accounting date.

Income derived from employment in Hong Kong by Mainland residents

The income arising from being employed in Hong Kong by Mainland residents is subject to Salaries Tax in Hong Kong. However, they can be exempt from the tax if they stay in Hong Kong exceeding 183 days in the concerned calendar year and their income is not paid by a Hong Kong resident and the remuneration is not borne by a permanent establishment or a fixed base that the employer has in Hong Kong.
Income derived from employment in China by a Hong Kong company by Hong Kong residents

If the Hong Kong residents stay in Mainland for more than 183 days in the concerned calendar year, then they are also subject to Individual Income Tax in Mainland. Since the Hong Kong residents are employed in Hong Kong, their salaries are liable to Salaries Tax in Hong Kong. Yet, they may apply for tax credit or tax relief for the portion of income that has paid tax in Mainland.

Tax relief

If a Hong Kong resident provides services both in Mainland and Hong Kong, he or she can apply for a tax relief in the form of credit regarding the income that has been double taxed in both regions. However, the tax relief is solely for the taxes covered in the Comprehensive Arrangement. For individuals, the tax credit is only applicable to Individual Income Tax.

Restrictions on the amount of tax credit

The tax credit should not be greater than the amount of tax payable regarding the income computed under the Inland Revenue Ordinance. The excess in the amount of tax paid over the tax credit cannot be set off against the tax in the other year. If there is no tax payable in that year or a loss is incurred, then no tax credit would be given to the tax paid in Mainland. Any disputes should be settled according to the procedures stated in the Inland Revenue Ordinance.

Other relief applicable to income from “dependent personal services”

Under section 8(1A)(c) of the Inland Revenue Ordinance, the income derived in Hong Kong that has been liable to taxes resembling to Salaries Tax can be excluded from Salaries Tax. For those who have paid the Individual Income Tax, they can apply for tax exemption for Salaries Tax via the tax return or application for revision of assessment under section 70A of the Inland Revenue Ordinance.