PLC Paper No. CB(2) 1311

Ref : CB2/SS/11/97

Paper for the House Committee Meeting
on 27 March 1998

Report of the Subcommittee on the Specification of Arrangements (Arrangements with the Mainland of China for the Avoidance of Double Taxation on Income) Order

Purpose

1 This paper reports on the deliberations of the Subcommittee on the Specification of Arrangements (Arrangements with the Mainland of China for the Avoidance of Double Taxation on Income) Order.

The Subsidiary Legislation

2 The Specification of Arrangements (Arrangements with the Mainland of China for the Avoidance of Double Taxation on Income) Order specifies that the arrangements set out in the Memorandum between the State Administration of Taxation of the Mainland of China and the Finance Bureau of the Hong Kong Special Administrative Region concerning the Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation on Income ("the Arrangement") shall be a double taxation relief arrangement under section 49 of the Inland Revenue Ordinance (Cap. 112).

3 The Order was gazetted on 27 February 1998 and tabled at the Provisional Legislative Council meeting on 4 March 1998.

Background

4 In response to the concern expressed by many organizations in Hong Kong on the problem of double taxation between the Mainland of China and Hong Kong, the Administration has discussed with the Mainland tax authorities and this has resulted in the making of the Arrangement. The Arrangement covers permanent establishments, shipping, aviation, land transport operations, services and personal taxation, etc.

5 The Arrangement is in the form of a Memorandum which was signed between the State Administration Taxation of the Mainland and the Finance Bureau of Hong Kong Special Administrative Region on 11 February 1998. The major provisions under the Arrangement include the following -

1. if the enterprise of one side carries on business through a permanent establishment on the other side, the profits of the enterprise may be taxed on the other side but only to the extent of the profits attributable to that permanent establishment;

2. profits from the operation of ships, aircraft or land transport vehicles carried on by an enterprise of one side on the other side shall be exempt from tax on the other side;

3. in respect of independent personal services including professional services, income derived by a resident of one side may be taxed on the other side only if he has a fixed place of business on the other side or if he stays on the other side for a period or periods exceeding an aggregate of 183 days in the calenda
4. r year concerned;

5. salaries, wages and other similar remuneration derived by a resident of one side in respect of an employment exercised on the other side may not be taxed on that other side under certain circumstances;

6. tax credit relief will be given for tax paid on the other side;

7. the tax authorities of the two sides may resolve by consultation any difficulties arising from the interpretation or application of the Arrangement and on other areas of elimination of double taxation not covered in the Arrangement; and

8. the taxes covered under the Arrangement are, in the Mainland, Individual Income Tax, Foreign Investment Enterprises Income Tax and Foreign Enterprises Income Tax; and in Hong Kong, Profit Tax, Salaries Tax and tax charged under Personal Assessment.

6 There is no provision on exchange of tax information between the tax authorities of the two sides under the Arrangement. The Administration will continue to abide by the secrecy provision under the Inland Revenue Ordinance in the protection of taxpayers’ information. The terms of the Arrangement are also consistent both with those of the Organization for Economic Cooperation and Development’s model text on double taxation relief arrangements.

7 Under the terms of the Memorandum, the Arrangement will enter into force when the two sides complete at their respective ends the requisite approval procedure and have notified each other in writing thereof. The Arrangement shall have effect -

1. in the Mainland of China, in respect of income derived on or after 1 July 1998; and

2. in Hong Kong, in respect of income derived in any year of assessment commencing on or after 1 April 1998.

The Subcommittee

8 The House Committee at its meeting on 6 March 1998 agreed to form a Subcommittee to study the subsidiary legislation referred to in paragraphs 2 and 3 above.

9 Under the chairmanship of Hon Eric LI Ka-cheung, the Subcommittee has held two meetings with the Administration and met with deputations at one of the meetings. The membership list of the Subcommittee is in Appendix I. The list of organizations which have expressed views on the subsidiary legislation is at Appendix II.

Deliberations of the Subcommittee

10 Members of the Subcommittee generally welcome the Arrangement which aims at minimizing the scope for double taxation between the Mainland and Hong Kong, thus enhancing the competitiveness of Hong Kong business operating on the Mainland.

11 In response to a member, the Administration has explained that in principle remuneration derived by a Hong Kong resident from an employment in Hong Kong is liable to Hong Kong tax only. However, where the employment is exercised in the Mainland, remuneration derived therefrom by a Hong Kong resident may not be liable to Mainland tax if -

1. he stays in the Mainland for a period or periods not exceeding an aggregate of 183 days in the calendar year concerned;

2. the remuneration is paid by an employer who is not a Mainland resident; and

3. the remuneration is not borne by a permanent establishment or a fixed base set up in the Mainland by the employer.

12 The Administration has further explained that where a Hong Kong resident derives income from an employment in the Mainland, the amount of Mainland tax paid in respect of that income will be allowed as a credit against his tax liability in Hong Kong subject to the amount of credit not exceeding the amount of Hong Kong tax computed on that income.

13 On the question of how a Hong Kong resident working or carrying on a business in the Mainland can obtain proof of his "Hong Kong resident" status for Mainland tax purposes, the Administration has confirmed that the Hong Kong resident may request the Inland Revenue Department to provide such proof. The Administration has stressed that there is no provision under the Arrangement for the exchange of tax information between the tax authorities in the Mainland and Hong Kong. Such information is provided to an individual taxpayer at his/her request. The Administration has also advised that a Hong Kong resident can seek an advance ruling from the Inland Revenue Department on how the provisions of the Arrangement apply to his/her own circumstances. The Inland Revenue Department will publish an Interpretation and Practice Note to assist the public in understanding the provisions set out in the Arrangement.

14 The Administration has further advised that under Article 5 of the arrangement, the tax authorities of the two sides will endeavour to resolve by consultation any difficulties arising from the interpretation or application of the Arrangement. A supplementary arrangement will be made as and when the two sides have agreed on further double taxation relief arrangements. The supplementary arrangement will be subject to the approval of the legislative in the normal way.

15 The Chairman has pointed out that it may be difficult to determine the source of profits of a joint-venture company which is incorporated in Hong Kong, has a board of directors comprising Mainland residents and Hong Kong residents of equal proportion and operates in both the Mainland and Hong Kong. In response, the Administration has advised that in such a case, the question of whether the profits are deemed to have derived from the Mainland or Hong Kong will be resolved by consultation between the tax authorities of the two sides as provided in clause 1(3) of Article 6 of the Arrangement.

16 A member has pointed out that a Hong Kong manufacturer setting up a factory in the Mainland is required to pay value-added tax (VAT) for the purchase of land, machinery or equipment, etc. regardless of whether profits will subsequently accrue from the manufacturing business in the Mainland. In his view, the Arrangement does not appear to provide any benefits to the manufacturer concerned. The Administration has explained that the profits on the sale of the goods concerned are apportioned on a 50:50 basis and that only 50% of the profits are liable to Hong Kong tax. In cases where the whole of the profits are deemed to be liable to Mainland tax, the amount of tax paid in the Mainland will be allowed as a credit against the manufacturer’s tax liability in Hong Kong under the terms of the Arrangement, subject to the amount of credit not exceeding the amount of Hong Kong tax computed on the profits concerned. The Administration has further explained that the VAT paid by a Hong Kong manufacturer can be regarded as allowable deduction for Hong Kong tax purposes. The VAT is however outside the scope of the Arrangement.

17 In response to a member’s enquiry, the Administration has re-affirmed that revenue and profits from the operation of ship, aircraft or land transport vehicles carried on by a Hong Kong enterprise in the Mainland will be exempt from Mainland tax irrespective of whether or not the Hong Kong enterprise has a permanent establishment in the Mainland. On a further query raised by the member, the Administration has responded that it will provide clarification in the Interpretation and Practice Note soon to be published that the term "international traffic" in clause 2(3) of Article 3 of the Arrangement means "cross-border traffic".

18 In response to the Chairman’s query concerning the "dual-contract" arrangement entered into between an individual in the high income group of the "personal services" category and his employer for the purpose of catering for the individual’s tax liability in the Mainland and in Hong Kong separately, the Administration has confirmed that such an arrangement will continue to be accepted for tax purposes in Hong Kong under the Arrangement. However, if it is shown that the making of such an arrangement is designed with intent to evade tax, offenders will be prosecuted under section 61A of the Inland Revenue Ordinance.

19 The Hong Kong Society of Accountants (HKSA) has pointed out that under Hong Kong’s tax regime, the basis of liability for tax is the source of income, irrespective of the place of "residence" of the taxpayer. The HKSA is of the view that as the Arrangement will apply to a Hong Kong or Mainland resident, it is essential that a clear definition of "resident" should be provided in the Hong Kong tax law in order to avoid any doubt or uncertainty in the implementation of the Arrangement. The Administration has advised that further clarification on the term "resident" will be provided in the Interpretation and Practice Note. In the longer term, it aims to introduce a legal definition of "resident" in the Hong Kong tax law to provide a sound basis for concluding similar agreements with other places in accordance with the Organization for Economic Cooperation and Development’s model text on double taxation relief arrangements.

20 In response to the HKSA, the Administration has stated that in the case of a branch of a foreign enterprise which is substantially managed and controlled in Hong Kong, or a company which is incorporated in a foreign country but operates in Hong Kong, such enterprise or company will also be able to enjoy the double taxation relief provided under the Arrangement. As regards the HKSA’s query that the Arrangement does not appear to cover areas of income such as those derived from interest, dividends and royalties, the Administration has indicated that it will hold further consultations with the Mainland tax authority in due course to address the areas of income concerned as well as other areas of double taxation relief not covered in the Arrangement.

Conclusion

21 Members generally agree with the Administration’s view that the Arrangement will facilitate business development between the Mainland and Hong Kong and lower the tax burden on Hong Kong enterprises operating in the Mainland. Members have also noted that the Administration will publish an Interpretation and Practice Note to explain more clearly the provisions set out in the Arrangement and that the Administration will resolve by consultation any problems arising from the implementation of the Arrangement as well as other areas of double taxation relief not covered in the Arrangement. Members are of the unanimous view that the Arrangement should be supported.

Recommendation

22 The Subcommittee recommends that the Specification of Arrangements (Arrangements with the Mainland of China for the Avoidance of Double Taxation on Income) Order published in the Gazette on 27 February 1998 be supported.

Advice sought

23 Members are invited to support the recommendation of the Subcommittee set out in paragraph 22 above.

Provisional Legislative Council Secretariat
26 March 1998

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Appendix I

Subcommittee on the Specification of Arrangements
(Arrangements with the Mainland of China
for the Avoidance of Double Taxation on Income) Order

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Appendix II

Subcommittee on the Specification of Arrangements
(Arrangements with the Mainland of China
for the Avoidance of Double Taxation on Income) Order

List of deputations/submissions received by the Subcommittee

- Hong Kong Society of Accountants

- Deloitte Touche Tohmatsu

- Goldman Sachs (Asia) L.L.C.