Although not typically regarded as an offshoring jurisdiction, Hong Kong offers many of the advantages of the traditional offshore jurisdictions – together with the advantages of the human infrastructure of its major financial centre.
The simple and predictable tax system of the Hong Kong Special Administrative Region (HKSAR) contains many of the desirable tax attributes of the traditional offshore jurisdictions. There is no capital gains tax, withholding tax, sales tax or VAT – and generally no tax on dividends or interest earned.
Moreover, only income and profits sourced from Hong Kong are subject to tax. Profits sourced from Hong Kong are subjected only to corporate profits tax of 17.5 per cent (16.5 per cent from the 2008-09 year of assessment), one of the lowest in the region.
This enables companies to set up offices in Hong Kong for operating offshore business without having to pay tax in Hong Kong from their offshore operations.
It is arguable that the low tax rates in Hong Kong are still not comparable with the traditional tax havens. Nevertheless, on the upside, Hong Kong is not regarded as an offshore tax haven by the Organisation for Economic Cooperation and Development (OECD), but just as a low-tax jurisdiction. It is therefore not subject to stringent review by the OECD.
That is, unlike many traditional offshoring jurisdictions that are perceived as tax havens, Hong Kong is regarded as a legitimate business centre with greater market acceptability.
Politically, legally and financially stable
Hong Kong is a ’tax haven’ in itself, with the ability to offer a stable political, legal and financial environment for offshore business – virtues simply unmatched by other traditional offshore locations.
According to the 2007 annual Economic Freedom of the World Report by the Cato Institute, Hong Kong is the world’s freest place to do business. It is equipped with a wealth of financial institutions, accounting and law firms, and numerous investment and consulting companies.
There are more than 900 practising barristers, 5,000 practising solicitors and 700 law firms, including major regional and international law firms.
Under the principle of ’one country, two systems’, Hong Kong has a high degree of autonomy in the management of its affairs, with its own separate legal system and its own tax regime.
A fundamental aspect of its legal system is the emphasis on the independence of the judiciary from the executive and legislative branches of government, meaning that the courts make their own judgments free from all political influence. This is afforded protection in the basic law, being Hong Kong’s mini-constitution.
Hong Kong has a full court system that is as comprehensive as other financial centres’. The Court of Final Appeal (CFA), being the highest appellate court in the HKSAR, includes as non-permanent judges leading judges from other common law jurisdictions, including two former chief justices of Australia and several law lords. This well-established court system is key to the success and continuing attractiveness to businesses of Hong Kong.
The gateway to the People’s Republic
Today, the bulk of offshore companies are set up for the purpose of investing in China. Often seen as the gateway to investing in the People’s Republic of China (PRC), Hong Kong is strategically located for setting up offshore companies to do business in China.
Recent tax changes
Recent PRC tax changes also further enhance Hong Kong’s competitive advantages. In particular, the corporate income law of the PRC adopted on 16 March 2007, which became effective on 1 January 2008, imposes withholding tax on dividends, interest and royalties at 10 per cent (for the detailed implementation rules promulgated on 28 Novermber 2007).
This has made Hong Kong a more favourable offshore jurisdiction for the PRC market than traditional offshore locations that have no or less favourable double tax treaties with China.
Double taxation arrangement
On 21 August 2006 the Central People’s Government and the HKSAR signed an arrangement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, which took effect from 1 January 2007 in the PRC and 1 April 2007 in Hong Kong. This move enhances further Hong Kong’s competitive advantage and its economic integration with the PRC.
Under the double taxation arrangement (DTA), the PRC does not tax the capital gains derived by a Hong Kong resident investor from the sale of portfolio interests in PRC companies, other than property companies. Withholding tax on dividends, royalties and interest paid by a PRC company to qualified Hong Kong investors is also reduced. Key advantages under the DTA are as detailed (see box) for a Hong Kong resident without a permanent establishment on the mainland.
Under the DTA a Hong Kong resident company includes a company incorporated in Hong Kong or a company normally managed or controlled in Hong Kong. However, the PRC authorities have indicated that they are unlikely to accept non-Hong Kong incorporated companies as Hong Kong-resident.
For new investments this does not present a significant problem. But it poses a difficulty for existing holding companies that cannot, according to the PRC tax authorities, be redomiciled into Hong Kong merely through shifting management or control to Hong Kong.
In order to take advantage of the DTA, an existing holding company will need to transfer its shares in each PRC company that it owns to a Hong Kong incorporated company. This may carry a tax cost as, from 1 January 2008, a tax-free transfer of the shares in a PRC company within a corporate group may only be possible if the transferee is a PRC tax resident.
Hong Kong’s mix of a favourable tax system, comprehensive legal infrastructure and mature commercial business environment makes it an ideal offshore jurisdiction. The PRC is now the biggest market for offshore companies.
A company structuring its business in the PRC through Hong Kong can enjoy low tax rates while at the same time enjoying strong legal protection and access to one of the world’s most dynamic financial centres.
Hayden Flinn is a partner at Mallesons Stephen Jaques. Chris Abbiss is principal and John Timpany is senior manager at KPMG Taxadvantages of the double taxation arrangement