Hong Kong’s Position to be Significantly Enhanced by New Tax Pact

On August 21, 2006, China’s mainland and Hong Kong signed a groundbreaking agreement in a bid to further enhance the potential of Hong Kong as the strategic gateway to China. Essentially a tax treaty in form, the new tax pact will ensure that business profits will not be doubly taxed in the two places, securing Hong Kong’s position as the ideal offshore base for foreign investments flowing into China. Analysts are confident that the new pact will sharpen Hong Kong’s competitiveness and encourage investment in the region by providing added incentives for international investors to enter the vast market on the Chinese mainland via Hong Kong.
 
Having contributed nearly 42% of China’s US$621 billion foreign investment over the last two decades, Hong Kong firms have played a critical role in developing China from an agrarian socialist state to an economic powerhouse. Unlike the United States, Britain and 80 other countries which have enjoyed preferential status to limit the taxes their nationals pay on items such as capital gains, Hong Kong had to rely solely on other advantages until this moment.
 
The new tax pact will cover profits that are classified as direct income, such as operating profits and employment income, and indirect income, such as dividends, interest and royalties. According to the new arrangements, maximum withholding tax for dividends a Hong Kong business receives from mainland investments will be reduced from 10 percent to 7 percent, and if the business holds at least 25 percent of the enterprise’s capital in the mainland, the rate can be further reduced to just 5 percent. Also importantly noted is that the pact also introduces a tax-credit agreement that will ensure that the same income will not be taxed twice.
 
With the new agreement in place, businesses in the region can assume much greater confidence as the preferential tax treatment will enable them to better assess their investment positions and greater synergies can be realized between Hong Kong and the Chinese mainland. The new arrangements will also promote Hong Kong’s economy, enhance its competitiveness and attract overseas capital by promoting cross-border financing arrangements and the transfer of technical know-how and patent rights between the two locations.
 
The ratification of the pact will be subject to an order under the Inland Revenue Ordinance, subject to the Legislative Council’s review and approval. If the pact is ratified before 31 December 2006, the new arrangement will come into effect with respect to Hong Kong taxes from the year of assessment beginning on or after 1 April 2007. With respect to taxes on China’s mainland, the pact will be effective on the taxable year beginning on or after 1 January 2007.
 
 
Since 1980, ICS Trust (Asia) Limited has been assisting SMEs and entrepreneurial corporates from all over the world establish operations in Asia. Please contact one of our senior managers for further information or advice about establishing your business operations in China by emailing us at ics@icstrust.com or by phone on (852) 2854-4544.
 
For more information about doing business in China or in Hong Kong, please visit our website at www.icstrust.com.