The introduction of a joint tax arrangement by the Hong Kong SAR and China has been welcomed by both investors and accountancy firms, the latter now having to advise clients on how to benefit from the new regulations while avoiding new pitfalls.
The new Double Taxation Arrangement (DTA) between Hong Kong and the mainland offers both benefits and uncertainties to the industry. Both governments have pledged to avoid double taxation. Foreign investment companies welcome the change while some investors in Hong Kong are cautious about the rectification procedures, says Yik Mei-ling, director, Horwath Tax Limited. The accountancy firm serves both local and overseas clients in a wide variety of business sectors.
Ms Yik says the one important advantage of the new tax arrangement is that it will help facilitate cross-border transactions and minimise double taxation on the same income between the two areas. On the other hand, it will also help combat evasion of income taxes.
The new DTA system became effective on 1 January 2007 in China and 1 April 2007 in Hong Kong. It is widely expected to soften some investment pitfalls related to the growth of the booming Chinese economy. It will also reduce withholding tax rates on dividends, royalties and interest payments.
Under the new arrangement on capital gains, Hong Kong investors disposing of shares in a mainland company will enjoy a full tax exemption in China under certain provisos. The shares transferred must be less than 25 per cent of the entire shareholding of the mainland company; and the assets of the company should not be mainly immovable property located in China.
"The new system provides sustainable long-term competitive advantages in terms of minimising double taxation of income and is favourable to those overseas corporations wishing to take their first steps towards doing business in China," says Ms Yik. "It's like combining the two tax systems into one."
However, she points out that the new system creates more complicated procedures for some Hong Kong companies. "As a result, some companies here will not necessarily be better off with the mainland regulations being tightened. Those local companies which used to enjoy offshore profits in Hong Kong may now become liable to taxes in China if they have a permanent establishment there," Ms Yik adds.
Also the new tax arrangement would have a substantial impact on companies which have inconsistent accounting records in Hong Kong and China. "They will have to reorganise their business procedures to comply with the new arrangement," she says. "There is an urgent need for them to redistribute their offshore claims. Closer exchange of information and regular communications between the two areas would close the loopholes that allow tax evasion between both places."
She points out that some Hong Kong investors have representative offices in the mainland but in theory they should only serve as liaisons but most representative office could be argued as doing real business there as the representative offices work beyond their allowed business scope.
Ms Yik adds that as the new system makes accounting procedures more transparent, investors will need to supply verification to prove the validity of their accounts. "Information could be traced back through written documents, and such verification would avoid disputes over many issues that used to fall into grey areas concerning taxes," she adds. The new DTA also gives both Hong Kong and mainland tax authorities the right to gather more information on business activities — a point which may cause increased tax burdens for some overseas investors.
Additionally, the new DTA changes the method used to count the number of days Hong Kong residents spend in mainland China from a calendar year basis to any 12-month period. Mainland individual income tax will now apply to such residents if they stay in China more than 183 days over a rolling 12-month period.
This in turn may lead to a labour redistribution for Hong Kong staff seconded to work in China since while they could avoid paying income tax under the old system, they would be liable under the new arrangement.
Because of the impact of this and many other changes, accounting firms are playing a more important role in advising clients about the implications of the DTA. "We also advise them about potential risks under the new system and assist them in restructuring their business activities here and on the mainland to meet the new requirements," says Ms Yik.
"Our strong team in mainland China helps to smooth out such problems affecting not only Hong Kong joint ventures but overseas companies entering business there and wanting to get a clear picture of the new tax system."
New Double Taxation Arrangement (DTA)
- Helps facilitate cross-border transactions and minimise double taxation on the same income between the two areas
- Would have a substantial impact on companies which have inconsistent accounting records in Hong Kong and China
- Makes accounting procedures more transparent
- Gives both Hong Kong and mainland tax authorities the right to gather more information on business activities
- May lead to labour redistribution for Hong Kong staff seconded to work in China