Hong Kong: Aircraft leasing tax regime adjusted to comply with BEPS

Lewis Lu	Curtis Ng

The Hong Kong government has revised the concessionary tax regime for certain aircraft leasing activities to ensure it requires require real economic substance and activity in Hong Kong.

The Hong Kong government gazetted a bill on March 10 2017 that introduces a concessionary tax regime for certain aircraft leasing activities. The new rules apply from the 2017-18 year of assessment. The main benefits of the proposed regime are two-fold.

• Aircraft leasing income earned by 'qualifying aircraft lessors' will be subject to concessional tax treatment i.e. applying a tax rate of 8.25%, which is half of the normal Hong Kong profits tax rate, to 20% of the gross rental receipts less deductible expenses such as funding costs, but excluding tax depreciation; and

• The same 8.25% tax rate will apply to 'qualifying aircraft leasing management activities'. This is widely defined to include, in addition to the standard lease management activities of procuring and leasing aircraft, a range of financing activities such as providing loans to associated companies to acquire aircraft, providing loans to airlines to acquire aircraft from qualifying lessors and providing residual value guarantees.

This legislation was a welcome development given the current tax regime made Hong Kong uneconomic as a location for situating international aircraft leasing companies. A key feature of the proposed regime was that it only applies to a Hong Kong-based leasing manager using a number of Hong Kong incorporated special purpose companies to own and dry lease aircraft to non-Hong Kong based airlines.

The draft legislation has been subject to consideration by a Bills Committee in the Legislative Council. At the committee meetings, there has been universal support for the underlying intent of the new law to remedy the existing anomaly in the tax law. The committee held its third meeting on the bill on May 22 2017.

At the latest meeting significant changes were proposed by the government to the bill. The reason for these changes relate to informal feedback from the OECD Forum on Harmful Tax Practices that the law as originally proposed could be seen as a so called harmful tax practice under the OECD BEPS initiative. While careful efforts were made in the initial drafting to ensure the regime would require real economic substance and activity in Hong Kong to be BEPS compliant, it is now clear that there is a concern with the fact the regime targets only leases to foreign airlines which are not also taxable in Hong Kong.

To address these concerns it is proposed that the requirement of leasing to a "non-Hong Kong aircraft operator" will be dropped and the relevant definition deleted. This means that leases to all airlines will potentially qualify for the new regime.

The law will now effectively allow Hong Kong leasing companies to elect to:

• Apply the existing law under section 23C of the IRO or the proposed section 15(1)(n) (which taxes all income from aircraft leasing) and claim tax depreciation. The ability to claim tax depreciation is restricted under section 39E of the IRO, which denies depreciation where an aircraft is leased to a non-Hong Kong airline; or

• Apply the new regime and be taxed using the 20% deemed profit regime and apply the concessional 50% tax rate.

Once an election is made to apply the new concessional regime this will be irrevocable.

As a consequence of this change in approach there have also been a number of other amendments especially around the anti-avoidance rules which sought to limit the scope of the concessionary regime where a Hong Kong tax deduction is being claimed. These have been replaced by a new provision that applies to payments between connected parties that will restrict deductions for amounts to which the tax concession applies to offset any tax benefit.

The Bills Committee reported to the House Committee on June 9 2017 supporting the passing of the bill with the aim of a second reading of the bill in the Legislative Council on June 21 2017.

Overall, the new regime remains a welcome change. The underlying issue has been addressed to make Hong Kong a more attractive base for aircraft leasing and management activities.

The proposed extension to all aircraft leasing activity is a welcome change to simplify the regime while allowing companies the right to continue to use the existing regime when leasing to local airlines.

Lewis Lu (lewis.lu@kpmg.com) and Curtis Ng (curtis.ng@kpmg.com)

KPMG China

Tel: +86 (21) 2212 3421

Website: www.kpmg.com/cn