Hong Kong looks to the future

When the Financial Secretary presented his 2015/2016 budget in February 2015 he announced a number of measures designed to increase Hong Kong's competitiveness and position Hong Kong as an international hub for financial services.

These measures included allowing private-equity funds to enjoy the same profits tax exemption available to offshore funds and providing a legal framework for introducing an open-ended fund company structure. More information regarding plans announced the previous year to develop Hong Kong as a treasury hub were also announced which should attract more multinational enterprises to set up their corporate treasury services for their group companies in Hong Kong.

A further positive proposal contained in the budget was to promote Hong Kong as an intellectual property (IP) trading hub providing high value-added IP services in the region.

The Hong Kong government has continued to prioritise the growth of Hong Kong's network of double tax agreements (DTAs) with its major trading and investment partners. Hong Kong has now concluded 32 DTAs, 11 with its top 20 trading partners, and negotiations are ongoing with a number of others including Germany and India. The government has also fully supported the OECD initiatives regarding a global standard on tax transparency.

Legislative changes were finalised in July 2015 and extended the profits tax exemption for offshore funds to private equity (PE) funds.

The changes were warmly welcomed by the Hong Kong PE industry and included the following key features:

• Extending the scope of transactions covered by the exemption to include investments in private companies incorporated outside of Hong Kong. This is a key feature of a PE fund's business so this is ultimately a crucial change.

• Exempting special purpose vehicles (SPVs), including Hong Kong SPVs, from Hong Kong profits tax on gains on disposal of a qualifying offshore portfolio company (this also includes gains by one SPV from the disposal of another SPV which holds a qualifying offshore portfolio company).

• Loosening an existing requirement that qualifying transactions be arranged through a person with a Securities and Futures Commission (SFC) licence to rely on the exemption. For offshore PE funds, the SFC licence requirement has been removed where the fund has at least five investors at its final close which have collectively committed more than 90% of the capital of the fund

The amending legislation provides scope for PE funds operating in Hong Kong to benefit from the offshore funds exemption, although this may require, in some instances, some operational changes to ensure that they benefit fully from the concessions.

Measures have been proposed to assist the development of Hong Kong as an IP hub and corporate treasury centre:

• With regard to IP, consideration is being given to extending the scope of tax deduction for capital expenditure incurred on the purchase of IP rights to appropriately cover more types of IP rights.

• The government has proposed amending existing tax laws to allow, under certain conditions, interest deductions under profits tax for corporate treasury centres and reduce profits tax for specified treasury activities by 50%, in other words a concessionary tax rate of 8.25%.

The Stamp Duty (Amendment) Ordinance 2015 became effective on February 13 2015 and amended the law to waive stamp duty payable on the transfer of shares or units of all exchange trade funds listed in Hong Kong. This stamp duty exemption put Hong Kong on an equal footing with other major financial markets and is another initiative to enhance Hong Kong's role as an international financial and asset management centre.

Since the last edition of this publication, Hong Kong has concluded new DTAs with South Africa and the United Arab Emirates. Neither have entered into force yet as they are still awaiting final ratification.

Hong Kong and China also signed the Fourth Protocol to the existing DTA between the two territories on April 1 2015 which amends the existing DTA in the following manner:

• Firstly, it reduces the withholding tax rate on lease rentals from aircraft leasing and ship chartering from 7% to 5%. Lease rentals from aircraft and ship leasing business (excluding the interest portion under a finance lease arrangement) are regarded as royalty payments for the purposes of the DTA and are dealt with by the royalties article. Under the current DTA, the withholding tax rate on royalties is 7%.

• The Protocol reduces the withholding tax rate on royalties from 7% to 5%. Once the Protocol becomes effective, Hong Kong will benefit from having the lowest withholding tax rate relating to lease rentals from aircraft and ship leasing businesses among the tax treaties that China has concluded in Asia and Europe. The reduction of the withholding rate to 5% and a clarification on the VAT position will enhance Hong Kong's competitiveness as a leasing hub serving the China market and removes a major impediment to Hong Kong becoming a major player in the leasing of aircraft into China.

• The protocol provides a tax exemption in China, provided a number of conditions are met, for gains derived by Hong Kong tax residents (including "Hong Kong resident investment funds" as defined in the protocol) from the disposal of shares of Chinese tax resident enterprises listed on recognised Chinese stock exchanges. This provides certainty on the China tax position for gains derived by a Hong Kong resident from the sale and purchase of shares listed on the Shanghai Stock Exchange under the Hong Kong-Shanghai Stock Connect.

• The Protocol also introduces a "main purpose test" to the DTA whereby benefits under the DTA will not be available if the main purpose for entering into the transaction or arrangement was to secure a more favourable tax position. This is in accordance with global trends and is similar to that proposed by the OECD in its final report on BEPS (Base Erosion and Profit Shifting) Action 6.

• Finally, the Protocol extends the definition of China's taxes subject to the exchange of information article under the DTA to include VAT, Consumption Tax, Business Tax, Land Appreciation Tax and Real Estate Tax.

• This protocol will enter into force after the completion of the ratification procedures and formal exchange of notification by both contracting parties.

The Hong Kong government announced in October 2015 that, subsequent to a public consultation process, it will put forward legislative proposals for implementing the new international standard on automatic exchange of financial account anformation in tax matters (AEOI).

In September 2014, the Hong Kong government indicated its support for the new OECD standard on AEOI and targeted a commencement date for information exchanges with appropriate partners by the end of 2018. The abovementioned consultation was a precursor to drafting legislation to put before the Legislative Council in early 2016.

In the response, the Hong Kong government reiterated that they will adhere to the OECD AEOI standard, including the broad definitions of financial institutions (FI), the scope of reporting FIs and reportable accounts, and the due diligence requirements, all of which form the building blocks of the proposed legislative framework in Hong Kong. To ensure certainty, the Hong Kong government intends making appropriate adaptations to some of the generic terms and requirements for enforcement with specific reference to Hong Kong local legislation where necessary.

The government will now focus on the drafting of the AEOI legislation, which it intends to introduce in the Legislative Council in early 2016. Should the legislation be enacted in 2016, then FIs will need to commence their due diligence procedures in 2017, with the first AEOIs taking place before the end of 2018.

Hong Kong's simple and low tax system provides key competitive advantages in attracting foreign investment. However, the recent global trend for reducing corporate tax rates and the growing use of tax incentives to attract targeted investments and business activities ensures that Hong Kong needs to remain on its toes with regard to competitiveness. Over the past two years, the government has introduced a number of initiatives with a view to attracting the targeted investments and business activities to Hong Kong. This trend is likely to remain although it is expected that the OECD's BEPS initiative and its eventual implementation may have a significant impact on Hong Kong's future policies.

Ayesha Macpherson Lau Partner, Tax KPMG China 8th Floor, Prince's Building 10 Chater Road Central, Hong Kong Tel: +852 2826 7165 ayesha.lau@kpmg.com Ayesha is the partner in charge for tax services in the HKSAR and the partner in charge for the Hong Kong market. She has been a specialist in the tax field for more than 20 years, initially with KPMG in London before joining KPMG in Hong Kong. Ayesha has extensive experience advising multinational clients in various industries on the local and regional tax implications of international group transactions and structures. She also has extensive experience in tax audit cases where she takes the lead during discussions and negotiations of compromise settlements with the Inland Revenue Department (IRD) in Hong Kong with the aim of minimising the additional taxes and/ or potential penalties, if any, which may be imposed by the IRD. Ayesha is a regular speaker and writer on tax matters and is the co-author of Hong Kong Taxation: Law and Practice (Chinese University Press), a leading textbook on Hong Kong taxation. Ayesha is the chairman of the International Fiscal Association Hong Kong branch. She was the chairman of the executive committee of the Hong Kong Institute of Certified Public Accountants' Taxation Faculty and its former taxation committee. She was elected as a member of the 2011 Election Committee for the Accountancy subsector. Ayesha is passionate about community service and has been appointed by the Hong Kong SAR government as a member of various advisory bodies. She is a member of the Council of the Hong Kong University, the Independent Commission Against Corruption Advisory Committee on Corruption, the Hong Kong Trade Development Council, the Standing Committee on Judicial Salaries and Conditions of Service, the Policy Research Committee of the Financial Services Development Council, and the Financial Infrastructure Sub-Committee of the Exchange Fund advisory committee. Ayesha was appointed as a justice of the peace on July 1 2013. She is a member of the HKICPA and the Institute of Chartered Accountants in England and Wales.

Darren Bowdern Partner, Tax KPMG China 8th Floor, Prince's Building 10 Chater Road Central, Hong Kong Tel: +852 2826 7166 darren.bowdern@kpmg.com Darren Bowdern is a partner in KPMG's Hong Kong tax practice. For more than 20 years, he has been involved in developing appropriate structures for investing into the Asia Pacific region, tax due diligence reviews in connection with M&A transactions and advising on cross-border transactions. Many of these projects comprise tax effective regional planning including consideration of direct and indirect taxes, capital and stamp duties, withholding taxes and the effective use of double taxation agreements. He also advises on establishing direct investment, private equity and other investment funds in Hong Kong.

Michael Olesnicky Senior Adviser, Tax KPMG China 8th Floor, Prince's Building 10 Chater Road Central, Hong Kong Tel: +852 29132980 michael.olesnicky@kpmg.com Michael Olesnicky is an Australian and US-trained lawyer who left legal practice and joined KPMG in Hong Kong in 2015. Michael's practice focuses on corporate tax and tax dispute work, as well as wealth management and estate planning matters. He has been the chairman of the Joint Liaison Committee on Taxation, which is a quasi-governmental committee which interfaces between tax practitioners and the Hong Kong Inland Revenue Department, from 1986 to now. He formerly served on the Hong Kong Inland Revenue Board of Review. He has served on a number of governmental and quasi-governmental tax committees in Hong Kong, and was previously a member of the law faculty at Hong Kong University where he remains as an honorary lecturer in the Department of Professional Legal Education.

Curtis Ng Partner, Tax KPMG China 8th Floor, Prince's Building 10 Chater Road Central, Hong Kong Tel: +852 2143 8709 curtis.ng@kpmg.com Curtis Ng joined KPMG's Hong Kong office in 1995 and became a tax partner in 2006. He is the head of real estate of our Hong Kong office. Curtis is well versed in the complexities of delivering compliance and advisory services to multinational clients in various sectors. His experience includes a depth of experience in cross-border business activities, and coordination and liaison with specialists to provide the most efficient and effective services. Curtis received his BSSc degree in economics. He is an associate member of the Hong Kong Institute of Certified Public Accountants (HKICPA) and Taxation Institute of Hong Kong. He is an executive committee member of the Taxation Faculty and a member of the tax specialisation development committee of the HKICPA. Curtis is also a certified tax adviser (Hong Kong).