A Protocol to the income tax treaty between China and Hong Kong would implement certain measures to address perceived treaty abuse pursuant to the OECD’s base erosion and profit shifting (BEPS) project as well as would provide tax relief to eligible researchers and teachers.
The Ching-Hong Kong income tax treaty entered into force 8 December 2006, and has been supplemented by Protocols in 2008, 2010, and 2015.
The new Protocol (signed 19 July 2019) would be the fifth Protocol to the income tax treaty and includes measures:
Anti-avoidance provisions on permanent establishment (PE) for commissionnaire arrangement
The fifth Protocol would extend the definition of “permanent establishment” (PE) under Article 5 the income tax treaty to reflect the transfer pricing legislation (2018) passed in Hong Kong as well as certain Departmental Interpretation and Practice Notes (DIPNs) published in July 2019 by the Inland Revenue Department. These measures were included in the Protocol to address treaty abuse pursuant to the BEPS project recommendations. The aim is for the treaty to follow international standard. In particular, the fifth Protocol effectively adopts the definition of “dependent agent permanent establishment” as used in BEPS Action 7.
Under the fifth Protocol, an enterprise—despite the absence of a fixed place of business—that is a non-resident may have a PE in Hong Kong in respect of any activities that a resident person undertakes for the enterprise if:
This PE determination, however, does not apply if the resident person: (1) carries on business in Hong Kong as an independent agent; and (2) acts for the enterprise in the ordinary course of that business.
On the other hand, the resident person is not an independent agent if the resident person acts exclusively, or almost exclusively, on behalf of one or more enterprises that are closely related to the enterprise.
Determining residence of entities located in both China and Hong Kong
Under Article 4 of the income tax treaty, if a person (other than an individual) is a resident of both China and Hong Kong, that taxpayer will be deemed to be a resident of only the jurisdiction where its “place of effective management” is located.
The fifth Protocol replaces this “tie-breaker rule” with a mutual agreement approach. Under this new measure, when a person (again, other than an individual) is a resident of both China and Hong Kong, the competent authorities of China and Hong Kong will “endeavour” to reach mutual agreement on the place of residence of this entity. The following factors are to be considered (on a case-by-case basis) when determining the place of residence:
Such an entity will not be allowed tax relief or an exemption from tax under the income tax treaty without the mutual agreement of the competent authorities.
Gain on disposal of shares or comparable interest in an entity with substantial immoveable property
Under Article 13 of the income tax treaty, gains derived from the alienation of shares in a company of which the assets are comprised not less than 50% immovable property situated in China or Hong Kong at any time within the three years before the alienation of shares may be taxed by China or Hong Kong (as the case may be). For instance, a Hong Kong resident who disposes of shares in a company with substantial immovable property in mainland China is subject to tax in mainland China, and no exemption from tax in mainland China is available under the income tax treaty.
The fifth Protocol extends the taxing right on alienation of shares to include comparable interests in other entities (e.g., partnership and trusts). Further, the fifth Protocol reflects an update to the quantum of “not less than 50%” and replaces it with “more than 50%.”
Tax exemption for certain teachers and researchers
A new article (Article 18) related to teachers and researchers is added to the income tax treaty under the fifth Protocol, to provide that a qualified teacher or researcher, employed by the qualified education or research institution in China or Hong Kong, and who engages in teaching or research activities for qualified education or research institution in the other jurisdiction, would be exempt from tax in that other jurisdiction with respect to the remuneration derived from these activities for a period of three years—provided that the remuneration paid to the teacher or researcher has been subject to tax in the jurisdiction where the person is employed.
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