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Hong Kong: Proposed tax measures for ship-leasing activities

Hong Kong: Tax measures for ship-leasing activities

The Hong Kong government released a proposal for a concessionary tax regime for certain ship-leasing activities.

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The proposal—Inland Revenue (Amendment) (Ship Leasing Concessions) Bill 2020 (17 January 2020)—would formally introduce a concessionary tax regime for certain ship-leasing activities. The legislation is expected to be introduced into the Legislative Council on 12 February 2020, and if approved, would be expected to be effective and apply to income earned from 1 April 2020 and onward. 

Overview

The main features of the proposed ship-leasing tax regime are:

  • Income from ship leasing and managing a ship-leasing business conducted from Hong Kong would be deemed to be taxable. For ship leasing, the taxable amount would include interest received under a funding or finance lease.   
  • The taxable income for qualifying lessors from operating leases would be calculated as 20% of the gross rental amounts (including sums payable under residual value guarantee) minus deductible expenses, but excluding tax depreciation. 
  • The taxable income for qualifying lessors from funding leases would be calculated as gross finance income (i.e., interest) under the lease minus deductible expenses. 
  • The tax rate on the profits of “qualifying ship lessors” would be 0%. 
  • There would also be a concessionary tax rate for “qualifying ship-leasing managers” conducting “qualifying ship-leasing management activities.” The range of “qualifying ship-leasing management activities” would be broadly defined to include—in addition to the standard lease-management activities of procuring and leasing ships—a range of financing activities such as providing loans to associated companies to acquire ships, and providing loans to ship operator to acquire a ship from a ship lessor.
  • The tax rate on the profits of “qualifying ship-leasing managers” would be 0% when services are provided to an associated company and would be 8.25% (half the normal tax rate) when those services are provided to a non-associate.


KPMG observation

The rules are closely modelled on the aircraft leasing concession although there are important differences in the scope and application of the two regimes. The ship-leasing regime is designed around a Hong Kong-based manager using separate Hong Kong incorporated special purpose companies to own and lease ships for use outside Hong Kong waters. While it appears to be possible for lessors to adopt a more integrated model with ship ownership and management in one company, it would be critical that any corporations looking to take advantage of the new regime pay attention to the qualifying conditions.

More details of the proposed regime

“Qualifying ship lessors” and “qualifying ship-leasing managers” (as defined in the legislation) would have to be corporations that conduct only qualifying activities, but some non-qualifying activity would be allowed for leasing managers. This would preclude the regime applying to passenger or cargo shipping businesses. Both managers and lessors would be required to be centrally managed and controlled in Hong Kong, with all the profit-generating activities conducted in Hong Kong and not attributable to any permanent establishment the company may have outside Hong Kong. There also would need to be an election (in writing) made to apply the regime.

The proposed legislation also contains a provision that would deem a ship to be a capital asset if it is held for three years as part of a qualifying ship-leasing business. Conceptually, as with the similar rules in the aircraft leasing regime, this would be a favourable addition because it would provide some clarity to the treatment when a ship is sold. For a ship sold before the three-year mark, the position would depend on the relevant facts and circumstances.  

There would be a safe harbour for qualifying ship-leasing managers to allow them to carry on certain non-qualifying activities, provided that at least 75% of the profits arise from qualifying activities and provided that the value of assets used by the company to conduct qualifying activities are at least 75% of its total assets.

Anti-avoidance measures

Common with all of Hong Kong’s new concessionary regimes there are several complex anti-abuse and anti-avoidance measures built into the regime. The key measures include rules to:

  • Require that any transactions between associated parties are conducted at arm’s length
  • Require that certain substance “threshold requirements” be met
  • “Ring fence” losses sustained when the qualifying lessor or qualifying lease manager qualify for the 0% tax rate
  • Deny the benefit of the relevant concessions when one of the main purposes of an arrangement is to obtain a tax benefit including a benefit under one of Hong Kong’s income tax treaties

The substance requirement would be detailed in a new schedule to the Inland Revenue Ordinance (tax law) and would require that for activities to be conducted or arranged to be conducted in Hong Kong, two conditions would need to be satisfied requiring an adequate number of employees and adequate operating expenditure.

  • For ship-leasing activity, the number of full-time employees would be two and the minimum operating expenditure would be HK$7.8 million.
  • For ship-leasing management activities, the number of full-time employees would be at least one and the minimum operating expenditure would be HK$1 million.

There would be other consequential amendments to Hong Kong’s tax law in relation to capital allowances and deductions.


KPMG observation

The new regime would reflect a change to Hong Kong tax law in that it would provide a tax concession to ship-leasing managers and for finance leasing that has been potentially uncertain if key activities are conducted in Hong Kong. For operating leases, Section 23B of the Inland Revenue Ordinance has for many years been understood to apply so that charter-hire income arising from the use of ships solely or mainly outside Hong Kong waters was effectively not taxed. Only a relatively recent complete change in the tax law assessing practice has created uncertainty with regard to this measure. Accordingly, the proposed regime would provide certainty going forward.


For more information, contact a KPMG tax professional:

David Ling | +1 609 874 4381 | davidxling@kpmg.com

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