Hong Kong: Proposed changes regarding deductions for foreign taxes paid

Hong Kong: Deductions for foreign taxes paid

The Hong Kong SAR government published a bill to amend the law relating to deductions for tax paid overseas.

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Under the proposals:

  • Section 16(1)(c) would be expanded to cover a broader range of overseas tax charged on a gross, withholding basis.
  • The deduction under section 16(1)(c) would be available to non-Hong Kong resident enterprises that are subject to tax on that income in Hong Kong even when a double tax agreement is in place with the other jurisdiction, subject to a condition that relief is not available for the tax suffered in the jurisdiction of residence.

Background

As a jurisdiction taxing only locally sourced income, Hong Kong has traditionally offered little in the way of double tax relief.  The proliferation of income tax treaties over the last 15 years has changed that treatment for jurisdictions with which there is an agreement in place, but Hong Kong continues not to offer unilateral tax relief when there is no income tax treaty in place.  There have been, however, two important exceptions to this principle:

  • It was generally accepted that tax arising on a gross basis qualified for a deduction under the general principles of section 16 as a payment not dependent on profits and necessary in order to generate the related income.  This principle was upheld in the Board of Review (Case D43/91), which remains the leading precedential case law on the matter in Hong Kong.
  • Section 16(1)(c) specifically allowed a deduction for taxes of a similar nature to Hong Kong profits tax arising on a limited number of items deemed to be taxable under Section 15 (broadly, interest and gains on certificates of deposit).  

When the law was revised in 2019, section 16(1)(c) was amended such that it only applied when the relevant tax arose in a jurisdiction with which Hong Kong did not have an income tax treaty (on the basis that the company would claim a credit under the income tax treaty, when  such a provision is in place).  No amendment was made to the basic principles of deductibility under section 16.

In July and August 2019, the Inland Revenue Department (IRD) issued two revised versions of Departmental Interpretation and Practice Notes (DIPN) 28, updating the IRD position to reflect the new legislation.  This view represented a significant change from accepted practice and was controversial.  In particular, the IRD argued that no deduction was available under general principles for withholding taxes, even if charged on a gross basis.  A deduction would only be available under section 16(1)(c) when there were no income tax treaty provisions available. Read TaxNewsFlash

The IRD’s position had consequences for a number of taxpayers, in particular those operating through branches in Hong Kong—although there might be a treaty with the jurisdiction in which the tax arose, non-Hong Kong residents were unable to take advantage of it.  It also cast doubt over the position of payments other than interest that had suffered overseas withholding tax because it was hard to see how these fitted into the IRD’s analysis.

The new law effectively seeks to address both of these difficulties.

KPMG observation

The proposed changes would clarify that a deduction is available for overseas withholding taxes suffered on income chargeable to Hong Kong profits tax.  It also addresses the anomalous situation in which a non-resident company was previously unable to get any relief on tax suffered in a jurisdiction with which Hong Kong has an income tax treaty.  These changes would be welcomed by the business community.

However, note that the mechanism by which Hong Kong could return to the status quo ante still potentially leaves a question as to how overseas tax suffered between April 2019 and the effective date of the new law would be treated.  Tax professionals have expressed hopes that the IRD would accept the same treatment would apply during that period and drop any outstanding queries on the matter (currently, a moratorium is believed to be in place regarding such queries).  Any taxpayers that have already accepted the IRD’s position might find themselves disadvantaged.

Also note that Hong Kong’s rules on double tax relief remain restrictive by international standards.  A deduction for overseas taxation still results in double taxation, albeit at a lower rate, and many other international center jurisdictions offer a unilateral credit for overseas taxation suffered, and a deduction is effectively only a fallback position when a credit cannot be applied (for example, because of an overall loss position).  Cases of effective double taxation may become more significant as Hong Kong adopts its laws to address BEPS 2.0.


For more information contact a KPMG tax professional:

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

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