Hong Kong: Income tax treaties to be modified by MLI

Hong Kong is one step closer to implementing the “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS” (MLI) following the deposit by the People’s Republic of China of its instrument of approval for the MLI.

When the MLI enters into effect in Hong Kong, a number of existing income tax treaties will be modified by the MLI to incorporate the tax treaty-related BEPS measures as recommended by the OECD under BEPS Action 6 (preventing tax treaty abuse) and Action 14 (making dispute resolution more effective). Both Actions 6 and 14 are a minimum standard under the BEPS 1.0 Action Plan.

Income tax treaties covered by the MLI: 39 out of 45 existing income tax treaties in Hong Kong’s tax treaty network are covered by the MLI. Those treaties that are not covered are those with China, Estonia, Finland, Georgia, the Macau SAR, and Serbia. These are either (1) not signed with a separate sovereign state (i.e., China and the Macau SAR), or (2) signed recently (in 2018 or after) and have already contained all the MLI provisions that Hong Kong has chosen to adopt.

MLI provisions adopted by Hong Kong: Hong Kong will only adopt those MLI provisions that implement the minimum standards under the BEPS 1.0 Action Plan that are related to tax treaties—namely preventing tax treaty abuse (Action 6) and making dispute resolution more effective (Action 14). Hong Kong has opted out of all the other MLI provisions that deal with other tax treaty-related measures to prevent BEPS.

Action 6 – Preventing tax treaty abuse

Hong Kong has adopted the following MLI provisions relating to Acton 6:

• To modify the preamble text of Hong Kong’s income tax treaties to: (1) specify that the treaties are not intended to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance; and (2) refer to the desire of the Contracting Parties to further develop the economic relationship and enhance the co-operation in tax matters; and   
• To adopt the principal purpose test (PPT)—i.e., to deny a treaty benefit if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless granting that benefit in those circumstances would be in accordance with the object and purpose of the tax treaty.

Among the 39 income tax treaties covered, two (Belarus and Pakistan) already contain the exact PPT language and will not be modified by the MLI; 18 treaties already contain a PPT but the wording of which is not the same; and the remaining 19 do not contain a PPT currently. Whether the 37 income tax treaties will be modified by the MLI to incorporate the exact PPT language will depend on the choice made by the relevant treaty partners.

The MLI provisions on mandatory binding arbitration are optional, and Hong Kong has chosen not to adopt them.

The effective dates of the changes to the Hong Kong income tax treaties by the MLI will vary from treaty to treaty, as it depends on a number of factors such as whether the relevant treaty partners have completed the ratification procedures of the MLI and which MLI provisions on “entry into effect” they have chosen to adopt.

Hong Kong has chosen the following provisions on entry into effect of the MLI provisions: 

• With respect to withholding taxes—The changes apply to events occurring on or after the first day of the next tax period that begins on or after 30 days after the date of receipt by the OECD of the notification by China that Hong Kong has completed its internal procedures for the entry into effect of the provisions of the MLI.
• With respect to all other taxes—The changes apply to taxes levied with respect to tax periods beginning on or after the expiration of a period of six calendar-months from 30 days after the date of receipt by the OECD of the notification by China that Hong Kong has completed its internal procedures for the entry into effect of the provisions of the MLI.

The potential impact of the MLI implementation on Hong Kong resident business groups will largely depend on the treaty jurisdictions where the groups are investing in or doing business with, as the changes brought by the MLI will vary from treaty to treaty.

Among the various changes brought by the MLI to Hong Kong’s income tax treaties, the most significant one will be the addition of the PPT to those Hong Kong tax treaties that currently do not contain such test or any other limitation of benefits provisions. The most affected treaties include those with Belgium, Ireland, Luxembourg, Malaysia, Thailand, the United Arab Emirates, and Vietnam. The newly added PPT will be applicable to all articles in the treaties, including the articles concerning dividends, interest, royalties, capital gains, and other income articles.

Hong Kong resident business groups that are receiving dividends, interest or royalties from the most affected tax treaty jurisdictions or planning to divest their investments in these jurisdictions need to review their existing holding and investment structures; assess the risks of treaty benefit denial resulting from the application of the PPT; and consider whether any changes to the current structures would be desirable.

Foreign resident entities seeking to obtain a treaty benefit (for instance, a reduced rate of withholding tax on royalties) from Hong Kong under a tax treaty could also evaluate whether the current structure or arrangement can withstand any potential challenges from the Hong Kong Inland Revenue Department under the PPT. 

For more information, contact a KPMG tax professional:

David Ling | davidxling@kpmg.com