Aircraft demand and the aircraft leasing industry in China has been growing rapidly. This growth is expected to continue and many leasing companies are keen to tap into this market. To grasp this opportunity, the Economic Development Commission under the Hong Kong government first urged the government to consider making Hong Kong an aviation leasing hub in 2013. In the 2015 Policy Address, the Hong Kong government announced its intention to develop Hong Kong's aerospace financing business so as strengthen Hong Kong's status as an international aviation and financing centre.
Despite the advantages of its geographical location, reliable legal system and well-developed financial centre, Hong Kong has yet to develop an attractive tax regime in order to compete with the long established leasing hubs of Ireland and Singapore. When compared to Ireland and Singapore, Hong Kong's current tax regime is not as appealing to leasing companies primarily for the following reasons:
(a) Corporate Tax Rates
The corporate tax rate in Hong Kong is 16.5%, whereas in Ireland it is 12.5% and in Singapore it is 5 to 10% only, depending on the satisfaction of certain conditions.
(b) Tax Depreciation Allowances
A Hong Kong lessor is not normally entitled to claim tax depreciation allowances in respect of aircraft acquisition costs for aircraft leased to non-Hong Kong based airlines. In other words, it is taxed on its gross lease rental income. However, in Ireland and Singapore, a lessor is entitled to claim tax depreciation on the cost of acquiring the aircraft and to offset that cost against its lease rentals. To put it in another way, it is taxed on its leasing profits only.
(c) Double Taxation Arrangements
A key commercial factor in the context of aircraft leasing is the withholding tax rate applicable to lease rentals. It is common for an aircraft lessor to pass the risk of withholding tax to its lessee by requiring its lessee to gross up the rental payments to make up the difference if withholding tax is applicable. Accordingly, if an aircraft lessor is based in a jurisdiction with more favourable withholding tax arrangements, it will be more popular with airlines. Each of Ireland and Singapore has an extensive double taxation arrangements network providing for favourable withholding tax reduction. Hong Kong has a long way to go to match the double tax arrangements offered by Ireland and Singapore to lessors.
As an important step to increase its competitiveness, Hong Kong and China signed the Fourth Protocol to the Arrangement for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income on 1 April 2014. Under this protocol, Hong Kong residents will have a further reduced cap (from 7% to 5%) on the withholding tax rate on aircraft leasing rentals received from mainland China, which is 1% lower than that offered by Ireland and Singapore. The Fourth Protocol will come into force after the completion of ratification procedures and notification by both sides.
It remains to be seen whether and how the Hong Kong government will reform the Hong Kong corporate tax regime for the aviation industry in support of its stated desire to make Hong Kong an aviation leasing hub.