On 3 June 2016, the HKSAR Government gazetted the Inland Revenue (Amendment) (No. 2) Ordinance 2016 (the new law) that sought to attract multinational and mainland China enterprises to establish corporate treasury centres (CTCs) in Hong Kong by amending the Hong Kong Inland Revenue Ordinance (IRO).
We welcome the enactment of the new law which will enable Hong Kong to compete regionally as a CTC hub and support Hong Kong's position as a leading international financial centre.
The New Law
1. New deduction section for interest paid to non-Hong Kong associated corporations
The new law removes the asymmetrical tax treatment of interest income and expense that CTCs currently face. Before the new law was passed, a CTC would not be able to claim a tax deduction for interest paid on money borrowed from an overseas associated corporation which was not a financial institution and in whose hands the interest income would not have been subject to tax in Hong Kong. This is regardless the money borrowed was used to generate taxable profits in Hong Kong. In fact, interest income from the CTC's on-lending activities in Hong Kong would normally be chargeable to tax in Hong Kong.
Subject to satisfying certain prescribed conditions, the newly added section i.e. section 16(2)(g) of the IRO provides that interest paid by a corporation, which carries on an intra-group financing business in Hong Kong, to its overseas associated corporations will be tax deductible.
One of the key prescribed conditions is that the interest income received by an overseas associated corporation is "subject to tax" in a territory outside Hong Kong. In this regard, the CTC incurring the interest expense has to demonstrate to the satisfaction of the Commissioner of Inland Revenue (CIR) that overseas tax of a nature similar to Hong Kong profits tax has been paid or will be paid by the overseas associated corporation in respect of the interest or sum concerned at not less than the applicable rate of either 8.25% (see point 2 below) or 16.5%.
However, the application of this newly added section is further subject to two newly added specific anti-avoidance provisions contained in sections 16(2CA) and 16(2CC) of the IRO. Briefly, section 16(2CA) concerns arrangements under which an overseas associated corporation passes the interest received to a related person which is not subject to tax in Hong Kong or overseas, or if subject to tax, the rate is less than the applicable rate, whilst section 16(2CC) deals with arrangements where the utilization of tax losses in Hong Kong is a main purpose.
2. Concessionary tax rate (i.e. 8.25%) for qualifying profits of a qualifying CTC
In addition to allowing a tax deduction for interest paid, the new law also grants tax incentives to CTCs in the form of a 50% concessionary rate for qualifying profits of a qualifying CTC under the newly added sections 14C to 14F of the IRO.
A CTC would be regarded as a qualifying CTC if it is a corporate entity solely dedicated to the conduct of one or more of the following corporate treasury activities: (1) carrying on an intra-group financing business; (2) providing corporate treasury services; or (3) entering into corporate treasury transactions.
Where the CTC undertakes other activities in Hong Kong, in addition to the abovementioned specified corporate treasury activities, it may still be regarded as a qualifying CTC if it satisfies the prescribed safe-harbor rules, or if it has obtained the CIR's determination. The safe-harbor rules refer to the conditions that the relevant profit derived from, and assets employed in, the CTC operations have to be both not less than 75% of the total profit derived and total assets employed by the CTC.
A qualifying CTC can make an election in writing to have its qualifying profits taxed at the concessionary tax rate of 8.25% (i.e., 50% of the normal rate of 16.5%). Once such an election is made, it is irrevocable for as long as the corporation remains as a qualifying CTC. The CTC is required to make a new election if it fails to qualify as a qualifying CTC in a particular year but becomes eligible again in a subsequent year.
Qualifying profits generally refer to profits accruing to a CTC in respect of any one of the above three specified corporate treasury activities undertaken by the CTC for its non-Hong Kong associated corporations and in respect of which no tax deductions were claimed in Hong Kong by any person as regards the sums received by the CTC. Otherwise, the amount of qualifying profits will be reduced by the amount so deducted in Hong Kong.
3. New deeming provisions for interest and related income of CTCs
As a result of the relaxation of the interest deduction rules discussed above, the new law also contains provisions deeming or clarifying that interest income on loans and related income in respect of certificates of deposit, bills of exchange and regulatory capital securities earned by a corporation carrying on an intra-group financing business in Hong Kong, will be chargeable to profits tax in Hong Kong under sections 15(1)(ia) and (la).
The deeming provisions will apply regardless that the "provision of credit" of the loans may be made outside Hong Kong and that the relevant contracts for disposal, redemption or presentation of the instruments concerned may be effected outside Hong Kong.
4. Effective dates
Section 16(2)(g) in respect of interest deductions and sections 14C to 14F in respect of the concessionary tax rate for CTCs will apply retrospectively to sums paid, received or accrued on or after 1 April 2016.
The new deeming provisions for the relevant interest income and profits derived from an intra-group financing business in Hong Kong under sections 15(1)(ia) and 15(1)(la) will only apply to sums received or accrued on or after the new law is gazetted.
It should be noted that the new interest deduction rules contained in section 16(2)(g) and the deeming provisions contained in sections 15(1)(ia) and 15(1)(la) apply to any corporation which carries on an intra-group financing business in Hong Kong, i.e., the application of these sections is not restricted to a qualifying CTC.
A practice note on the new law is expected to be issued by the Hong Kong Inland Revenue Department shortly.
The application of the new law could be complicated in certain circumstances. Taxpayers should seek professional tax advice where necessary.
Disclaimer: The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.