In brief:
Upon enactment of the amended tax legislation on 12 March 2010 for adopting the latest international standard on exchange of information, Hong Kong is moving in full throttle to expand its comprehensive double tax arrangement ("CDTA") network. Eight new CDTAs have since been signed to increase the total number of signed CDTAs to thirteen as of 22 June 2010.
The expansion of CDTA network would promote bilateral and global business investment into and out of Hong Kong and open up vast opportunities for tax planning for international human capital movement and mitigation of double taxation. Equally important, it is high time for employers and employees to examine the sustainability of the tax filing positions adopted while they are embarking on the journey to the era of enhanced tax transparency.
The past 
Before 1997, Hong Kong did not enter into any CDTAs as it is not a sovereign state and it has been administering a territorial basis of taxation under its simple taxation regime with low tax rates. Subsequent to its reversion to Mainland China, the first CDTA (signed with Mainland China) came into effect in Hong Kong on 1 April 1998. By year 2008, in a decade's time, only four more CDTAs had been signed, namely with Belgium, Thailand, Luxembourg and Vietnam.
Although there were treaty negotiations with a few European countries including the United Kingdom and France, CDTAs were successfully signed with Belgium (2003) and Luxemburg (2007). One of the reasons for dragging back Hong Kong in the expansion of CDTA network was partly inherent in its tax law in which the Inland Revenue Department ("IRD") cannot collect any tax information unless it is for domestic tax purposes. Because of this domestic law limitation, Hong Kong has been adopting the 1995 version of Exchange of Information ("EoI") article of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention such that the IRD may refuse to collect and supply information requested by a CDTA contracting party if the IRD does not need it for domestic tax purposes. However, this would be in mismatch with the international trend of adopting the 2004 OECD EoI article under which a country has the obligation to gather and provide the information requested by a CDTA contracting party irrespective of whether there is a domestic tax interest.
The catalyst for expanding Hong Kong's CDTA network came following the Group of Twenty's ("The G20") meeting held in April 2009. The G20 threatened sanctions on uncooperative tax jurisdictions and financial centres that do not co-operate on tax issues or fail to help in cross-border tax evasion cases. If Hong Kong does not implement transparency measures to help stopping tax evasion by residents of other tax jurisdictions, it could be put on the "Grey List" (i.e. tax havens or other financial centres that have committed to the internationally agreed tax standard but have not yet substantially implemented it) and be subject to sanctions. In this regard, Hong Kong is required to have 12 CDTAs with the 2004 OECD EoI article by end of year 2010.
As soon as the tax legislation was amended in March 2010, Hong Kong has entered into eight new CDTAs (namely with Brunei, The Netherlands, Indonesia, Hungary, Kuwait, Austria, the United Kingdom and Ireland) and updated the CDTA with Mainland China, with the 2004 OECD EoI article, by 22 June 2010. Hong Kong is also in the process of updating the remaining four "old" CDTAs with the 2004 OECD EoI article. In addition, the government has also concluded negotiation of CDTAs with France, Liechtenstein and Japan, and more CDTAs are in the pipeline.
CDTAs signed based on the 1995 OECD Eol article
(All the 4 CDTAs are already effective) |
| Belgium, Thailand, Luxembourg and Vietnam |
CDTAs signed based on the 2004 OECD Eol article
(Except the CDTA with Mainland China, all the remaining 8 CDTAs are not yet effective) |
Mainland China [note], Brunei, The Netherlands, Indonesia, Hungary, Kuwait, Austria, United Kingdom and Ireland
[note]: The 3rd Protocol was signed on 27 May 2010 to update the EoI article to the 2004 OECD EoI article |
Domestically, the Departmental Interpretation and Practice Notes ("DIPN") No. 47 was issued by the IRD on 10 June 2010 to provide guidelines on the implementation of exchange of information and the related safeguards.
From the individual tax perspective, an individual would be able to utilise the treaty benefits under a CDTA to enjoy full exemption of employment income ("the 183-day exemption") and tax credit to mitigate the extent of double taxation, provided that he qualifies as a tax resident and satisfies other requisite conditions provided under the CDTA. It is also provided under a CDTA on the treatment of other sources of income derived from other capacities, which may include directors' fees, independent personal service, artistes and sportsmen, pensions, government service, students, etc.
To qualify for the 183-day exemption of employment income, the following three conditions must be satisfied:
- The individual is present in the other Party for a period or periods not exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the taxable period concerned;
- The remuneration is paid by, or on behalf of, an employer who is not a resident of the other Party; and
- The remuneration is not borne by a permanent establishment ("PE") [or a fixed base] which the employer has in the other Party.
Under the CDTAs signed with Belgium and the United Kingdom, it is also necessary to satisfy the 4th condition which requires that the remuneration is taxable in the Party to which the individual is a tax resident according to the laws in force in that Party.
For individuals who are liable to Hong Kong Salaries Tax ("HKST") on their employment income but qualify to utilize the 183-day exemption to be exempt from HKST, they are required to lodge a claim for such exemption in their annual Individual Tax Returns, which is subject to the IRD's review and approval.
For individuals who are tax resident of Hong Kong and who wish to utilize the 183-day exemption to exempt their employment income in a CDTA contracting party of Hong Kong, it is important to understand the local rules and requirements for utilizing the 183-day exemption, such as the record filing requirement effective from 1 October 2009 in Mainland China.
Besides the above tax administration requirements, due care should be exercised to review (i) the assignees' tax residency, (ii) the day counting methodology which has to be supported by accurate travel record, (iii) the cost recharge and (split) payroll arrangement and (iv) the PE exposures. These factors would have an impact on the individuals' eligibility to the 183-day exemption and should be reviewed carefully.
To be effective in managing the overseas tax exposures of frequent travellers and international assignees, an accurate travel tracking system would be indispensible. It is also important to understand correctly the thresholds of physical presence for income exemption under the latest local tax regulations in addition to that for the 183-day exemption under CDTAs, in order to maximize the tax saving opportunities that could be generated from upfront planning on the timing and duration of business travel and international assignments.
Aside from the individual tax concern, companies should leverage on the travel tracking system to put in place a mechanism to monitor the duration of projects and connected projects that its employees are working on in the overseas tax jurisdictions for the purpose of mitigating the potential PE exposures, since the existence of a PE would affect the individual's eligibility for the treaty benefit even though they do not exceed the 183-day threshold and would also trigger potential corporate tax exposures.
The increase in transparency of tax information would lead to a higher risk of challenge from the Hong Kong and overseas tax authorities. Under the amended tax legislation, the IRD assessor can now collect information concerning tax of a foreign territory with which Hong Kong has a CDTA, a Magistrate can issue search warrants for information concerning tax of a foreign territory with which Hong Kong has a CDTA, and it is now an offence if a person, without reasonable excuse, gives any incorrect information in relation to any matter or thing affecting the person's own liability (or the liability of any other person) to any tax of a foreign territory with which Hong Kong has a CDTA. This amendment is to remove the stumbling block for Hong Kong to conclude a CDTA which contains provision for the exchange of tax information irrespective of whether there is a domestic tax interest.
In light of the heightened risk of tax challenge, employers and employees may wish to conduct a health check on the past and present tax positions taken in Hong Kong and overseas, focusing on the following areas:
- Filing position (e.g. split contract arrangement, tax planning implemented).
- Employees' eligibility for full or partial exemption.
- Sourcing of and the trailing tax liability on bonus, equity compensation, post-departure termination payments, tax equalization settlement, etc.
- Feasibility to incorporate tax planning opportunities in line with the latest tax regulations and practices.
Companies should start revisiting their local and global tax and mobility policies concerning employees moving into and out of Hong Kong to tap into the widening choices of tax planning opportunities in Hong Kong's expanding CDTA network. They are recommended to concurrently review the various areas in tax filing and tax planning to identify and mitigate any inherent tax risk exposures that would become more vulnerable as Hong Kong is embracing the latest internationally accepted EoI standard to become a transparent tax jurisdiction. Last but not the least, a reliable travel tracking system should be put in place to serve the dual purpose of (i) upfront individual tax planning on the timing and duration of business travel and international assignments and (ii) mitigation and management of PE exposures arising from employees working on projects and connected projects overseas.
