News Flash Hong Kong

The proposed relaxation of deduction of foreign for purpose

March 19, 2021 Issue 2

In brief

The Inland Revenue (Amendment) (Miscellaneous Provisions) Bill 20211 (the Bill) was gazetted on March 19, 2021. The Bill, among other things, seeks to amend the (IRO) to enhance the deduction of foreign taxes for profits tax purposes as a means for relieving in Hong Kong. Upon enactment of the Bill, the revised rules on foreign tax deduction will take effect from the year of assessment 2021/22.

This News Flash focuses on the proposed revised rules for foreign tax deduction in Hong Kong. For other matters addressed in the Bill, namely the tax treatment for amalgamation of companies under the court-free procedures, the tax treatment for transfer or succession of specified assets under certain circumstances and the statutory framework for furnishing of tax returns (including e-filing of profits tax returns), please refer to our upcoming Hong Kong Tax News Flashes, April 2021, Issue 3 and 4.

In detail Foreign tax deduction rules in Hong Kong

The existing rules and practice

The Inland Revenue Department (IRD) revised the Departmental Interpretation and Practice Notes No. 28 – Deduction of Foreign Taxes (revised DIPN 28) in July 20192. Based on the revised DIPN 28, the following rules apply for deduction of foreign taxes for profits tax purposes:

• foreign taxes paid on profits or income, including withholding taxes (WHT) on royalties, licensing fees and service fees, are not deductible under section 16(1) of the IRO;

• foreign taxes paid (by either a Hong Kong or non-Hong Kong resident person) on specified interest, gains and profits3 are deductible under section 16(1)(c) of the IRO, provided that they are paid in a jurisdiction which does not have a double taxation agreement (DTA) in force with Hong Kong (i.e. non-DTA jurisdiction); and

• other foreign taxes and duties which are not calculated by reference to profits or income (e.g. goods and services tax and value added tax) can be deductible under section 16(1).

For foreign WHT paid on an income by a Hong Kong resident person in a DTA jurisdiction, despite no deduction is allowed, double tax relief may be available by means of a under the applicable DTA if the same income is subject to profits tax in Hong Kong.

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The proposed changes to the existing rules

The Bill proposes the following changes to the existing foreign tax deduction regime:

1. section 16(1)(c) will basically remain the same providing deduction of foreign taxes in respect of specified interest, gains and profits3 for both a Hong Kong resident person or a non-Hong Kong resident person who paid taxes on such income in a jurisdiction outside Hong Kong, subject to the conditions in section 16(2J) and section 50AA.

2. section 16(1)(ca), a new provision, is added to provide deduction of foreign taxes paid by a Hong Kong resident person or a non-Hong Kong resident person on its income if it is proved to the Commissioner’s satisfaction that “specified taxes”4 are paid in a jurisdiction outside Hong Kong in respect of such income chargeable to profits tax in Hong Kong, subject to the conditions in section 16(2J) and section 50AA.

3. both section 16(1)(c) and the newly added section 16(1)(ca) are subject the conditions specified in the revised section 16(2J) and section 50AA. As such, deductions under sections 16(1)(c) and 16(1)(ca) are not available for a Hong Kong resident person in respect of foreign taxes paid in a DTA jurisdiction. Under the existing IRO provisions, tax credit for foreign taxes paid by a Hong Kong resident person is available under section 50A.

4. the revision of section 16(2J) has the effect of extending the existing deduction of foreign taxes paid in respect of specified interest, gains and profits3 under section 16(1)(c) to non-Hong Kong resident persons who paid such taxes in a jurisdiction outside Hong Kong that is a DTA jurisdiction. Deduction is available for both Hong Kong and non-Hong Kong resident persons who paid such taxes in a non-DTA jurisdiction under the existing section 16(1)(c).

5. for a non-Hong Kong resident person, section 50AA(2A) is added specifying deduction under section 16(1)(c) or 16(1)(ca) is further subject to the condition that the person had taken all foreign tax minimisation steps in the jurisdiction where the income is received or receivable (i.e. source jurisdiction) and in the residence jurisdiction of that person, including double tax relief in its residence jurisdiction. If relief of the amount of foreign taxes paid in the source jurisdiction is available in the residence jurisdiction of the non-resident person after taking all the foreign tax minimisation steps, section 50AA(2A) further limits the deduction under section 16(1)(c) or 16(1)(ca) to the extent of the portion of foreign taxes that are not entitled to relief in the residence jurisdiction.

Subject to the enactment of the Bill, the revised rules for foreign tax deduction will take effect from the year of assessment 2021/22. PwC observations • The table below summarises the double tax relief available for foreign taxes paid on (a) specified interest, gains or profits under section 16(1)(c)3 and (b) other gross income in different scenarios under the existing and proposed revised deduction rules: Double tax relief Foreign taxes paid in a DTA jurisdiction Foreign taxes paid in a non-DTA jurisdiction

HK residents Non-HK residents HK residents Non-HK residents

Tax credit Available Not available Not available Not available (no change) under section 50 Tax deduction Not available Not available Available under section Available under section (existing rules) 16(1)(c) for (a) 16(1)(c) for (a) Not available for (b) Not available for (b)

Tax deduction Not available Available under sections Available under sections Available under sections (proposed rules) 16(1)(c) for (a) or 16(1)(c) for (a) or 16(1)(ca) 16(1)(c) for (a) or 16(1)(ca) 16(1)(ca) for (b), subject to for (b), subject to the for (b), subject to the the restrictions mentioned restrictions mentioned in restrictions mentioned in in (5) above (3) above (5) above

Note: Granting of double tax relief by way of a tax credit or deduction will be subject to the ”foreign tax minimisation” condition specified in section 50AA i.e. the claimant needs to have taken all reasonable steps to minimise the foreign tax payable before a double tax relief is sought.

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• As shown in the table above, the proposed amendments do not change the tax treatment of Hong Kong resident persons who have paid foreign taxes on gross income in a DTA jurisdiction, i.e. such persons can only claim a tax credit under the applicable DTA and no deduction of the foreign taxes paid is available.

• The proposed amendments to the foreign tax deduction rules would address the following situations of double taxation:

Situation 1

A Hong Kong company has paid e.g. WHT on royalty income in Jurisdiction A, which is a non-DTA jurisdiction. Assuming the same royalty income is subject to profits tax in Hong Kong.

Based on the proposed amendments, the Hong Kong company may claim a tax deduction in Hong Kong for the WHT paid in Jurisdiction A.

Situation 2

A Hong Kong branch of an overseas entity (e.g. a bank) has paid WHT on certain gross income (e.g. interest income) in Jurisdiction A (which can be a DTA or non-DTA jurisdiction). Assuming the same income is subject to profits tax in Hong Kong. The overseas entity is a tax resident of Jurisdiction B which exempts foreign income attributed to a (PE) located overseas. Since Jurisdiction B does not tax the income, the entity is not able to claim any relief in Jurisdiction B for the WHT paid in Jurisdiction A.

Based on the proposed amendments, the Hong Kong branch may claim a tax deduction in Hong Kong for the WHT paid in Jurisdiction A.

The takeaway

We welcome the proposed changes to foreign tax deduction rules as they would address the double taxation issue currently faced by Hong Kong taxpayers in the two situations discussed above. Allowing deduction for foreign tax not in the DTA context is a domestic tax issue and should not be considered as not in accordance with any DTA. The proposed relaxation of deduction for foreign taxes should be conducive to developing Hong Kong as an intellectual property or a service hub in the region.

As the new rules will only take effect from the year of assessment 2021/22 but not retrospectively, there should be cases where Hong Kong taxpayers may have been exposed to double taxation as a result of the revision of the IRD’s assessing practice specified in the revised DIPN 28 in the years of assessment 2019/20 and 2020/21. We hope the IRD could consider taking a pragmatic approach and allowing a deduction of foreign taxes paid by these taxpayers during the transition period where appropriate as an interim measure before the new rules come into effect.

Endnotes

1. The Bill can be accessed via this link: https://www.gld.gov.hk/egazette/pdf/20212511/es32021251114.pdf 3 PwC News Flash Hong Kong Tax

2. Please refer to our Hong Kong Tax News Flash, August 2019, Issue 7, for a more detailed discussion on the revised DIPN 28 and the IRD’s existing assessing practice via this link: https://www.pwchk.com/en/hk-tax-news/2019q3/hongkongtax-news-aug2019-7.pdf

3. Such interest income, gains and profits include (1) Hong Kong sourced interest income derived by a corporation or a person other than a corporation carrying on a or business in Hong Kong, (2) interest income derived by a financial institution through or from the carrying on of its business in Hong Kong, (3) interest income derived by a corporation through or from the carrying on of its intra-group financing business in Hong Kong and (4) gains or profits from sale or other disposal or redemption of a certificate of deposit, bill of exchange or regulatory capital security in certain circumstances, which are deemed as taxable in Hong Kong under section 15(1) of the IRO.

4. Specified tax means tax imposed by a jurisdiction outside Hong Kong on a person that is (1) of substantially the same nature as profits tax, (2) charged on a certain percentage of gross income without deduction for outgoings and expenses and (3) not in respect of specified interest, gains or profits under section 16(1)(c)3.

Let’s talk

For a deeper discussion of how this impacts your business, please contact:

PwC’s Leaders based in Hong Kong

Charles Lee Jeremy Ngai Jeremy Choi +852 2289 8899 +852 2289 5616 +852 2289 3608 [email protected] [email protected] [email protected]

Rex Ho Cecilia Lee Jenny Tsao +852 2289 3026 +852 2289 5690 +852 2289 3617 [email protected] [email protected] [email protected]

Kenneth Wong +852 2289 3822 [email protected]

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In the context of this News Flash, China, Mainland China or the PRC refers to the People’s Republic of China but excludes Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region. The information contained in this publication is for general guidance on matters of interest only and is not meant to be comprehensive. The application and impact of laws can vary widely based on the specific facts involved. Before taking any action, please ensure that you obtain advice specific to your circumstances from your usual PwC’s client service team or your other tax advisers. The materials contained in this publication were assembled on March 19, 2021 and were based on the law enforceable and information available at that time. This News Flash is issued by the PwC’s National Services in Mainland China and Hong Kong, which comprises of a team of experienced professionals dedicated to monitoring, studying and analysing the existing and evolving policies in taxation and other business regulations in China, Hong Kong, Singapore and Taiwan. They support the PwC’s partners and staff in their provision of quality professional services to businesses and maintain thought-leadership by sharing knowledge with the relevant tax and other regulatory authorities, academies, business communities, professionals and other interested parties. For more information, please contact: Long Ma +86 (10) 6533 3103 [email protected] Please visit PwC’s websites at http://www.pwccn.com (China Home) or http://www.pwchk.com (Hong Kong Home) for practical insights and professional solutions to current and emerging business issues.

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