New tax treaty between France and Hong Kong
Negotiations between Hong Kong and France had begun in September 2003 and started again in October 2009. A double taxation agreement (DAT) was signed on 21th october 2010 between France and Hong Kong.
This new DTA will certainly be effective on 1st of January 2012.
The special administrative region (« SAR ») of Hong Kong has a basic legislation including a basic tax treaty network while being one of the most sizeable trading, banking and financing centres worldwide.
After more than 20 years of economic reform, Hong Kong has become one of the most important financial markets for cross-border direct investments. Tax treaties haven’t moved Hong Kong closer to international tax norms. The goal of tax conventions is to increase investment and reduce tax avoidance. In the future, in negotiating tax treaties, Hong Kong will attempt to balance its right to participate in the gains accruing to foreign companies and the need to provide a flexible and attractive tax environment.
The past few years has shown many dramatics changes in the fortunes of every market place of the world, even the Hong Kong market. The collapse of Lehman Brothers in September 2008 triggered a sea of change in the global financial climate, and within just a few weeks, capital market activity dropped off a cliff, grounding fundraising to a halt, and the size and volume of existing deals were severely diminished.
Even as the situation is producing uncertainties, signs of improvement can be pointed out. Many changes are expected, particularly concerning worldwide financial flow and information on firm’s situations globally that is becoming more transparent. in this context,
Even if investors are taking a much more conservative approach and focusing on risk management, the new Tax convention could secure many new aspects of practicing investment in Hong Kong.
Hong Kong is actively conducting negotiations with many countries, in particular with France, but the main problem relates to exchange of information. Exchange of information under the 1995 OECD Convention is more restrictive because the Inland Revenue Department can only transfer information to third parties for a solely tax-related purpose with the consent of the Hong Kong government. Hong Kongis so far only prepared to go up to the 1995 OECD Model but no further than that.
Acceding to the 2005 OECD Convention would probably allow the SAR to conclude tax treaties with major economic players and raise its profile and competitiveness. Hong Kong had, previously signed only five double taxation treaties: with Belgium, Thailand, China, Luxembourg and Vietnam before the reform.
I. Reform: A Necessity
Recently, Hong Kong has adopted a reform of its legislation regarding the international exchange of information which put forward the conclusion of a tax treaty between France and Hong Kong. This would be the first Tax convention between both of these states.
Hong Kong, which is one of the world’s leading financial markets, has a basic tax treaty network. The legislative modifications of 2010 (the reform took place in HongKong on March 12
th, 2010) with the entry coming into force by the Inland Revenue Department. (Amendment, Ordinance No. 1 of 2010) could well change matters and allow European countries, including France, to benefit from the advantages relating to the conclusion of treaties intended to prevent double taxation.
First of all, this reform appeared to be necessary. The international financial world is becoming more transparent since the collapse of Lehman Brothers that triggered a sea of change in the global financial and economic climate. The fight against tax avoidance is presently a top priority for many states. For that reason, Hong Kong had to reform its legislation in order to facilitate the exchange of information in particular with European countries such as France.
The example of Singapore, that has modified its legislation at the end of 2009 and signed many protocols or amendments with more that fifteen of its trading partners, shows that its necessary for Hong Kong to change its legislation. Singapore is currently no longer included on the OECD »s grey list.
By the extension of its network of treaties, Hong Kong will facilitate exchanges with important economic partners since the reform takes place with improved worldwide tax transparency in Hong Kong that was signed in March 2010. Three new tax agreements with Brunei, The Netherlands and Indonesia, now permits Hong Kong to able to solidify several negotiations with other countries: United Kingdom, Italy, Ireland, Spain, and France (This Memo only concerns the tax convention betweenHong Kong and France).
II. The main innovation of this reform : The Exchange of Information Clause
The main disposition of this Convention is about exchange of information from tax authorities between both states. Hong Kong authorities will have prerogative to investigate even if they do not require the information requested for their own tax purposes. Some restrictions are existing in the new treaty (the information request must concern a tax coming under the scope of the exchange of information clause; the exchange of information must correspond to a detailed request of the foreign authorities and may be neither spontaneous nor automatic; no retroactive effects of the reform).
Further to the safeguard measures considered by the OECD model (concerned, in particular, confidentiality obligations and what the information may be used for), special dispositions have been adopted to protect the rights of the taxpayers to whom the information requests are delivered.
III. Other consequences and advantages concerning the conclusion of this treaty
Negotiations between Hong Kong and France had begun in September 2003 and started again in October 2009 (after a suspension in 2004 because of Hong Kong’s inability to adopt the 2004 version of the OECD model with respect to the exchange of information).
Negotiations have recommenced with France are now in their final stages. The imminent conclusion of the tax convention announced will certainly benefit both of the states and economies. It will promote reciprocal investment in the two countries and encourage enduring settlements. By reducing the risks of double taxation for companies and also for private individuals and by allowing French and Hong Kong investors to better evaluate their effective tax rate, the new tax convention will allow the various players to limit the negative tax impacts of the current legislation.
A. The elimination of tax disputes that hinder trade between France and HongKong
Allocation of taxation rights
France and Hong Kong have a territorial system for the taxation of profits (unlike most of the states that had chosen a worldwide system for the taxation of profits). In theory, situations in which companies incur double taxation of their profits should be limited. However, in practice, these risks are present, particularly since the notion of « tax residence » is not clearly defined inHong Kong legislation. Equally,, the notion of « Hong Kong source profits » include many uncertainties that have to be enlightened in order to offer greater security to French investors inHong Kong (and also to Hong Kong players in France)
Abolition or reduction of withholding taxes
Although no withholding tax is currently presented by Hong Kong in respect to dividends paid to a parent company located in France, dividends paid by a French subsidiary to a Hong Kongparent company are subject to a withholding tax of 25% in France. Such tax currently constitutes an outright loss for the parent company in Hong Kong because it cannot deduct it from its taxable income.
The future tax convention between France and Hong Kong would no doubt provide for a reduction or an abolition of withholding taxes concerning dividends, royalties, interest flow and capital gains.
Abolition or reduction of double taxation in relation to transfer pricing
When tax authorities intend to reassess the taxable income of a French company following a transfer of profits to a related entity located in Hong Kong, Hong Kong currently refuses to grant a correlative adjustment because of the nonexistence of a tax treaty. Therefore, by the conclusion of a tax treaty, greater security for the transfer pricing policy will be possible for international groups that locate part of their profits in Hong Kong.
The adjustment offered by the Hong Kong legislation on the basis of the treaty will not be systematically implemented however.
Even if tax authorities in Hong Kong will still be able to refuse an adjustment in considering that such an adjustment carried out in France is not sufficiently justified either in its principle or its amount, or if one of the entities concerned by the adjustment is in a tax loss position (Hong Kong does not recognize the existence of double taxation in this particular last case).
The risks of a reassessment in Hong Kong following a transfer pricing readjustment are more limited because of the absence of specific regulations. They are existing nevertheless in the case of French groups which try to locate part of their Hong Kongprofits in French entities that are operating structurally at a loss.
B. Possibilities of limitations of certain French anti-avoidance mechanisms
French black and grey lists of « non-cooperative » countries
France is one of the first States to have reinforced its internal mechanisms to tackle tax havens, by the creation of the concept of « non-cooperative » States (article 238-OA of the French tax code« FTC »). This article settles restrictive concrete measures in order to dissuade French firms from doing business with such States (abolition of the parent-subsidiary regime as from 1 January 2011, and an increase in the withholding tax rates in France to 50%).
Hong Kong is not on the French « black list » that was published on the 12th of February of this year. Willingness has been shown in recent months by HongKong to conform to the OECD’s international standards in relation to tax transparency and the exchange of information (characterized by the will to sign several conventions and by the modification of its legislation). It should be noted that this list is updated on the 1st of January of each year. Hong Kong’s non-inclusion on the black list will thus depend not only on the conclusion of a tax treaty with France, but a country could also be entered on such a list when it is accused of failing to cooperate on tax issues, and will be slapped by punitive taxes and certain financial transactions.
Towards a neutralization of French anti-abuse measures
The notion of « anti-abuse regulations » covers numerous laws, measures and practices in France. It aims to establish a just balance between the public interest in undertaking (tackling) abuse and the need to avoid restrictions on cross-border activities and also seeks to coordinate the application of anti-abuse measures in relation to third countries, in order to protect the tax bases in France.
Although Hong Kong is not on the French black list of « non-cooperative » countries, France still regards it as having a privileged tax regime. Even if this consideration could lead the application of anti-avoidance measures, the tax convention could make it more possible to reduce tax difficulties for French investors in Hong Kong.
The implementation of a tax treaty between France and Hong Kong could also limit the scope of article 209B of the FTC or 990E of the same code. This tax treaty could as well eliminate the risk of application of article 123 (bis) of the FTC (this article is applied for individuals). These articles complete French anti-avoidance devices by subjecting profits of branches and subsidiaries in which a French company holds a stake of more than 50% of corporate income tax in France (only when these entities are located in a low-tax country and do not provide proof of any truly industrial or commercial activity carried on locally). Nevertheless, Hong Kong shows with its recent reforms and willingness of concluding tax conventions, her wish to not be perceived as a tax haven. Regarding this, the double taxation treaty could favor French investments on its territory by rejecting the application of these mechanisms.
Trainee at Veirano Advogados, Brazil