Hong Kong plans to adopt OECD’s standard on international tax transparency. Roddy Sage investigates how would that be carried out: who gets the certificate of residence—the alibi for cross-border taxation?
Prior to the conclusion of Hong Kong’s first comprehensive double taxation treaty (CDTA), the Inland Revenue Department (the Department) adopted a fairly relaxed attitude towards international tax issues. Hong Kong taxpayers did not pay tax on offshore income, there being a pragmatic attitude as to what constituted “income” arising in or derived from Hong Kong. Little attention was paid to transfer pricing, there were no debates as to which exchange of information clause to adopt in negotiations with treaty partners, and there was no obligation to enter into Taxation Information and Exchange Agreements with non-treaty partners.
Gradually, under pressure from the OECD and the G20, the Department has arguably ceded authority for regulating its international tax issues to the OECD. It now seems as if Hong Kong and the world are answerable to the international tax police and to politicians hoping for additional tax revenues to support budget deficits caused by excessive government spending.
The two latest chapters in this delegation of authority are the granting of a Certificate of Residence (COR) and the Automatic Exchange of Financial Account Information in Tax Matters (AEOI).
In order to obtain benefits under a CDTA, a person needs to be a resident of one of the countries to which the treaty applies. Often, this needs to be confirmed to the tax administration of a treaty partner by requiring the Department to issue a COR. The definition of a Hong Kong resident in a typical CDTA, as applicable to a corporation, is:
“a company incorporated in the Hong Kong Special Administrative Region, or, if incorporated outside the Hong Kong Special Administrative Region, being centrally managed and controlled in the Hong Kong Special Administrative Region”
It is quite clear that a corporation incorporated in Hong Kong is entitled to a COR; there are no other qualifications required. However, the Commissioner of Inland Revenue, in its meeting with the Hong Kong Institute of Certified Public Accountants, stated:
COR would not be issued to companies that did not carry out any business in Hong Kong.
“It was vitally important for the IRD to uphold the terms and purpose of Hong Kong CDTA’s by not issuing CORs to those who were clearly not entitled to relief from foreign taxes, since the IRD had to act in good faith according to the terms of CDTA.”
When asked whether a COR would be issued to a company that, although incorporated in Hong Kong, had no physical presence in and was not controlled and managed in Hong Kong, the Commissioner remarked:
“Since such companies did not carry out any business activities, COR would not be issued… the IRD had to act in good faith in fulfillment of its obligation under a CDTA and a COR application would be rejected if a paper company was incorporated in Hong Kong merely to obtain treaty benefits.”
The interpretation of the definition of residence has led to detailed questions being asked of taxpayers, and to applications being rejected where the applicants could demonstrate that they had a physical presence in Hong Kong, i.e. premises, staff and administrative personnel with the authority to execute contracts etc. Clearly, this is not a requirement of the definition of a resident as stated in the CDTA. It would appear that rather than applying the form of the treaty and applying the word of the law in favour of its own residents, the Department has adopted its own interpretation in order to satisfy what it believes are its obligations to its treaty partners.
The second issue relates to the “Consultation Paper on Automatic Exchange of Financial Account Information Tax Matters in Hong Kong”.
In the Government’s press release, Professor K C Chan, the Secretary for Financial Services and the Treasury, remarked:
“Hong Kong will adopt a pragmatic approach to legislate for all essential requirements of the OECD standard of AEOI, and will ensure effective implementation of the new standards.”
Of the G20 members of the Global Forum of Transparency and Exchange of Information for Tax Purposes, over 90 have agreed to implement the OECD Standard for AEOI. Hong Kong has indicated that it will also adhere to this standard, based on its desire to be “a responsible member of the international community” and to “avoid being labelled as an ‘uncooperative’ jurisdiction, which will affect our position as an international centre”.
The change from providing information only on request to the automatic exchange of information will require legislative change. The consultative document is a question not of whether to adopt the OECD standard, but of how the necessary amendments will be incorporated into Hong Kong’s existing legislation.
Despite the importance and significance of Hong Kong as a financial centre, the Department has little or no alternative but to tow the line. The adoption of international standards assures Hong Kong that is not marginalised, but this does not give the Government permission to ignore the criterion that Hong Kong’s tax system should be simple and easy to administer. More importantly, the manner in which legislation is interpreted and applied should be driven not by an obligation to third parties but rather by the honest and judicial meaning given to Hong Kong law.
Executive Chairman of Equiom Hong Kong, Associate member of Institute of Taxation
Sage has over 30 years of experience in accounting, international tax planning and investment structuring, enhanced by considerable knowledge of cross-border, onshore and offshore transactions. He spent over 20 years with a ‘Big Four’ accountancy firm, 14 of which were as a partner, including 10 years as the Senior Tax Partner for Hong Kong and China. Sage co-founded AFP Holdings Limited; a corporate services and taxation advisory group located in Hong Kong. Following Equiom’s acquisition of both businesses in January 2015, Roddy was appointed Executive Chairman of Equiom Hong Kong.”]