News Flash. Hong Kong Tax. Mexico became the first North American country that signed a tax treaty with Hong Kong. August 2012 Issue 7

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1 News Flash Hong Kong Tax August 2012 Issue 7 Our International Tax Advisory Team Contacts Nick Dignan Tel: nick.dignan@hk.pwc.com David Smith Senior Advisor Tel: david.g.smith@hk.pwc.com Jeremy Ngai Tel: jeremy.cm.ngai@hk.pwc.com Kenneth Wong Tel: kenneth.wong@hk.pwc.com Scott Lindsay Tel: scott.lindsay@hk.pwc.com Our International Tax Advisory team provides professional advice on a wide range of cross-border investment activities including inbound and outbound structuring, cross border financing, managing investment funds and global mergers and acquisitions. With a strong global network, our local international tax specialists can provide dynamic and robust tax solutions to multi-jurisdictions business operations of our clients. Mexico became the first North American country that signed a tax treaty with Hong Kong Hong Kong signed a comprehensive double tax agreement ( CDTA ) with Mexico on 18 June The CDTA with Mexico ( the HK/Mexico CDTA ), being the first treaty signed by Hong Kong with a North American country, includes a number of unique features as compared to the other treaties signed by Hong Kong. This News Flash highlights the key features of the HK/Mexico CDTA, shares our observations on some of its distinctive features and provides an update on the latest status of Hong Kong s treaty network. Salient features of the CDTA with Mexico 1. Effective date Jurisdiction Effective date Hong Kong Depending on when the CDTA enters into force; the earliest possible date is 1 April 2013 Mexico Depending on when the CDTA enters into force; the earliest possible date is 1 January Withholding tax ( WHT ) rates on passive income The table on the next page provides a comparison of the non-treaty and treaty withholding tax rates on dividends, interest,

2 from a perspective of a Hong Kong resident company deriving income from Mexico. Dividends Interest Royalties Professional service fees Mexico non-treaty rate Nil 0 to 30% 1 5 to 30% 2 Nil or 25% 3 HK/Mexico treaty rate 4 Nil 0/4.9/10% 5 10% 6 0% 7 Notes 1. The WHT rate depends on the type of payer/recipient of the interest payment and the type of loan/instrument from which the interest is paid. For example, interest paid on loans with duration of 3 or more years granted or guaranteed by certain governmental financial entities is exempt from WHT. Interest paid to duly registered foreign banks is subject to WHT at 10% in general but the rate is currently reduced to 4.9% under the domestic transitory laws for registered banks resident in countries which are a treaty partner of Mexico. The same reduced rate for banks is included in the HK/Mexico CDTA (see note 5 below). The 30% WHT will reduce to 29% in 2013 and then to 28% in 2014 and subsequent fiscal years. 2. The WHT rate depends on the type of intellectual property concerned. For example, the WHT rate for (1) use of any copyright of scientific, literary or art work; (2) use of any scientific, commercial or industrial equipment; or (3) payments for transmission via satellite, cable and optic fibre, etc. is 25% whereas the WHT rate for patents, trademarks and brand names, etc. is 30% for The 5% WHT applies for the use of railroad cars. 3. The 25% WHT applies if the source of wealth is considered to be located within Mexico, i.e. when the service is rendered therein. The service is presumed to be rendered in whole within Mexico when partially proven to be rendered in Mexico, unless the taxpayer demonstrates that part of the service was rendered abroad, in which case the tax should be computed only on the part of the consideration corresponding to the proportion in which the service was rendered in Mexico. The service is also deemed to be rendered in Mexico, absent proof of the contrary, when the payment for the said service is made by a Mexican resident to a foreign related party. 4. See "Limitation of benefit / domestic anti-avoidance provisions" below. 5. The 0% rate applies to (1) interest received or paid by the HKSAG Government or other agreed governmental institutions or (2) interest arises in Mexico and is paid in respect of a loan for a period or not less than 3 years granted by a governmental financial institution as agreed from time to time (e.g., by Banco Nacional de Comercio Exterior, S.N.C., Nacional Financiera, S.N.C. or Banco Nacional de Obras y Servicios Públicos, S.N.C.). The 4.9% rate applies if the beneficial owner is a bank. The 10% rate applies in all other cases. 6. The term royalties as used in the HK/Mexico CDTA is extended to cover, inter alia, (1) considerations for the reception of (or right to receive) or certain use (or right to use) of visual images and/or sounds for the purpose of transmission by satellite, cable, optic fibre or similar technology and (2) gains from alienation of any right or property mentioned in the royalties article where the gains are contingent on the productivity, use or disposition of such right or property. 7. The 0% rate applies when a Hong Kong resident company performs services in Mexico without creating a permanent establishment in Mexico. 3. Definition of resident A company incorporated in Hong Kong is automatically a Hong Kong resident under the HK/Mexico CDTA. For a company incorporated outside Hong Kong, the company will be treated as a Hong Kong resident if it is normally managed or controlled in Hong Kong. In addition, the protocol to the HK/Mexico CDTA specifically includes a trust from the definition of a person in relation to Hong Kong in applying the CDTA. Practically, this means that a trust that is normally managed or controlled in Hong Kong will be regarded as a Hong Kong resident and covered by the CDTA when investing or carrying on business in Mexico. In cases of dual residency (i.e. where a person other than an individual is a resident of both Hong Kong and Mexico according to the provisions of the CDTA), there is no tie-breaker rule specified in the CDTA and the issue has to be settled by mutual agreement between the competent authorities of both contracting parties. In the absence of such agreement, no treaty benefit will be granted. Similar provisions can be found in the treaties Hong Kong signed with Hungary, Japan and the Netherlands. 4. Permanent establishment ( PE ) In addition to the usual provisions on fixed place PE, the HK/Mexico CDTA also includes provisions on construction site and service PEs. That is, a Hong Kong resident will have a PE in Mexico if its building site, construction, assembly or installation project or related supervisory activities in Mexico last more than six months or if it furnishes services (including consultancy services) within Mexico for a period or periods aggregating more than 183 days within any 12-month period. In computing the duration of activities for construction site or service PE purposes, the activities carried on by enterprises associated with the Hong Kong resident will have to be taken into account if the activities of both the Hong Kong resident and the associated enterprises are identical or substantially similar. News Flash Hong Kong Tax 2

3 As far as agency PE is concerned, in addition to an agent having and habitually exercising an authority to conclude contracts in Mexico in the name of a Hong Kong enterprise, an agent without such authority but habitually maintains a stock of goods or merchandise in Mexico from which he regularly delivers goods or merchandise on behalf of a Hong Kong enterprise will also constitute a PE of the Hong Kong enterprise in Mexico. This is in accordance with the provisions on agency PE in the United Nations ( UN ) Model Tax Convention. Similar agency PE provisions can be found in the treaties Hong Kong signed with Indonesia and Malaysia. One distinctive feature of the HK/Mexico CDTA is that insurance activities are carved out from the scope of the PE and business profits articles (Article 5 of the Protocol to the HK/Mexico CDTA). That is, the provisions in these two articles will not affect the domestic laws on taxation of any income derive from any form of insurance activities. Special provisions on insurance enterprises are also included in the PE article of other Mexican treaties such as those signed with China, Japan, Singapore and the US. The effect of this is a Hong Kong insurance company can be regarded as having a PE in Mexico (as pursuant to the domestic laws of Mexico) if it engages in activities of insuring risk or collecting premiums in Mexico through a party other than an independent agent. 5. Taxing right of business profits According to the business profits article of the HK/Mexico CDTA, Mexico has taxing right on: (1) the profits attributable to a Mexican PE of a Hong Kong enterprise; and (2) the profits attributed to sales in Mexico of goods or merchandise of the same or similar kind as those sold through that Mexican PE. The taxing right in (2) above is stipulated in the UN but not the OECD Model Tax Convention. Mexico reserves the right to tax the business profits derived from the sale of goods or merchandise carried out directly by the home office (of the PE) situated in the other contracting state (i.e. the home office situated in Hong Kong), provided that those goods or merchandise are of the same or similar kind as those sold through the PE. Nevertheless, the rule will not apply when the Hong Kong enterprise can prove that the sales have been carried out for reasons other than obtaining a benefit under the CDTA. The taxing right in (2) above should only be seen as a safeguard against abuse and not as a general force of attraction principle. 6. Capital gains Under the domestic law of Mexico, capital gains derived by a non-resident from the disposal of shares in a Mexican company are generally subject to a tax of 25% (election may be made to pay tax at 30% on the net taxable profits if certain requirements are met). Also, when more than 50% of the book value of shares to be transferred arises, directly or indirectly, from real property located in Mexico, including cases where the shareholding is structured in different tiers, the gains from the transfer are considered Mexican source income subject to income tax. Exemption from taxation may apply for sale of shares through the Mexican Stock Exchange or sale of government securities. The HK/Mexico CDTA does not provide exemption for gains derived from the sale of shares in a Mexican company. For gains derived from the sale of shares of a company deriving more than 50% of its asset value directly or indirectly from immovable property situated in Mexico, the HK/Mexico CDTA also allows Mexico to tax such gains. An exemption for transfer of the shares between group companies is included in the CDTA provided that certain specified conditions are met and the cost of the shares is rolled over in any subsequent transfer. 7. Limitation of benefit / domestic anti-avoidance provisions The beneficial owner requirement is present in both the interest and royalties articles in the HK/Mexico CDTA. The protocol to the HK/Mexico CDTA also contains anti-abuse provision in respect of the dividends, interest and royalties articles that targets at back-to-back arrangement involving a conduit company. News Flash Hong Kong Tax 3

4 The provision, which is similar to that found in the CDTA between Hong Kong and Switzerland, denies treaty benefits under the dividends, interest and royalties articles if: (1) a transaction or series of transactions is structured in such a way that a Hong Kong resident receiving dividend/interest/royalty income from Mexico pays, directly or indirectly, at least 50% of that income (at any time or in any form) to another person who is not a resident of either contracting party and who, if receiving that income directly from Mexico, would not be entitled to the same (or more favourable) benefit in respect of that income available under the HK/Mexico CDTA; and (2) the main purpose of structuring such a transaction or series of transactions is to obtain benefits under the HK/Mexico CDTA. In addition, the miscellaneous rules article in the HK/Mexico CDTA confirms that both contracting parties can apply their domestic laws and measures concerning tax avoidance. In the case of Mexico, such domestic laws and measures concerning tax avoidance include the laws and measures regarding thin capitalisation, controlled foreign corporation (preferential tax regimes) and back-to-back loans. The Protocol to the HK/Mexico CDTA also includes a provision that deals with double non-taxation arising from a divergent classification of a piece of income (Article 21 Other Income ). In such situation, each contracting party can keep the right of taxing such income in accordance with its domestic laws. 8. Mutual agreement procedure ( MAP ) Unlike all other treaties that Hong Kong has signed so far which provide that any agreement reached under MAP shall be implemented notwithstanding any time limits in the domestic law of the contracting parties, the MAP article in the HK/Mexico CDTA states that any such agreement shall be implemented within the time limits as provided in the laws of the respective contracting parties. It is understood that Mexico considers that the implementation of reliefs and refunds following a mutual agreement should remain linked to the time limit prescribed by their domestic laws (which is five years after the date the respective return is filed in general but can be extended to 10 years in certain circumstances). For a Hong Kong company, this means that the Inland Revenue Department ( IRD ) can refuse to give a corresponding adjustment and the related double tax relief to the company if the mutual agreement giving rise to such adjustment / relief is reached after the statute of limitations of 6 years for the year of assessment concerned. 9. Exchange of information ( EoI ) The HK/Mexico CDTA adopts the latest OECD model EoI article, with the following additional safeguards against possible abuse of the article: (1) restricting the scope of information exchange to taxes covered under the CDTA; and (2) the information exchanged shall not be disclosed to any persons or authorities other than those of the contracting parties for any purpose. PwC observations Latest status of Hong Kong s treaty network As of the end of July 2012, Hong Kong has signed 25 CDTAs with various jurisdictions. The table on the next page summaries the implementation status of the CDTAs signed by Hong Kong since 2010 and the tax years from which these CDTAs became/will become effective in Hong Kong and the other contracting states. News Flash Hong Kong Tax 4

5 Country Date of signing Date of entry into force Effective from year of assessment (Hong Kong) Effective from (The other contracting state) CDTAs signed in Brunei March 2010 December /12 1 January Netherlands March 2010 October /13 1 January Indonesia March 2010 March /14 1 January Hungary May 2010 February /13 1 January Kuwait May 2010 Pending Pending Pending 6. Austria May 2010 January /13 1 January UK June 2010 December /12 1 or 6 April Ireland June 2010 February /13 1 January Liechtenstein August 2010 July /13 1 January France October 2010 December /13 1 January Japan November 2010 August /13 1 January New Zealand December 2010 November /13 1 April 2012 CDTAs signed in Portugal March 2011 June /14 1 January Spain April 2011 April /14 1 April Czech Republic June 2011 January /14 1 January Switzerland October 2011 Pending Pending Pending 17. Malta November 2011 July /14 1 January 2013 CDTAs signed in Jersey February 2012 Pending Pending Pending 19. Malaysia April 2012 Pending Pending Pending 20. Mexico June2012 Pending Pending Pending Challenges ahead in applying the treaties in practice With the continuous expansion of Hong Kong s treaty network, one of the challenges ahead for both taxpayers and tax authorities will be minimising the uncertainties arising from the interpretation and application of some of the less clearly defined treaty provisions. One example is how the term at any time or in any form used in the anti-abuse provision in the treaties with Switzerland and Mexico should be applied in practice. Another example is what is regarded as identical or substantially similar activities in assessing whether the activities of associated enterprises should be taken into account for the purpose of construction site/service PE determination under the HK/Mexico CDTA. More guidance or clarification from the tax authorities on how they interpret these and other treaty provisions of which the application is subject to interpretation will be necessary in order for taxpayers to better appreciate how those provisions are intended to operate in practice. News Flash Hong Kong Tax 5

6 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 PricewaterhouseCoopers client service team or your other tax advisers. The materials contained in this publication were assembled on 3 August 2012 and were based on the law enforceable and information available at that time. To make enquiries about our Hong Kong tax and business advisory services, please feel free to contact the following lead specialist partners: Entertainment & Media Colin Farrell Tel: colin.farrell@hk.pwc.com Industrial Products Medinah Ip Tel: medinah.ip@hk.pwc.com Info-Comms Suzanne Wat Tel: suzanne.wat@hk.pwc.com Financial Services Florence Yip Tel: florence.kf.yip@hk.pwc.com Logistics & Transportation Reynold Hung Tel: reynold.hung@hk.pwc.com Real Estate KK So Tel: kk.so@hk.pwc.com Retail & Consumer Products Tim Leung Tel: tim.leung@hk.pwc.com Investigation Services Kaiser Kwan Tel: kaiser.kwan@hk.pwc.com International Assignment Services Mandy Kwok Tel: mandy.kwok@hk.pwc.com Personal Financial Services John Wong Tel: john.cw.wong@hk.pwc.com Merger & Acquisition Nick Dignan Tel: nick.dignan@hk.pwc.com Transfer Pricing Cecilia Lee Tel: cecilia.sk.lee@hk.pwc.com Company Fiduciary & Administration Services John Wong Tel: john.cw.wong@hk.pwc.com Customs & International Trade Colbert Lam Tel: colbert.ky.lam@hk.pwc.com International Tax Advisory Nick Dignan Tel: nick.dignan@hk.pwc.com Tax Accounting Services Suzanne Wat Tel: suzanne.wat@hk.pwc.com Value Chain Transformation Tim Leung Tel: tim.leung@hk.pwc.com Our regional contacts: Beijing Edward Shum Tel: +86 (10) edward.shum@cn.pwc.com Chongqing Robert Li Tel: +86 (23) robert.li@cn.pwc.com Dalian Rex Chan Tel: +86 (411) rex.c.chan@cn.pwc.com Guangzhou Daisy Kwun Tel: +86 (20) daisy.kwun@cn.pwc.com Hangzhou Jenny Chong Tel: +86 (21) j.chong@cn.pwc.com Hong Kong Peter Yu Tel: peter.sh.yu@hk.pwc.com Macao Pat Wong Tel: pat.lk.wong@hk.pwc.com Nanjing Jane Wang Tel: +86 (25) jane.y.wang@cn.pwc.com Ningbo Ray Zhu Tel: +86 (21) ray.zhu@cn.pwc.com Qingdao Steven Wong Tel: +86 (532) steven.wong@cn.pwc.com Shanghai Peter Ng Tel: +86 (21) peter.ng@cn.pwc.com Shenzhen Charles Lee Tel: +86 (755) charles.lee@cn.pwc.com Singapore Lennon Lee Tel: lennon.kl.lee@sg.pwc.com Suzhou Linjun Shen Tel: +86 (512) linjun.shen@cn.pwc.com Taiwan Steven Go Tel: +886 (2) steven.go@tw.pwc.com Tianjin Kelvin Lee Tel: +86 (22) kelvin.lee@cn.pwc.com Xiamen Mike Chiang Tel: +86 (592) mike.chiang@cn.pwc.com Xian Elton Huang Tel: +86 (29) elton.huang@cn.pwc.com This Hong Kong Tax News Flash is issued by the National Tax Policy Services in Hong Kong and China, 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 PricewaterhouseCoopers partners and staff in their provision of quality professional services to businesses and maintain thoughtleadership by sharing knowledge with the relevant tax and other regulatory authorities, academies, business communities, professionals and other interested parties. For more information, please contact: Matthew Mui Tel: +86 (10) matthew.mui@cn.pwc.com Please visit PricewaterhouseCoopers websites at (China Home) or (Hong Kong Home) for practical insights and professional solutions to current and emerging business issues PricewaterhouseCoopers Ltd. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers Ltd. which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.