Capital Investment Visa in Hong Kong:Immigration Considerations and Tax Issues 1 Abstract The Capital Investment Visa is a recently introduced Hong Kong entry visa. Its requirements are not found in the immigration law. Many people are not aware of its criteria, plus the low tax holders of this Visa enjoy. This paper discusses the Visa and related tax saving schemes. 1. Introduction On 27 October 2003 the Hong Kong Immigration Department (HKID) announced a new category of entry visa called the Capital Investment Visa. Three years later the scheme has only attracted 952 successful cases out of 1,467 applicants. 2 It is submitted that the relatively low number of attempts is due to two main reasons: the strictness of the criteria as well as a lack of understanding of the Hong Kong (HK) tax system. This paper outlines the requirements of this Visa, followed by issues to be taken into account in mitigating immigrants HK tax liabilities. In preparing for this paper, the second writer received generous advice from HKID. This information is particularly valuable because the requirements for obtaining all the HK entry visas do not appear in the local immigration statute 3 and its subsidiary legislation. 1 By Dr. Daniel H K Ho and Dr. K L Alex Lau, Department of Accountancy and Law, Hong Kong Baptist University (danielho@hkbu.edu.hk and alexlau@hkbu.edu.hk). This paper will appear in the Tottel s Journal of Immigration, Asylum and Nationality Law, Vol. 21, Part 1 in early 2007. 2 These were figures as of 30 June 2006. See www.immd.gov.hk/ehtml/hkvisas_13_19.htm. A year ago, the HK Economic Times of 6 October 2005 cited figures released by HKID as of 30 June 2005. There were 575 approvals out of 856 applications. 3 HK Immigration Ordinance, Chapter 115, Laws of HK. For a full text see www.justice.gov.hk. 1
Instead, they are contained in confidential internal guidelines of HKID and are not open to the public. The immigration portion below is based on the second writer s 18 years practice on HK immigration law. HKID clarified many grey areas in the course of writing this paper. Aside from the Immigration Ordinance, the other major piece of legislation containing immigration criteria is the HK Constitution called the Basic Law. One Article 4 defines who can become a Permanent Resident of HK. However, the Basic Law does not contain the requirements to secure any one of the HK entry visas. A person becomes a Permanent Resident only after he secures an entry visa and then resides in HK for seven years continuously. Thus, black letter law does not provide any assistance. The HKID website provides information booklets and guidelines on the entry visas. However, the information is not exhaustive. A potential applicant often needs to find out all the requirements through a process of trial and error. There is one practice adopted by HKID which further confuses the issue. HKID advised the second writer, and this has been confirmed time and again by his professional practice in the last 18 years, that HKID is duty-bound to accept any application, no matter how hopeless it is. A file will be opened and the case will be fully considered. In addition, there is no pre-screening process to expedite cases so that an applicant can find out quickly whether his case is promising or not. Each case is considered through the same prescribed procedure. An application takes about two to four months to process. In short, 4 Article 24. 2
there is insufficient transparency on the visa requirements, coupled with a lengthy processing period. 2. Categories of HK Resident Visas The main resident visas available to businessmen to enter HK are: -Employment, -Employment (Investment), and -Capital Investment The Employment (Investment) Visa is suitable to business owners. Successful applicants must commence or continue to invest in a business operation in HK, to bring about economic benefits to the territory. This Visa is not suitable to those who are not familiar with the HK business environment or simply were not businessmen by training. The Employment Visa is for someone intending to work in HK as an employee, but not as an investor. The requirements of the Employment Visa are strict. Only people not otherwise readily available in HK may be granted this Visa. There is however a special feature which links up the Capital Investment Visa and employment in HK. After securing the Capital Investment Visa, the successful applicant is permitted to work in HK as an employee 5. This means a person who wants to work in HK but does not satisfy the strict Employment Visa criteria may still do so if he obtains the Capital Investment Visa. 5 See para 8.2 on www.immd.gov.hk/pdforms/id(e)968.pdf. 3
3. The Capital Investment Visa The Capital Investment Visa operates under HKID s Capital Investment Entrant Scheme (the Scheme). According to HKID, the objective of the Scheme is to facilitate the entry for residence by capital investment entrants (the entrant), ie persons who make capital investment in Hong Kong but would not be engaged in the running of any business here. The entrant is allowed to make his choice of investments amongst permissible assets without the need to establish or join in a business This Visa permits passive investment. The main requirements of the Visa are as follows: -to passively invest HK$6.5 million in HK based assets defined as Permissible Investment Asset Classes 6, such as real properties, company securities or other moveable properties situated in HK, -to have held the said sum for at least two years prior to investing in HK, and -be able to maintain the applicant and his family after arriving in HK The allowance of passive investment effectively relieves applicants from making active investments. This is the main attraction of the scheme. However, it is submitted that the Visa fails to attract a substantial number of applicants because the other requirements of the Visa are too strict. To start, the investment amount of HK$6.5 million (about US$ 833,333) is too high by international standards. Amongst the investor migration categories of popular destinations, the respective requirements are much lower: -Canada (C$400,000)(about US$ 360,000) 7 6 For a detailed description, see http://www.immd.gov.hk/ehtml/hkvisas_13_5.htm. 4
-Australia (A$500,000)(about US$ 385,000) 8 -USA (US$500,000) 9 Many potential migrants may therefore ask themselves: if I have to pay so much to come to HK, why not go elsewhere instead? Their investments amounts are lower. 4. Special Additional Restrictions for PRC Residents HKID imposes an additional requirement for PRC applicants resident in the Mainland. This imposition is a policy implementation in line with exit and foreign exchange control exercised by the PRC Central Government. This requirement is significant concerning the Capital Investment Visa because the country with most interest in applying for it is the PRC 10. Indeed, 53% of approved cases come from PRC nationals. 11 The additional requirement is that a Mainland PRC resident must also have permanent residence (PR) status from a third country before qualifying to apply for the Capital Investment Visa. He need not be a citizen of that country though. Therefore, a Mainland PRC resident should first identify a third country. After securing the PR status in that country, he can then apply for a Capital Investment Visa. The big question is, having landed in the third country and found that it is enjoyable to live and work there, plus it 7 See www.cic.gc.ca 8 See www.immi.gov.au 9 See www.usconsulate.org.hk 10 According to HKID figures, 80% of the enquiries on the Capital investment Visa came from PRC nationals. See HK Economic Times 6 October 2005. 11 See www.immd.gov.hk/ehtml/hkvisas_13_19.htm. 5
costs less to invest than in HK, does that person still want to continue with his HK plans? If a PRC national does not have PR status from another country, then he does not qualify to apply for a Capital Investment Visa, no matter how affluent or successful he is. There is another twist to the story. It seems that a PRC national can satisfy the above requirement by obtaining a PR status from any third country. HKID advised that this is not true in practice. Countries such as the USA, Australia and Canada have no problem. But a PR status from a Third World country, particularly where the applicant is approved by only investing a substantial amount in that country but with no other requirements, such as obtaining police and medical clearances, may not be recognised by HKID for the purpose of obtaining the said Visa. This is so even if the immigration law of that country does not require anything else before granting a PR status. Therefore, a potential applicant should clarify with HKID before making any commitment. 5. Permanent Residency Too Far Away Even if one secures a HK entry visa, the road to achieve PR status is much longer than those in the popular destinations outlined above. A PR can live in a place indefinitely, and does not need any approval prior to entering into employment. It is the most preferred immigration status in any jurisdiction. A HK resident visa holder must continuously reside in HK for seven years before becoming a PR. 12 In Canada, Australia, and the USA an immigrant becomes a PR when he reaches that country for the first time with his immigrant visa. If it costs more to migrate to HK than to the other countries 12 Basic Law Article 24 6
mentioned, and it takes much longer to become a PR, then is HK really more attractive than these other countries? The application figures speak for themselves. The answer is probably no. There is no black and white definition of what constitutes continuous residence before becoming a HKPR. It is a factual test. From cases handled by the second writer as well as advice from HKID, a person will have to be physically resident in HK for at least an average of nine months in each of the seven qualifying years. This may be quite difficult to fulfill. A person who can spare HK$6.5 million to invest should be quite successful in his career elsewhere. His work may require frequent travels. To spend enough time in HK continuously over seven years is not easy. 6. PRC Citizenship Hard to Get This may be a long way in the future but it should be on the mind of every immigrant at some time before and after settling down in HK. The difficulty of securing the HKPR status has already been discussed. But compared with obtaining citizenship in HK, PR may still be a more straightforward issue. HK became part of the People s Republic of China (PRC) on 1 July 1997. Nationalities of HK residents are now governed by the PRC Nationality Law. A Law is a PRC national statute applicable across the whole country. A HK Capital Investment Visa holder who wants to apply for PRC citizenship must first give up his own nationality because PRC law does not recognise dual nationality. 7
On the other hand, PRC citizenship is not automatically conferred. There is no formula given under the Nationality Law. HKID advised that they look into various factors before reaching a decision, including the local connections of the applicant with HK and the PRC, and the Chinese language proficiency of the applicant. Since 1997, HKID advised that only several hundred applicants have been successful in securing PRC nationality in HK. Although none of them were holders of the Capital Investment Visa, the nationality requirements are the same for holders of all HK resident visas. In short, a holder of the Capital Investment Visa must be aware that the PR status will probably be the ultimate goal to be achieved in HK. Nationality is very difficult to get unless the applicant has an exceptionally strong tie with HK and the PRC. If a person succeeds in obtaining the Visa, there are many tax saving schemes open to him. HK enjoys an exceptionally low tax rate by international standards. It will be recalled that the Capital Investment Visa holder can also enter into employment in HK. Below is a summary of various schemes available to reduce his HK tax exposure. 7. General Overview of the HK Tax System Tax law in HK is governed by various pieces of legislation including the Basic Law of the HK Special Administrative Region of the PRC, statutes and subsidiary legislation passed by the Legislative Council (eg Inland Revenue Ordinance (IRO), Stamp Duty Ordinance (SDO), Estate Duty Ordinance (EDO) 13 and Inland Revenue Rules) and decisions in precedent cases. The administration of income tax in HK is carried out by the 13 Estate Duty has been abolished with effect from 11 February 2006. 8
Inland Revenue Department (IRD), Board of Inland Revenue and Board of Review. The IRD is headed by the Commissioner of Inland Revenue (CIR) who issues Departmental Interpretation and Practice Notes (DIPN) to explain how the IRD would interpret the legislation and how IRD would enforce the law in practice. 14 These DIPNs, however, have no legally binding force and are issued for information and guidance of taxpayers only. The tax year in HK runs from 1 April to the following 31 March. Hence, the current tax year of 2006/2007 refers to the period from 1 April 2006 to 31 March 2007. HK operates a territorial source system of income taxation. Only income that has a source in HK will be liable to tax; non-hk source income is not within the tax net. Unlike other jurisdictions (eg the US, Canada, the UK and Australia), the nationality, domicile or residence of a person is generally of no relevance for HK tax purposes. HK income tax could be divided into three broad classes, namely property tax covering rental income; salaries tax covering employment, office and pension income; and profits tax covering business profits. If a person s income does not fall within the above-mentioned charging net, the income is not subject to tax in HK. In addition, no tax will be imposed on capital gains. HK does not have (but may do so in future) any systems of sales tax (eg Valueadded Tax in the UK and Goods and Services Tax in Australia) 15 ; and it does not have the Pay-As-You-Earn mechanism. In short, HK operates a simple income tax system when compared to those in developed economies. 14 The CIR is also the Collector of Stamp Revenue and Commissioner of Estate Duty. 15 In July 2006, the Financial Services and the Treasury Bureau of the HK Government issued a consultation document entitled Broadening the Tax Base: Ensuring our Future Prosperity. What s the Best Option for HK? The main issue in this document is whether or not Hong Kong should introduce Goods and Services Tax (GST). The consultation period will end by 31 March 2007 after which a report on the views received will be prepared for government of the next term (i.e. 1 July 2007 30 June 2012) to consider whether to implement GST in HK. 9
8. Investment in Real Properties in HK: Rental Income Property tax is charged on owners receiving income from rental properties located in HK. 16 The source concept relates to the physical location of the rental properties. 17 Accordingly, rental income from real properties located outside HK is not liable to property tax. Immigrants may therefore continue to own their overseas rental properties after they have migrated to HK as no property tax will be levied on these non-hk source rental income. However, if they purchase properties in HK for rental purposes, the rental income will be liable to HK property tax even if they are not physically present in HK. Subsequent gains on disposal of the rental properties located in HK could be exempt from HK tax if the IRD agrees that the nature of these gains is capital in nature. 18 Similarly, gains on disposal of the overseas rental properties are not subject to HK tax as they are offshore in nature. 19 There are only a few items which could be deducted from the rental income in deriving the net assessable value to which standard tax rate (which is 16% for the year of assessment 2006/2007) is applied to compute the property tax payable. These include 16 Section 5(1), IRO. 17 Paragraph 20(a), DIPN 21. 18 Capital gains derived from the realization of a long-term investment are exempt but profits from the trading of real properties are taxable. Whether a person is carrying on a trade or not is a question of fact. It is always necessary to consider all the relevant circumstances objectively and to examine the person s intention in carrying out the activities. The following arguments are generally useful in establishing nontaxability claim for the gains on disposal of the rental properties: the properties have been acquired as a long-term investment; the intention has not changed; and the period of holding is long enough to demonstrate the long-term holding intention. 19 The IRD regards the source of profits from sale of real property is the location of the property: paragraph 20(b), DIPN 21. 10
irrecoverable rents (which have to be proved to become bad by the owner), rates paid by owner, 20 and a statutory allowance of 20%. 21 Other expenses including repairs, management fees paid by owners and interest on bank loan to finance the acquisition of the real properties are not deductible under property tax. 22 In order to claim deduction of the interest expenses incurred on money borrowed, in connection with financing of a real property which generates rental income subject to property tax, 23 the immigrant is advised to elect personal assessment which is a not a tax on income, but a means to relieve persons who are liable to property tax and profits tax. However, the immigrant has to meet the age (18 or more, or under that age if both parents are dead) and the residency (refers to permanent resident or temporary resident of HK) requirements before he could elect the personal assessment. 24 Permanent resident means the immigrant is ordinarily residing in HK while temporary resident refers to the immigrant is present in HK for 180 days (in aggregate) in that year of assessment in which the personal assessment is elected or 300 days (in aggregate) in HK in two consecutive years of assessment (with one being the year of assessment in which the personal assessment is elected). It should be noted that the permanent resident just mentioned is for tax purposes. It is different from the same term mentioned earlier for immigration purposes. 20 Rates are one of HK's indirect taxes levied on properties. Rates are charged at a percentage of the ratable value which is the estimated annual rental value of a property at a designated valuation reference date, assuming that the property was then vacant and to let. For the current financial year 2006/2007, the rates percentage charge is 5% and the designated valuation reference date is 1 October 2005. 21 Sections 7C(1), 7C(3) and 5(1A)(b)(i), IRO. 22 Under property tax, the statutory 20% allowance is deemed to cover all related expenses incurred by the owner on the real property. Therefore, all other actual expenses incurred by the owner will not be deductible for property tax purposes. 23 Under personal assessment, the amount of interest deduction is limited the net assessable value: section 41(1), IRO. 24 Personal assessment is one of the few places in the IRO where residency status is important. 11
Immigrants may also consider setting up limited companies in HK (and become shareholders of these companies) to own the real property located in HK. Although there are some costs for limited companies (eg incorporation costs, business registration fee, audit fee and a slightly higher tax rate 25 ), company expenses in relation to the generation of the rental income are generally deductible for profits tax purposes provided they satisfy the deduction rules. 26 If interest expenses are incurred in the production of the rental income, these expenses are deductible under profits tax provided that they fulfill the specified criteria. 27 Also, the property-holding company is entitled to commercial building allowance (which is equal to 4% on the cost of construction of the property). Another potential benefit of using a HK limited company to hold the rental property in HK is the stamp duty saving on subsequent disposal. If an immigrant owns a HK property in his own name and subsequently disposes it to a new buyer (who might be a relative of the immigrant), the stamp duty payable could amount to 3.75% of the higher of consideration or market value. 28 However, if the rental property is owned by a HK limited company, the new buyer (who might be a relative of the immigrant) could purchase the rental property indirectly by acquiring the shares of that property-holding company. The stamp duty payable for the transfer of these HK shares is only 0.2% of the 25 For the year of assessment 2006/2007, rental income from properties located in HK derived by limited companies are subject to profits tax rate at 17.5%, which is 1.5% higher than property tax rate if the real properties are held by individual in his/her own name. 26 The deduction rules under profits tax are laid down in sections 16 and 17, IRO. 27 Interest expenses incurred on money borrowed are deductible under profits tax if sections 16(1), 16(1)(a) and 16(2) of the IRO are satisfied and the limitation clauses under sections 16(2A)-16(2F) do not apply. 28 The sale and purchase agreement (which is known as agreement for sale under SDO) in respect of a residential immovable property in Hong Kong is chargeable with stamp duty at rates ranging from a fixed amount of $100 to 3.75% on the higher of consideration or market value: Head 1(1A), SDO. A fixed stamp duty of $100 is payable on the conveyance on sale (which is executed in conformity with a duly stamped agreement for sale) under section 29D(2). The seller and purchaser are jointly and severally liable for the payment of the stamp duty in respect of sale and purchase of residential immovable property in Hong Kong. In practice, the Collector of Stamp Revenue usually collects the stamp duty from the purchaser because the purchaser is usually the one who has contracted to pay for the stamp duty. 12
share value (which is basically equivalent to the net asset value of the HK propertyholding company). 29 The differential in stamp duty rate of 3.55% (ie 3.75%-0.2%) could therefore generate huge savings for transfers of HK real properties if they are owned by companies incorporated in HK. A further stamp duty saving arrangement is to have the HK real properties registered in the name of an overseas company which keeps the register of members outside HK. Since the shares of such overseas company will not be regarded as HK stock for stamp duty purposes, 30 the disposal of the HK real property via the transfer of such shares is exempt from HK stamp duty. It should be noted that rental income will be chargeable to profits tax instead of property tax if the HK real property is owned by a limited company. 31 In order to avoid double taxation of rental income, the limited company is advised to make an application in writing to the CIR to request for an exemption from the property tax. 32 If the limited company has paid property tax on its rental income, such tax paid could be allowed to offset the profits tax payable by the limited company. 33 9. Investment in Real Properties in HK: Self Occupation Generally, there is no tax exposure if immigrants have purchased properties in HK and used them as their residences. Similar to the rental properties, any subsequent gains on 29 Head 2(1), SDO. 30 HK stock is defined in section 2 of the SDO as stock, the transfer of which is required to be registered in Hong Kong. This means that if a company maintains its register of members outside HK, then the shares of such company are regarded as non-hk stock. 31 This is because of the definition of business under profits tax to include the letting or sub-letting by any limited company to any person of any premises: section 2, IRO. 32 Section 5(2)(a), IRO. 33 Section 25, IRO. 13
disposal could be exempt from HK tax if the IRD agrees that the nature of these gains is capital in nature. In case the immigrants have any income chargeable to HK tax (eg employment income) and have purchased real properties in HK for residential purposes, they may be entitled to deductions of home loan interest under salaries tax and personal assessment if the following conditions are satisfied: 34 The person is the owner of the dwelling; The dwelling is situated in HK and is used exclusively or partly for residential purposes; The dwelling is wholly or partly used by the person as his place of residence (or as the principal place of residence if there is more than one place of residence at the same time in the year of assessment); Home loan interest is paid by the person on a loan applied wholly or partly for acquisition of the dwelling; The loan is secured by a mortgage or charge over the dwelling or over any other property in HK; and The lender is the HK government, a financial institution, a registered credit union, a licensed money lender, the HK Housing Society, the person s employer, or any organisation or association approved by the CIR. 10. Investment in Listed Securities 34 Section 26E, IRO. The maximum amount of home loan interest deduction is $100,000 for the year of assessment 2006/2007. Each individual taxpayer is entitled to the deduction for 10 years for his/her life. In other words, it is not necessary that a taxpayer has to apply for the 10 years continuously. 14
Income generated from investment in listed securities does not have significant HK tax implications. Dividends from shares, whether listed in HK or not, are exempt from HK tax. 35 Subsequent gains on disposal of shares listed in HK are generally not taxable. 36 Also, gains on disposal of shares listed overseas are offshore in nature and hence not subject to tax in HK. 37 However, HK stamp duty at 0.2% on the higher of consideration or market value is payable for each purchase and sale transaction of shares listed in HK; 38 but no HK stamp duty is payable for buying and selling of shares listed overseas. As such, it seems more preferential, from a HK taxation perspective, for immigrants to invest in listed securities than in real properties in HK. 11. Working in HK: Employed v Self-Employed 35 Dividends received from limited companies which are chargeable to HK profits tax are exempt from tax under section 26(a), IRO. In practice, dividends received from overseas companies are not taxable as the source of such income is possibly outside HK. 36 It is the current IRD practice not to tax gains (and therefore to allow losses) obtained by individuals from buying and selling shares listed in HK. Even if an individual spends all his/her time by buying and selling shares listed in HK and has pays close attention to the market through close contact with his/her stockbroker, the IRD will generally ignore such activities. The trend of Board of Review (informal tax court) decisions in this area is well summarized in D38/96 where it is stated that although it is not essential that a person carrying on a trade or business must have an office and staff and organization, where none of these attribute exist, there must be other clear evidence of carrying on a trade or business. See also D11/97 for similar decision reached. 37 The determination of the source of profits arising from the trading of listed shares is generally based on the location of the stock exchange where the shares are listed and traded: paragraph 20(c), DIPN 21. This is based on the rationale that any sales or purchases of listed shares are required to be effected and registered in the place where they are listed. 38 Parties effecting the sale and purchase of shares listed in HK (which are regarded as HK stock under section 2(1), SDO) have to prepare and stamp contract notes for the sale and purchase and an instrument of transfer: section 19(1) and Heads 2(1) and 2(4) respectively, SDO. Stamp duty on the contract notes under Head 2(1) is 0.2% on the higher of consideration or market value of the shares; stamp duty under Head 2(4) on the transfer is HK$5. The seller and purchaser are solely liable for their own respective shares of stamp duty at the rate of 0.1%. They are not individually liable for the whole 0.2% stamp duty. 15
There is a key difference from HK taxation perspective for a person working with an employment and for a person who is self-employed. The former one is a contract of service which refers to the relationship between an employer and an employee; whilst the latter one is a contract for service which refers to the relationship between a principal and an independent contractor. Income from employment will be charged under salaries tax but income from self-employed will be charged under profits tax. 39 Profits tax rate for limited companies (17.5% for the year of assessment 2006/2007) is generally higher than salaries tax standard rate (16% for the year of assessment 2006/2007); but profits tax rate for unlimited companies (eg sole proprietorship) is the same as salaries tax standard rate (both at 16% for the year of assessment 2006/2007). 40 In addition, the deduction rules under profits tax are much more lenient than those of salaries tax. 41 In determining whether a person is employed or self-employed, there is a general question to ask: Is the person who has engaged himself to perform these services performing them as a person in business on his own account? 42 If the answer is 39 The charging sections are section 8(1) and 8(1A) for salaries tax and sections 14(1) and 15(1) for profits tax. 40 In HK, salaries tax payable is the lower of tax computed using a set of progressive rates (which range from 2% - 19% for the year of assessment 2006/2007) and that of tax calculated using the standard rate (16% for the year of assessment 2006/2007). Such a comparative calculation also applies to tax calculation under personal assessment. 41 The general deduction rule under salaries tax is laid down in section 12(1)(a) which provides that all outgoings and expenses, other than expenses of a domestic or private nature and capital expenditure, wholly, exclusively and necessarily incurred in the production of the assessable income are deductible from the assessable income. The general deduction rules under profits tax are laid down in section 16(1) which provides that expenses are deductible to the extent to which they are incurred during the basis period for that year of assessment by the taxpayer in the production of chargeable profits; and section 17(1) which provides that the expenses must not be capital in nature or for domestic or private purposes. 42 A good summary of the factors to be considered in determining whether the income arises from a relationship of employment or whether it is from a contract for the provision of service by an independent contractor can be found in Market Investigations v Minister of Social Security [1969] 2 QB 173. 16
affirmative, then it is a contract for service. Otherwise, it is a contract of service. In practice, the IRD will examine other factors including: 43 The degree of control exercised by the party demanding the services; Whether the person providing the services is part and parcel of the organisation demanding the services; and Whether the person providing the services has to risk his own capital, etc In general, a person will be chargeable to profits tax in HK if the following three conditions are all satisfied: 44 A person carries on a trade, profession or business in HK; Profits are derived from that trade, profession or business, other than profits arising from the sale of capital assets; and Those profits arise in or are derived from HK. It should be emphacised that the place of incorporation is irrelevant in determining whether a limited company is carrying on a business in HK. Factors to be taken into consideration include the place where the board of directors meet and make decision, the place where the company s day-to-day activities are conducted, etc. Even a company is considered to be carrying on a business in HK, the profits will only be taxed in HK if they arise in or are derived from HK. The source of profits is very much dependent on the nature of the profit earned. The guiding principle adopted by the IRD and various courts 43 Appendix B, DIPN No. 25. 44 Section 14, IRO. However, a person will still be chargeable to profits tax in HK if he has certain deemed receipts (e.g. a non-resident person receiving royalties income from HK person for the use or right to use of intellectual property) under section 15(1), IRO. 17
is: what are the operations from which profits are earned and where these operations are carried out. 45 If the nature of the profit earned is by way of a service fee, the normal test would be the location of performing the service. 46 If they are trading profits in nature, then the source would generally be determined by the place where the contracts of sale and purchase are effected. 47 12. Working in Hong Kong under Employment: Source of Employment The source of employment plays an important role to determine the salaries tax exposure of a taxpayer. If a taxpayer has a HK source employment, all of his income from that employment is basically chargeable to salaries tax unless the taxpayer has rendered all services outside HK. In this connection, a taxpayer will be regarded as having rendered all services outside HK if he has visited HK for a total of not exceeding 60 days (the socalled 60-day rule ). 48 On the other hand, a taxpayer with a non-hk (ie foreign) employment and has rendered services in Hong Kong is generally chargeable to salaries tax based on his time spent in HK (unless the taxpayer visits HK for a total of not exceeding 60 days). 49 The IRD will generally accept that a foreign employment exists if the place of negotiation, conclusion and enforceability of employment contract is outside 45 The broad guiding principle as stated in paragraph 1, DIPN 21 is: one looks to see what the taxpayer has done to earn the profits in question and where he has done it. Also see the landmark cases on the source of profits in HK of the decisions of the Privy Council in CIR v Hang Seng Bank (3 HKTC 351) and HK-TVB International v CIR (3 HKTC 468). 46 Paragraph 20(e), DIPN 21. 47 Paragraphs 6-7, DIPN 21. The IRD interprets the word effected as contemplate the actual steps leading to the existence of the contracts including the negotiation and, in substance, conclusion and execution of the contracts. 48 Sections 8(1) and 8(1B), IRO. 49 Sections 8(1A) and 8(1B), IRO. 18
HK, the place of residency of employer is outside HK, and the remuneration is paid outside HK. 50 Although there is no statutorily definition of visit, the common interpretation of this word refers to short and temporary stay. As such, an immigrant who has chosen HK as his new home and work base would not qualify as visit to HK and hence the 60-day rule does not apply to exempt his income from HK salaries tax. 51 However, if the immigrant genuinely fulfils the criteria for a foreign employment, he will be entitled to time-basis claim and only his income related to his services rendered in HK is subject to salaries tax. 52 In addition, if the immigrant is fully liable to HK salaries tax on employment income, as his source of employment is a HK, but also has paid overseas personal income tax (because his presence in that overseas jurisdiction is substantial), then he could claim that portion of income that is subjected to overseas income tax to be exempt from HK salaries tax. 53 Furthermore, an immigrant who is present in Mainland China, Belgium and Thailand for not exceeding a total of 183 days in a year could be exempt from personal 50 Paragraph 4, DIPN 10. It should be noted that these three factors are not conclusive, and the CIR may look further than the external or superficial features of the employment or examine other factors in determining the situs of employment. 51 The 60-day rule looks at the number of days of a taxpayer s visit to HK during a year of assessment. Both days of arrival in and departure from Hong Kong are counted as visits days in HK: D 29/89, D 12/94 and D20/00. The 60-day rule only applies to employment income; it does not apply to office income. Income from a HK office (usually determined by the place where the central management and control of the company is located) is fully taxable even if the person (e.g. director) has never visited HK. On the other hand, income from a non-hk office is exempt from HK salaries tax. 52 The IRD practice is to count only one of the day of arrival and day of departure as days in HKfor timebasis claim purposes. This is different from the day counting rule under the 60-day rule where both days are counted. 53 Section 8(1A)(c), IRO. 19
income tax in these jurisdictions under the double tax arrangement signed between HK and Mainland China, Belgium and Thailand respectively. 54 13. Working in Hong Kong under Employment: Remuneration Package Employment income from services rendered in HK is taxable if the taxpayer visits HK for a total of exceeding 60 days in a year of assessment, whether the source of employment is in HK or not. However, some fringe benefits, when structured properly, will not be liable to salaries tax. For example, the free use of company car (either for leisure or business purposes) by employee does not generate any taxable income to the employee. Another example is the provision of a place of residence by employer to employee. The usage of such residence place, either rent-free (ie the employer provides the place of residence directly to the employee without any charge; or the employer fully reimburses the rental expenses paid by the employee) or at a rent (ie the employer provides the place of residence directly to the employee but deduct a certain percent of salaries for the usage; or the employer partly reimburses the rental expenses paid by the 54 In February 1998, a memorandum concerning double taxation was entered into between HK and Mainland China. DIPN 32 was issued in June 1998 to provide further guidance on the operation of this double tax arrangement. In late 2003, HK entered its first comprehensive double tax agreement with Belgium. In September 2005, HK entered its second comprehensive double tax agreement with Thailand. The general conditions before an individual employee who is a tax resident of HK (tax residency is usually determined by whether a person ordinarily residing in HK or staying in HK for substantial days) would not be taxed in Mainland China, Belgium and Thailand under the respective the double tax arrangement/agreement are as follows. First, the individual employee stays in Mainland China/Belgium/and Thailand for not more than 183 days (in aggregate) in the calendar year concerned. Second, the remuneration is paid by, or on behalf of, an employer who is not a resident of Mainland China/Belgium/Thailand. Third, the remuneration is not borne by a permanent establishment or a fixed base which the employer has in Mainland China/Belgium/Thailand. It should be noted that HK and Mainland China signed a new double taxation arrangement on 21 August 2006 to extend the scope of the original arrangement signed in 1998. The above-mentioned three criteria for avoidance of double taxation for employment income remain the same under the new HK-Mainland China double tax arrangement which will take effect after the completion of ratification procedures for both sides. 20
employee), is not chargeable to salaries tax. Instead, a nominal taxable amount known as rental value (which is basically 10% of the employment income) is imputed as taxable income. 55 Cash allowance (though labeled as housing allowance) provided to an employee (with no control over its actual use) would likely be regarded as additional emolument of the employee and is fully taxable, notwithstanding that the employee did spend the allowance on housing. Accordingly, in order to implement the housing arrangement effectively from a tax perspective, the following issues should be noted: 56 The intention of the employer and employee on the nature and use of the rental refund would have to be clear; and Sufficient control would have to be exercised by the employer over the payment so that the payment is effectively a refund of rent and not just an additional emolument to be spent in any way that an employee may desire. Immigrants are therefore advised to negotiate with their employers to structure a taxefficient compensation package. It should be mentioned that there should be proper reasons and documentation for the various items of the remuneration; otherwise the CIR may challenge them under the tax avoidance provisions. 57 In this connection, the IRD has 55 Since rental costs for residential flats are expensive in HK (which could amount to about 20-30% of monthly salaries), the rental value figure is generally smaller than the rental refund amount. Section 9(2) of the IRO provides that the rental value shall be deemed to be 10% of the net employment income. Alternatively, the ratable value of the place of residence may be elected as the rental value under section 9(2)(b). In addition, if such place of residence is a hotel, hostel or boarding house, the rental value will be charged at 4% (for one room) or 8% (for two rooms) instead of 10%. 56 To determine whether a payment is a rental refund or housing allowance, the starting point is the terms of the employment contract. If it is stated in the employment contract, then one needs to examine if the terms of the contract have been properly carried out. This includes whether the employer has any control of use of the money and any supporting evidence in such direction (e.g. a stamped tenancy agreement and rental payment receipts): Peter Leslie Page v CIR (2002) 5 HKTC 683. 57 Typically, the CIR may apply section 61A of the IRO if the sole or dominant purpose for entering into a transaction was to enable a person to obtain a tax benefit. 21
generally agreed that the following benefits in kind (ie a reward in a form other than money) will not be subject to salaries tax if they are: 58 Not convertible into cash; Provided by the employer in such a way that the employer has a sole and primary liability to pay for that benefit; A settlement of the employer s liability not guaranteed by any other person; and Not benefits specifically chargeable to tax (eg gain on share option). 14. Setting up Businesses in Hong Kong: Unincorporated v Incorporated Immigrants may wish to use their expertise and experience to operate their own businesses after their arrival in HK. Often, immigrants may choose to establish an unincorporated business (eg sole proprietorship) or set up a limited liability company in running their businesses in HK. Unincorporated businesses are different from incorporated businesses in that they do not have a separate legal entity. For unincorporated businesses, all the drawings, salaries and interest on capital paid or payable to sole proprietor or his spouse are treated as withdrawal of capital which are not deductible for profits tax purposes. 59 On the other hand, if an immigrant becomes the director of the limited company, then his director s salaries are deductible by incorporated businesses. It is therefore noteworthy for immigrants to understand the following differences before they decide on which form of business vehicles to be used for their new businesses in HK: 58 DIPN 16. 59 Sections 17(1)(c) and 17(2), IRO. 22
Starting the new business as a sole proprietor The sole proprietor will be liable to profits tax as an individual and profits from business taxed at standard rate which is 16% for the year of assessment 2006/2007. Business expenses (eg advertising cost, equipment rental) are generally deductible and depreciation allowance will be granted on equipment acquired. However, drawings by sole proprietor are not deductible. No annual audit is required. The sole proprietorship business is required to file annual profits tax returns. The sole proprietorship is required to notify chargeability within four months following end of first accounting period. Business tax loss sustained can only be carried forward. Alternatively, if the sole proprietor elects personal assessment, then the business tax loss can be used to off set other income of the same year. Setting up a limited liability company The limited company is liable to profits tax as taxpayer and profits from business is taxed at corporate rate which is 17.5% for the year of assessment 2006/2007. Business expenses (eg advertising cost, equipment rental) are generally deductible and depreciation allowance will be granted on equipment acquired. In addition, directors salaries are deductible. Annual audit is required and the audit fee is deductible. Capital duty on capital injected into the new limited company. However, there is no 23
stamp duty on issue of new shares. The limited company is required to file annual profits tax returns. The limited company is required to notify chargeability within four months following end of first accounting period. Business tax loss sustained by the limited company can only be carried forward. 15. Conclusion HK residence visas have often been described as mysterious because their requirements are not found in the law. It is hoped that this paper, with the generous help of HKID, clears up a lot of doubts in the minds of potential applicants under the Capital Investment Visa. In addition, the holder of this Visa is entitled to enter into employment in HK. The Employment Visa is very hard to get, because the applicant must demonstrate to the satisfaction of HKID that he possesses qualifications and experience not otherwise readily available in HK. A Capital Investment Visa holder has no such requirement. He can work anywhere he wants in HK. In addition, the exceptionally low tax rates in HK are only applicable on income generated locally. This is a tremendous incentive to the visa holder to work in HK, thereby contributing to the HK economy. It is submitted that HKID has not done enough in the past to promote the Capital Investment Visa. As a result, its benefits are not fully appreciated by potential applicants. It has already been shown that the investment amount for this Visa is higher than the amounts required by the USA, Canada and Australia. The low number of applicants 24
speaks for themselves. The writer is not aware of any proposal from HKID to lower the investment figure. Unless and until HKID promotes this Visa more extensively, or decrease the investment amount, it is submitted that HK may lose out in the global competition to attract investor immigrants. -END- 25