One of the attractive features of doing business in Hong Kong is the simplicity of its tax system. But for many e-businesses looking to expand into Asia, the choice of location to base their operations will be dependent upon many factors including infrastructure, quality of employees, capital markets, and customer base. Issues such as taxation tend to be considered at the very end of such a list, if at all.
However, for many internet start-ups which ignore the tax issues now, the consequences may often be very painful financially when confronted with tax bills later because of a tax inefficient structure, which may also prove costly to unwind. In this article, I comment briefly on some of the features of Hong Kong's tax system which may be attractive to e-businesses when compared with some of its neighbours in Asia.
Low Corporate Tax Rate
Hong Kong's profits tax rate is 16%, which is low when compared with the normal corporate tax rate in other Asian countries. However, Hong Kong offers comparatively little in the way of specific tax incentives for various industries unlike many other Asian countries. These tax incentives may result in a lower corporate tax rate for specific industries for either a period of time (for example tax holidays for the first few years followed by a reduced tax rate for later years), or indefinitely (for example Singapore is offering a tax incentive for e-businesses to tax them at only 10% on their trading profits).
Capital Gains
One very attractive feature of Hong Kong's tax system is that it does not impose any tax on capital gains. Other countries in the region, for example Australia, do impose a tax on capital gains earned by non-residents on the disposal of assets located within their borders. Thus, for founders of an e-business in Hong Kong who make a significant capital gain on the sale of their shares, either after an Initial Public Offering ("IPO") or a buy-out, they will generally not be subject to Hong Kong profits tax on the gain. Any reorganisation of the Group structure will also not trigger any taxable gains in Hong Kong.
Hong Kong stamp duty will be payable on the transfer of shares in a Hong Kong company, but it is common for many e-businesses to start with a holding company in a tax-free country such as Bermuda or the Cayman Islands and therefore the Hong Kong stamp duty costs can also be avoided.
Source-based Jurisdiction
Hong Kong will only impose profits tax on entities carrying on a business in Hong Kong which derive income from sources within Hong Kong. To the extent that a Hong Kong based e-business has significant income earning operations outside Hong Kong, it may be possible to treat the profits from such overseas operations as not subject to tax in Hong Kong. For example the set-up of a branch in a foreign country with its own server for customers in that country may enable the Hong Kong company to claim that the profits from the foreign branch are offshore sourced and therefore exempt from Hong Kong profits tax. However any offshore profits claims will be scrutinised by the Inland Revenue Department
Withholding Taxes
Hong Kong does not impose any withholding taxes on dividends or interest payments by a Hong Kong resident to a non-resident. There is an effective withholding tax on royalty payments by a Hong Kong resident to a non-resident which is usually at a rate of 1.6%, unless the intellectual property which is being used was previously owned by an entity carrying on business in Hong Kong, in which case the effective withholding tax rate will be 16%. For example, if the Hong Kong e-business pays a royalty to a US entity for the commercial exploitation of a computer software program in Hong Kong, this royalty payment would attract a 1.6% withholding tax.
This compares favourably with other countries in Asia which will normally impose withholding taxes on dividends, interest and royalty payments to non-residents, usually at higher withholding tax rates.
However, Hong Kong does not have a tax treaty network with other countries (apart from the PRC) which means that royalty payments received by a Hong Kong e-business from other countries would be subject to the normal royalty withholding tax rate applicable in that country. Tax treaties usually provide for a reduction in the normal royalty withholding tax rate.
Capital Expenditure
Hong Kong offers generous tax depreciation allowances for capital expenditure on plant and equipment. The costs of computer hardware and software can be deducted in full in the year of acquisition provided that they are used in the production of taxable profits. Even the cost of general plant and equipment will qualify for an initial allowance of 60% of the cost in the year of acquisition and an annual allowance of 10%, 20% or 30% on the residual balance.
Tax Losses
Most e-businesses will have tax losses at least for the first few years of operations given the high operating costs and capital expenditure as they attract business. Tax losses in Hong Kong can be carried forward indefinitely and used to offset taxable profits in later years. There are few restrictions on the carry forward of losses and a change of ownership in the company does not prevent the carry forward of such losses unless it is motivated purely for tax reasons. However, tax losses cannot be transferred between countries as is allowed in other countries like Australia so it is important that the tax losses are booked in the correct company and can be later offset against future profits.
Alexander Yuen is a Senior Manager, Tax & Legal Support Services, PricewaterhouseCoopers Ltd.
Email: [email protected]
