New Double Tax Arangements Between Mainland China and Hong Kong

China and Hong Kong signed an agreement on new Double Tax Arrangements ('DTA') to replace the old DTA signed 8 years ago. The new DTA is taking effect since January 1, 2007 in the Mainland and from April 1, 2007 in Hong Kong.

The new Arrangement covers both Active/Direct Income and Passive Income.

ACTIVE/ DIRECT INCOME

Business Profit

For business profits generated via a foreign-invested enterprise ("FIE"") in the Mainland, there is no significant change. However, transfer pricing rules are expected to be issued soon and may come into effect after the March 2007 session of the National Party Congress.

Employment Income

For employment income the period of presence in China for Hong Kong employees changes from a "calendar" year to any rolling 12-month period. The limit for not having to declare income is still 183 days.

PASSIVE INCOME

For FIEs, the most significant difference is in the withholding tax on passive income. This includes:

Dividends

Dividends received by HK companies from an FIE in the Mainland are currently exempt from Foreign Enterprise Income Tax (FEIT) under Article 19 of the PRC FEIT Law. In the new DTA, Hong Kong companies are faced with a withholding tax of 5% on dividends, provided that the Hong Kong enterprise's shareholding in the Mainland company is 25% or more. Otherwise a 10% withholding tax rate applies. This is still the lowest among all DTAs signed by the Mainland.

Interest

In the new DTA, the withholding tax rate on interest received by Hong Kong entities does not exceed 7% versus 10% as specified in most other tax treaties with China.

Royalties

Under the new DTA, the withholding tax rate on Royalties is 7%. Again this is the lowest of all DTAs signed by the Mainland.

Capital Gains

Full tax exemption is provided for any capital gains derived by a Hong Kong enterprise from disposal of shares of a Mainland company, provided that:
1. The shares sold are less than 25% of the shareholding of the Mainland company; and
2. The assets of the Mainland company do not comprise mainly of immoveable property situated in the Mainland

Whilst this DTA grants Hong Kong preferential tax treatment in a number of areas, it also provides for the exchange of information. The latter could have a major impact on Hong Kong companies operating in China, and vice versa, especially for those Hong Kong companies claiming offshore income, i.e. tax-free status.