Canada's First Tax Treaty with Hong Kong
The first tax treaty between Canada and the Hong Kong Special Administrative Region of the People's Republic of China was signed on November 11, 2012, but it has not yet come into force. A notable feature of the treaty is the reduction of withholding tax rates.
Under the treaty, the withholding tax rate on dividends is 5 percent if the corporate beneficial owner controls, directly or indirectly, at least 10 percent of the voting power of the dividend payer (15 percent otherwise). The withholding tax on interest and royalties is 10 percent. Anti-avoidance rules may apply to deny benefits where structures or relationships are created and one of the main purposes is to obtain treaty benefits.
The new rates are particularly beneficial to Hong Kong residents who receive payments from Canada. The reduction in withholding taxes will be large; in the absence of a treaty, Canada applies a general 25 percent withholding tax rate on certain cross-border payments. On the other hand, Canadian residents will see little, if any, reduction of Hong Kong withholding taxes from the treaty. Hong Kong has no withholding tax on interest and dividends, although royalties are taxed at rates that range from 4.95 to 16.5 percent.
The treaty will apply to persons who are resident in one or both of the "parties" to the treaty. The term "party" (as opposed to "contracting state," the term typically used in Canada's other tax treaties) is reflective of Hong Kong's status as a special administrative region of China. In 1997, China assumed sovereignty over Hong Kong under the "one country, two systems" principle. The constitution-like Basic Law of Hong Kong, which remains in effect until 2047, stipulates that Hong Kong has a high degree of autonomy in all matters except foreign relations and defence. Thus, Hong Kong retains the British common-law tradition, and its judicial and tax systems remain completely separate from those of mainland China.
The treaty makes Hong Kong a particularly attractive jurisdiction through which Chinese entities can make investments into Canada. Hong Kong's advantages are its business and language expertise, its sophisticated financial market, and its retention of the common-law tradition. Hong Kong may also be used by a Chinese parent corporation as a place to park and redeploy profits from operating jurisdictions. Profits repatriated to China may be subject to stringent exchange controls and other regulatory approvals.
Residence is determined under article 4 of the treaty. The provisions for individuals are conventional and include the usual tiebreaker rules to address situations in which individuals are resident in both parties. Non-individuals are resident in a party by virtue of their place of incorporation or constitution; however, they may also be resident in a party if they are centrally managed and controlled there, notwithstanding that they are incorporated or constituted elsewhere. The only tiebreaker applicable to dual-resident non-individuals is by determination of the competent authorities of the parties.
Articles 6 and 13 provide the party in which immovable property is situated with the ability to tax income from the use, rental, and sale of immovable property (defined to include livestock and equipment used in agriculture and forestry). Gains may be taxed only in the party in which the alienator (the seller) is a resident, subject to the exceptions in article 13. However, there is generally no tax on capital gains under Hong Kong domestic law. Gains from certain speculative transactions may be subject to a 16.5 percent profit tax (15 percent for unincorporated businesses).
For a discussion of other aspects of the treaty, see "New Hong Kong Treaty," Canadian Tax Highlights, December 2012.
Felesky Flynn LLP, Edmonton