On November 11, 2012, the Government of Canada signed a tax treaty with the Government of the Hong Kong Special Administrative Region of the People’s Republic of China (referred to herein as “Hong Kong”) for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income. Since it has been held that the Canada-China Tax Treaty does not apply to Hong Kong, there was a need for a separate tax treaty between Canada and Hong Kong. This positive development should promote business between Canada and Hong Kong and could also have an impact on the structuring of certain inbound investments into Canada.
The new Canada-Hong Kong Tax Treaty (the “Tax Treaty”) is comprehensive and is similar in many respects to Canada’s other bilateral tax treaties. Some highlights include:
- A resident of Canada or Hong Kong will only be subject to taxation in the other Party on profits from a business carried on in such Party to the extent such business profits are attributable to a permanent establishment in the other Party. The term “Party” is used in the Tax Treaty instead of “Contracting State” since Hong Kong is not a sovereign state.
- Withholding tax on dividends will generally be limited to 15%. Withholding tax will apply at a rate of 5% to dividends paid to a company if the company is the beneficial owner of the dividends and controls, directly or indirectly, at least 10% of the votes of the dividend paying company.
- Withholding tax on interest payments will generally be limited to 10% for non-arm’s length debt. However, the withholding tax rate on interest payments will be reduced to 0% for arm’s length debt. These reduced withholding tax rates will not be applicable if the interest is participating interest. Interest payments (other than participating debt interest) on arm’s length debt are generally exempt from Canadian withholding tax under the Income Tax Act (Canada) (the “Act”) such that there is no need to rely on the exemption under the Tax Treaty.
- Withholding tax on royalties will generally be limited to 10%. Unlike some of Canada’s other tax treaties (e.g., the Canada-US Tax Treaty), there are no carve-outs for certain royalties, such as those relating to copyright in respect of the production or reproduction of literary, dramatic, musical or artistic works; payments for the use of, or right to use, computer software; payments for the use of, or right to use, patents or information concerning industrial, commercial or scientific experience. However, certain of these payments may be exempt from Canadian withholding taxes under the Act.
- Capital gains derived by a resident of a Party from the sale of shares deriving more than 50% of their value directly or indirectly from immovable property situated in the other Party may be taxed in that other Party. The Tax Treaty does not include a carve-out for immovable property (other than rental property) in which the business was carried on.
- Anti-treaty shopping provisions are included in each of the dividend, interest and royalty articles. These provisions preclude treaty benefits where one of the main purposes of any person concerned with the assignment or transfer of the dividend, interest or royalty, or with the creation, assignment, acquisition or transfer of the shares or debt claim (as applicable) or other rights in respect of which the dividend, interest or royalty is paid, or with the establishment, acquisition or maintenance of the person that is the beneficial owner of the dividend, interest or royalty, is for the resident of a Party to obtain tax benefits under the relevant article of the Tax Treaty.
- The Tax Treaty includes dual resident tie-breaker rules for individuals, which are common in most of Canada’s tax treaties. Dual residency of a person other than an individual must be settled by mutual agreement of the competent authorities of the Parties.
- Another key aspect of the Tax Treaty is that Canadian resident companies with Hong Kong subsidiaries should generally be able to repatriate net active business earnings of a Hong Kong subsidiary without any additional Canadian taxes in accordance with the exempt surplus regime applicable to foreign affiliates.
Entry Into Force
The Tax Treaty will come into force on the date of the later of the notification by Canada and Hong Kong that the Tax Treaty has been ratified in accordance with their respective domestic laws. In Canada, the Tax Treaty will apply to tax withheld at source on amounts paid or credited to non-residents on or after January 1 in the calendar year following the year in which the Tax Treaty enters into force. The Tax Treaty will generally apply to other Canadian taxes for taxation years beginning on or after January 1 in the calendar year following the year in which the Tax Treaty enters into force.