EY Tax Alert India signs its first tax treaty with Hong Kong
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21 March 2018
EY Tax Alert
India signs its first tax treaty
with Hong Kong
Tax Alerts cover significant tax Executive summary
news, developments and changes
On 19 March 2018, India and Hong Kong signed a comprehensive tax treaty for the
in legislation that affect Indian avoidance of double taxation and prevention of fiscal evasion with respect to taxes on
businesses. They act as technical income (the treaty or DTAA). As per a press release of the Government of India (GoI)[1] ,
summaries to keep you on top of the tax treaty will stimulate flow of investment, technology and personnel from India to
Hong Kong and vice versa, prevent double taxation and provide for exchange of
the latest tax issues. For more information between the two countries. It may also improve transparency in tax matters
information, please contact your and help curb tax evasion and tax avoidance.
EY advisor. The text of the treaty is currently published on the Hong Kong Government’s website [2].
However, the GoI is yet to make an official publication of the treaty.
[1] Source – www.pib.nic.in
[2] http://www.info.gov.hk/gia/general/201803/19/P2018031600803.htmThe significant provisions of the treaty include, inter alia, Key features of the DTAA
source country taxation rights on capital gains from
transfer of shares, other income, beneficial rate of
taxation of dividend at the rate of 5% on gross dividend
• Taxes covered
and 10% on interest, royalty, fees for technical services
The DTAA covers income tax in India, including
(FTS), provisions on service permanent establishment
surcharge thereon. It also covers identical or
(Service PE), exchange of information and mutual
substantially similar taxes that may be imposed in
agreement procedures (MAP). Profits of an enterprise
future. It does not include any penalty or interest or
from operation of ships or aircraft in international traffic
fine imposed under the domestic laws relating to the
are primarily taxed in the resident country. However,
covered taxes.
profits from operations of ships are subject to source
taxation also but at a rate of 50% concessional tax. Certain
provisions are influenced by OECD’s Multilateral • Residential status:
Instrument[3] (MLI) on Base erosion and profit shifting
(BEPS) such as the principal purpose test (PPT), In Hong Kong, the residential status for individuals
competent authority (CA) rule as the tie-breaker test for is determined basis the physical stay in Hong Kong
dual resident entities, MAP provisions and corresponding and includes an individual who ordinarily resides in
adjustments in transfer pricing cases. Interestingly, the Hong Kong[6], whereas for the companies/other
benefit of provisions of dividend, interest, royalty, FTS and persons, the criteria is its place of incorporation/
capital gains has been made subject to the “main or one of constitution and place from where it is normally
the main purpose” test which is in addition to a general managed or controlled, if incorporated/constituted
rule on the lines of the PPT of the MLI. The treaty also outside Hong Kong[7].
gives primacy to anti-avoidance provisions under the
domestic laws. In India, every person who is liable to pay tax by the
The treaty will come into force after the completion of reason of his/her domicile residence, place of
administrative procedures by both the countries, in management or any other similar criterion, is
particular, on the date on which the second country considered as resident for the applicability of the
notifies the completion of such procedures. DTAA.
This Tax Alert highlights the key provisions of the treaty, The term ‘person’ is defined in the DTAA to include
based on the text available on the Hong Kong partnership, trust and any other body of persons
Government’s website. which is treated as a taxable unit.
Background and facts Tie-breaker tests in case of dual residency:
On the lines of the OECD Model Convention (MC),
Hong Kong has emerged as an investment holding hub for residential status of an individual shall be
Multinational enterprises (MNEs) looking for investment, determined based on his/her permanent home or
especially in Asia region. Further, the trade relations centre of vital interests or habitual abode or lastly,
between India and Hong Kong have strengthened in the through MAP.
recent times. So far, there was no Double Taxation
Avoidance Agreement (DTAA) between India and Hong Treaty residency of other taxpayers (non-
Kong; accordingly, the tax implications in relation to individuals) shall be determined by MAP having
transactions between India and Hong Kong were evaluated regard to its Place of Effective Management
as per the Indian Tax Laws (ITL). (POEM), place of incorporation or constitution, and
any other relevant factors. This provision is along
Section 90 of the ITL authorizes the GoI to enter into a DTAA the lines of MLI.
with a foreign country or specified territory. Hong Kong was
notified as a specified territory in April 2010[4]. This paved In absence of MAP, dual residents are not entitled
the way for India to negotiate and sign a DTAA with Hong to any relief or exemption from tax under the tax
Kong. On 10 November 2017, the Union Cabinet of India treaty, except as may be agreed by the CA.
issued a press release indicating the approval for entering
into a DTAA with Hong Kong[5]. On 19 March 2018, India
signed its first DTAA with Hong Kong.
[6]
By way of protocol, it is clarified that an individual ‘ordinarily resides’ in
Hong Kong if the individual has a substantial presence, permanent home or
habitual abode in Hong Kong, and he has personal and economic relations
with Hong Kong.
[7]
[3] Refer EY Alert dated 6 July, 2017 titled “India signs MLI to implement tax By way of protocol, it is clarified that a company incorporated/ any other
treaty related measures to prevent BEPS” person constituted outside Hong Kong is “normally managed or controlled” in
[4] Hong Kong if its executive officers and senior management employees make
GoI Notification No S.O.909(E) (Source – www.pib.nic.in) day-to-day key decisions in Hong Kong for the strategic, financial and
[5] operational policies of the company or the person, and the staff of the
Source – www.pib.nic.in
company or the person conduct in Hong Kong, the day-to-day activities
necessary for making those decisions.• Scope of Permanent Establishment (PE) and • Shipping and Air transport:
profit attribution:
• Profits of an enterprise from operation of ships or
aircraft in international traffic is taxed only in the
• In addition to fixed place PE, the DTAA covers other
resident country. Unlike the 2011 UN MC as well as
forms of PE like Construction PE, Service PE and
various Indian treaties, resident country taxation is
Agency PE. These provisions are comparable to the
not specifically linked to the POEM of the enterprise.
2011 UN MC.
• Profits from operation of ships in international traffic
• The DTAA provides six months threshold to trigger a
may also be taxed in the source state with 50%
Construction PE and it includes a building site,
reduction in taxes imposed.
assembly or installation project or supervisory
activities.
• Along the lines of this Article, Capital Gains from
alienation of ships or aircraft or movable property
• A Service PE is created when services, including
pertaining to their operation is also be taxable only in
consultancy services, are furnished for the same or a
the resident state of the alienator.
connected project for an aggregate period of more
than 183 days within any 12-month period.
• Further, remuneration derived in respect of an
employment exercised aboard such ship or aircraft is
• Agency PE definition covers authority to conclude
only taxable in the resident state of an operating
contract (except preparatory and auxiliary activities),
enterprise.
maintaining stock of goods/merchandize for regular
delivery, securing orders wholly or almost wholly for
the principal or its associated enterprises. The • Associated Enterprises (AE) –
provision does not incorporate the MLI recommended Corresponding adjustment on account of
provisions on Agency PE. transfer pricing provision
• The DTAA also states that where the activities of an • The DTAA provides that a corresponding adjustment
agent are devoted wholly and almost wholly on behalf may be made in the profits of AE in the other
of the enterprise, the agent will not be considered as contracting state:
an independent agent. Unlike the UN MC as well as
certain Indian treaties, the additional condition of • where an adjustment has been made by a country
satisfying arm’s length requirement for qualifying as to profits of a resident, based on arm’s length
an independent agent, is absent in the DTAA. condition and taxes are levied on such profits
adjusted and
• Certain activities are listed as exempt from creating a
PE like storage/ display, maintenance of stock for • such profits are also taxed in the hands of AE in
storage/ display/ processing, purchasing goods/ the other contracting state
merchandize or collecting information, preparatory or
auxiliary activities. • This provision is to relieve double taxation in the
other contracting state and is in line with India’s
• Attribution of business profits commitment made as part of Article 14 on dispute
resolution mechanism of OECD’s BEPS.
• Article 7 of the DTAA provides for source taxation
of business profits to the extent attributable to PE
in source country. The provision is modelled along • Taxation of Dividends, Interest, Royalty,
the lines of Article 7 of the 2011 UN MC, however,
the force of attraction rule is absent in the DTAA.
FTS:
• Passive streams of income like dividend, interest,
• Further, unlike the UN MC, the restriction on
royalty and FTS are primarily taxable in the resident
allowability of expenses payable to Head Office by
country. Such income are also taxed in source
way of royalties, fees, commission, etc. is absent in
country at a tax rate of 5% on dividend and 10% on
the DTAA.
interest, royalties and FTS on gross basis. Where
such incomes are effectively connected to a PE in
• The provision allows for application of a formulary
source country, taxation will be governed by the
apportionment method or any other prescribed
provisions of Article 7 on net basis.
method, as may be customary in the source
country and to the extent it is in accordance with
• Under a unique provision, such beneficial tax rates
the principles of Article 7.
cannot be availed if the main purpose or one of the
main purpose of any person concerned with
• The DTAA also contains the exclusion for
creation/assignment of shares /other rights or debt
purchasing activity. This provision is not present in
or royalty rights or performance of services is to
the 2011 UN MC or the 2017 OECD MC.
take advantage of these Articles by means of that
creation/assignment. This is similar to Principal
Purpose Test laid down in MLI.
• Definition of royalty and FTS is similar to those in the
UN/ OECD MC. Further, there is no condition of“make available” in FTS making its scope broader • Non-discrimination
compared to India’ treaties with Singapore,
Netherlands, etc.
• Like the OECD/ UN MCs, the DTAA provides non-
discrimination provisions on the basis of nationality
• Capital Gains taxation: of taxpayer, treatment of PE in source country,
deductions claimed as well as on the basis ownership
• Capital gains arising from sale of immovable property of taxpayer
and from sale from of shares of a company which
derives more than 50% of its asset value directly or • MAP
indirectly from immovable property will be taxed in the
country where the immovable property is situated.
• The DTAA provides for MAP on the lines of MLI
provision. Amongst other things, it states that a
• Capital gains from sale of other shares will be taxable
taxpayer may present its case to a CA in its resident
in the country which the company is a resident.
country within three years from the first notification
of the action resulting in taxation. The CA would then
• Gains from sale of any other property may be taxed in
endeavour to resolve the case by mutual agreement
each country in accordance with the provisions of its
which will be implemented notwithstanding any time
domestic laws.
limits in the domestic laws.
• Similar to other passive income streams, benefits
under this Article are also subject to the ‘main purpose • Exchange of information (EOI):
or one of the main purpose’ test.
• The scope of the EOI provision in the DTAA aligns
with international standards on transparency and the
• Independent Personal Services: provisions in the OECD/ UN MC. This EOI provision
works to exchange the information that is
• Income derived by an individual from the performance
foreseeably relevant for carrying out the provisions
of professional services or other similar independent
of the DTAA or to the administration or enforcement
activities shall be taxable only in the resident state
of the domestic law concerning taxes of every kind
unless such individual has a fixed place in the source
state or his/her aggregate stay in the source state and description [8].
exceeds 183 days in any 12-month period
commencing or ending in the year concerned. • The information can be used for purposes other than
tax, with the prior approval of the authority
providing such information and if such information
• Dependent Personal Services
may be used for such other purposes under the laws
of both states.
• Income in respect of employment may be taxed in
source country where employment is exercised unless:
• EOI would also be possible in respect of persons who
are not residents of the Contracting State, as long as
• His/her aggregate presence in the source state
the information requested is in possession of the
does not exceed 183 days in any 12-month period
concerned State.
commencing or ending in the tax year under
consideration and
• Specifically, information held by banks or financial
institutions can be exchanged under the EOI Article.
• The remuneration is paid by an employer who is not
resident of source country and
• By way of protocol to the treaty, it is clarified that
the requested state shall also disclose any past
• The remuneration is not borne by the PE or fixed
information insofar the information is foreseeably
base which employer has in other country.
relevant for a fiscal year or taxable event following
that date on which the DTAA has effect.
• Other income
• Primary rights to tax ‘other income’ is accorded to the
• Anti-avoidance provisions
resident country. Such income may also be taxed in in
the source country where such income is arising.
• The provisions of the DTAA will not prevent a
country from the application of its domestic law and
measures concerning tax avoidance or evasion.
• Method to eliminate double taxation:
• In order to eliminate the double taxation on a person,
both countries India and Hong Kong allows foreign tax
credit for the taxes paid in either of the countries. The
[8] It is clarified, by way of protocol, that in addition to the taxes covered by
relief is provided by way of credit method subject to
the DTAA, the EOI Article shall also apply to (i) the wealth tax (ii) the excise
maximum deduction limit. and customs duties (iii) the goods and services tax (GST) and (iv) the sales
and value added taxes.• Also, treaty benefits shall not be granted if the main
purpose or one of the main purposes of any persons is
non-taxation or reduced taxation through tax evasion liberal use of PPT in respect of overall
or avoidance (including through treaty-shopping treaty and passive income streams in
arrangements aimed at obtaining reliefs provided in particular. Introduction of
the DTAA for the indirect benefit of residents of third corresponding adjustment for transfer
jurisdictions). This provision is comparable to the PPT pricing variations is in line with India’s
rule as well as language of the Preamble as per BEPS
commitment under OECD’s project on
Action 6 incorporate in the MLI[9].
BEPS to provide access to MAP in
transfer pricing cases.
• Cases of legal entities not having bona fide business
activities shall also be covered by the provisions of this Interestingly, the treaty does not
Article. include any of the MLI proposals on PE,
which are otherwise broad scoped and
largely adopted by India through its
Comments MLI positions. The anti-avoidance
provisions of the treaty are fairly broad
India’s tax treaty with Hong Kong was and also give overriding authority to
expected for some time and is certainly the domestic law provisions, e.g.,
a welcome step. The treaty is similar to GAAR and transfer pricing provisions
most of India’s treaties which are based under the ITL.
on both OECD as well as UN MC. On the
The treaty might ensure regulation in
lines of recently negotiated/amended
the taxation system between India and
Indian treaties, this treaty provides for
Hong Kong to a large extent and is
extended source taxation rights,
intended to promote business relations
especially on gains from transfer of
between the two countries. The treaty
shares, income from service
is welcome particularly at a time when
arrangements, passive stream of
the ITL has expanded the source rule
incomes as well as other incomes.
to tax Significant Economic Presence
Allowance of foreign tax credit for the
of market players operating remotely
taxes paid in either of the countries will
in India.
reduce the tax burden for the genuine
taxpayers. Also, the broad scope of The treaty will come into force after
provisions on exchange of information the completion of administrative
may enable India and Hong Kong to procedures by both the countries.
fulfil their respective international
obligations on enhancing tax
transparency and combating tax
evasion.
Both India and Hong Kong are
signatories to MLI. The treaty includes
some selective provisions of OECD’s
MLI, as aforesaid, which primarily
represent the “minimum standards” of
OECD’s BEPS project to be
implemented by the OECD/ G 20
member countries. This treaty
negotiation preludes India’s approach
and commitment to the MLI. There is a
[9] Refer EY Alert dated 6 July, 2017 titled “India signs MLI to implement tax
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