On 11 November 2012, Hong Kong signed a comprehensive double taxation agreement (CDTA) with Canada. This is the second CDTA that Hong Kong has concluded with a jurisdiction on the North American continent, the first one being with Mexico. This brings the number of CDTAs Hong Kong has concluded with other jurisdictions to 26.
The CDTA with Canada contains several favorable provisions, which are expected to boost closer economic and trade ties between Hong Kong and Canada.
This alert summarizes the salient points of the provisions as applicable to Hong Kong residents.
Who is covered by the CDTA
The CDTA only applies to persons who are residents of either Hong Kong or Canada. In this regard, a company that is incorporated or constituted under the laws of Hong Kong automatically qualifies as a Hong Kong resident. A company which is not so incorporated or constituted will only be regarded as a Hong Kong resident if it is “centrally managed and controlled” in Hong Kong.
This is the fifth CDTA (after those with Belgium, the United Kingdom, Ireland and the Czech Republic) that adopts this more stringent residence test than the “normally managed or controlled” test commonly used in other CDTAs that Hong Kong has concluded.
Tax benefits available to Hong Kong residents under the CDTA
- Active business profits of a Hong Kong resident enterprise will not be liable to tax in Canada unless they are attributable to a permanent establishment (PE) maintained by the Hong Kong enterprise in Canada. Where a Hong Kong enterprise has maintained a PE in Canada, only profits attributable to the PE will be liable to tax in Canada.
- A Hong Kong resident enterprise will not be liable to tax in Canada if it simply maintains a buying office in Canada which only makes purchases for the Hong Kong resident enterprise.
- Hong Kong resident airliners and ship owners will not be subject to tax in Canada in respect of profits derived from international traffic. However, income of a Hong Kong resident airliner so exempt from taxation in Canada under the CDTA will be charged to tax in Hong Kong under the relevant provisions of the Hong Kong tax code.
- Non-resident companies carrying on business in Canada through a branch are taxable at the full corporate tax rate on their net business income earned in Canada, and they must pay an additional tax of 25% on after-tax profits that are not invested in qualifying Canadian property.
In this regard, the protocol to the CDTA provides that business profits attributable to a Canadian PE or income from the trading of immoveable property in Canada by a Hong Kong resident company, that have been re-invested in Canada, are to be excluded from the computation of the additional 25% branch tax. For other cases, this branch tax in Canada will be reduced from 25% to 5% under the CDTA.
- Where a Hong Kong resident enterprise transacts business with an associated Canadian resident enterprise in such a way that the profits that accrue to the Canadian resident enterprise are less than that which would accrue on an arm’s length basis, the Canadian tax authorities can make a primary adjustment to increase the profits of the Canadian resident enterprise to an arm’s length result. In such case, the Hong Kong tax authorities are obliged under Article 9 (Associated Enterprises) of the CDTA to make an appropriate adjustment to the profits of the Hong Kong resident enterprise so as to avoid double taxation.
Article 9 of the CDTA, however, further provides that a contracting party should not make a primary adjustment to the profits of an enterprise in the circumstances described above after the expiry of the time limits provided for in its domestic laws, and in any case, after seven years from the end of the taxable year concerned.
Exemption or reduction of tax on dividends, interest, royalties and capital gains on disposal of shares
Subject to a specific anti-avoidance provision applicable to dividends, interest and royalties, the following table summarizes the applicable withholding rates for the captioned income flows received from Canada by a Hong Kong resident as the beneficial owner.
| Tax rate \ Passive income || Dividends || Interest || Royalties || Capital gains on disposal of shares |
| Normal with holding rate || 25% || 0%/ 25%2 || 25% || 7.5%4 |
| Reduced rate under the CDTA || 5%/15%1 || 0%/ 10%3 || 10% || 7.5% |
1 A 5% rate applies if the beneficial owner of the dividends is a company (other than a partnership) that controls directly or indirectly at least 10% of the voting power in the company paying the dividends. For other cases, the 15% rate applies.
2 Under the Canadian domestic tax law, no withholding tax is imposed on interest paid to payees who are dealing at arm’s length with the payer in general. However, withholding tax at a rate of 25% typically applies to interest paid or credited to related non-residents.
3 0% rate applies in the following situations if the recipient is:
(i) The Hong Kong government, the Hong Kong Monetary Authority, a political subdivision or a local authority of the Hong Kong government, or any wholly-owned agency or instrumentality of the Hong Kong government, political subdivision or local authority agreed from time to time between the competent authorities of Hong Kong and Canada
(ii) Dealing at arm’s length with the payer, subject to certain specific anti-avoidance provisions against payments disguised as interest
For other cases, 10% rate applies.
4 In respect of the disposal of shares in a private company, the domestic tax law of Canada generally only charges capital gains tax in Canada where, within the preceding 60 months of the disposal, the company derived its value principally from real or immovable property located in Canada. Under the provisions of the CDTA, Canada retains its right to tax such gains in Canada.
Included in Article 26 (Miscellaneous Rules) of the CDTA are provisions which:
- Explicitly provide that nothing in the CDTA shall prevent a contracting party from applying the provisions of its domestic laws which are designed to prevent tax avoidance, including measures relating to thin capitalization
- Target entities which are residents of a contracting party (but are beneficially owned or controlled, directly or indirectly by one or more persons which are not residents of that contracting party) and which enjoy a preferential tax regime in that contracting party. Under the relevant provisions of Article 26, most of the tax benefits conferred by the CDTA would be denied where the relevant entities would be subject to substantially higher amount of tax in that contracting party where it beneficially owned by one or more individuals who were residents of that contracting party. These anti-avoidance provisions appear to have no application to Hong Kong resident entities because none enjoy a preferential tax regime in Hong Kong on the aforesaid basis
Mutual Agreement Procedure (MAP) and arbitration
Similar to all other CDTAs that Hong Kong has concluded, the CDTA contains a MAP Article. Under the MAP Article, if the actions of one or both contracting parties result, or will result, in a person being assessed to tax in a manner not in accordance with the provisions of the CDTA, such person can seek remedy by way of the MAP. This would generally involve such person presenting their case to the competent authority of their resident side within three years from the date of the first notification to them of the actions resulting in taxation not in accordance with the provisions of the CDTA.
The competent authority of the contracting party of which such person is a resident, will then consider and resolve the case on its own if possible or, where necessary, endeavor to resolve the case with the competent authority of the other contracting party. Any agreement reached under the MAP shall be implemented within the time limits provided for in the domestic laws of the contracting parties.
However, if the competent authorities are unable to reach an agreement, the CDTA provides for an arbitration mechanism. The procedure of this arbitration mechanism shall be established later by way of an exchange of notes between the contracting parties.
Avoidance of double taxation
Where the income of a Hong Kong resident is subject to tax in both Hong Kong and Canada, the Hong Kong resident may credit the tax paid in Canada on the relevant income against the Hong Kong tax liability charged on the same income. The tax credit available is, however, limited to the Hong Kong tax charged on the income.
Effective date of the CDTA
The CDTA will only come into force in the tax year following the calendar year in which the relevant ratification procedures are completed. Assuming that the ratification procedures can only be completed in 2013, the CDTA shall then have effect as follows:
- For Hong Kong: for any year of assessment beginning on or after 1 April 2014
- For Canada: for any income year beginning on or after 1 January 2014