Hong Kong Tax Alert: 24 January 2013
Reasonable commercial return
The “reasonable commercial return condition” is more restrictive than the equivalent UK provision on which it is based. It provides that the return under the bond arrangement must not exceed an amount that would be a reasonable commercial return on money borrowed of the amount of the bond proceeds in each period from commencement of the specified term of the scheme to each scheduled payment date or the redemption payment.
Therefore, where the profile of the returns under the bond arrangement is such that greater amounts are paid in earlier periods than in later periods the bond arrangement will fail the “reasonable commercial return” condition and not be a qualified bond arrangement. This clearly limits the flexibility with which the pay-out profile of a specified ABS may be structured.
Further, the condition considers whether the maximum total amount of the bond return exceeds a reasonable commercial return in each period from commencement to the date of an additional or redemption payment. What is considered to be a “reasonable commercial return” is subjective and is likely to cause uncertainty for market participants.
We understand that the Government will clarify what they view as a “reasonable commercial return” in a practice note , however we note that clarity in the drafting of the legislation is always preferable to a non-statutory practice note which is neither binding on the Inland Revenue Department (“IRD”) nor the tax payer.
Duration of a specified ABS
The “maximum term length condition” provides that the specified term of a specified ABS must not exceed 15 years. Therefore, where the specified term is longer than 15 years, the specified ABS will fail the “maximum term length condition” and not be a qualified bond arrangement.
While the maximum term length was increased from 10 years during the consultation process, we note that there is no such condition for conventional bonds.
Under the Bill, if at any time, a qualified bond arrangement or qualified investment arrangement fails to meet the conditions requisite and is disqualified, it will be treated as never having been a qualified bond arrangement or qualified investment arrangement. This may create uncertainty and discourage market participants from specified ABS, particularly those with longer maturities which may be at greater risk of failing one of the qualifying conditions.
This was highlighted during the consultation period; however the Government felt that avoidance opportunities may exist if this provision was relaxed.
Stamp duty exemption – Security
The Bill requires security to be provided to the satisfaction of the CSR in respect of the stamp duty that would be due, apart from the reliefs for qualified investment arrangements, before any relief will be applied to an instrument. This would appear to be an unnecessary additional burden on the parties to the arrangements and we note that relief under section 45 of the SDO for conveyance from one associated body corporate to another does not require security to be provided even though that relief may be withdrawn if the claimant subsequently fails the conditions requisite.
The Government has indicated that security may be provided in forms other than cash, for example by way of bank guarantee. It is expected that the types of security and the proposed security arrangements will be clarified by way of a practice note.
Record keeping and assessments – Time limits
The Bill requires records relating to transactions acts or operations relating to the specified ABS to be retained for the later of the expiry of 7 years after the completion of the transactions, acts or operations to which they relate; or the expiry of 3 years after the end of the specified term of the specified ABS. This is not a requirement in relation to ordinary bonds.
The Bill also lengthens the normal 6-year time limitation for raising additional assessments under section 60 of the IRO under certain circumstances in the event that a qualified bond or investment arrangement is subsequently disqualified.
For stamp duty purposes, it will be necessary to keep relevant documentation for a period of one year after the expiry of the specified ABS. Historically, the SDO did not impose any requirements for the taxpayer to maintain records for a specific period of time. These measures apply additional administrative burden to taxpayers and do not apply to equivalent conventional bonds. However the Government believes they are necessary to prevent avoidance.
In particular the extended assessment periods are primarily targeted at avoidance involving “unlisted specified ABS” which may cater for a high degree of customization in payment terms towards the end of the specified ABS, which may cause the specified ABS to be disqualified only in its later years.
The Bill was introduced to the Legislative Council for the first reading and commencement of second reading debate on 9 January 2013. A Bills Committee is formed to study the Bill in detail and the first meeting of the Bills Committee will be held on 29 January 2013.
The Government has also indicated that after the enactment of the proposed legislation, the IRD will issue practice notes explaining its interpretations and practices for the administration of the new law.
Meanwhile, clients who have any enquiries or suggestions on the Bill should contact your Ernst & Young tax representative. Full provisions of Bill are accessible here.