The comprehensive double taxation agreement with Malaysia contains several favorable provisions, which are expected to boost closer economic and trade ties between Hong Kong and Malaysia.
On 25 April 2012, Hong Kong signed a comprehensive double taxation agreement (CDTA) with Malaysia. This brings the number of CDTAs Hong Kong has concluded with other jurisdictions to twenty-four.
This alert summarizes the salient points of those 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 Malaysia.
In this regard, a company that is incorporated or constituted under the laws of Hong Kong automatically qualifies as a Hong Kong resident. For a company which is not so incorporated or constituted, it would be regarded as a Hong Kong resident only if it is “normally managed or controlled” in Hong Kong, a residence test commonly used in other CDTAs Hong Kong has concluded.
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 be completed in 2012, the CDTA shall then have effect as follows:
- For Hong Kong: for any year of assessment beginning on or after 1 April 2013
- For Malaysia: for any income year beginning on or after 1 January 2013
Mutual Agreement Procedure (MAP)
Similar to all other CDTAs 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 issue with the competent authority of the other contracting party. Any agreement reached under the MAP shall be implemented notwithstanding any time limits in the domestic laws of the contracting parties.
Avoidance of double taxation
Where the income of a Hong Kong resident is subject to tax in both Hong Kong and Malaysia, the Hong Kong resident may credit the tax paid in Malaysia on the relevant income against the Hong Kong tax liability charged on the same. The tax credit available is, however, limited to the Hong Kong tax charged on the same income.
The CDTA also contains a tax sparing provision enabling a Hong Kong resident to claim certain notional Malaysia taxes as having actually been paid for tax credit purposes in Hong Kong. In this context, the notional Malaysia taxes refer to those taxes which would have been payable for any year but for an exemption from or a reduction of tax granted as a result of certain tax incentives in Malaysia.
Typically, a tax sparing provision applies to grant tax credit of the notional underlying taxes of a dividend stream in a home state from an investment project enjoying tax incentives in a host state. However, as Hong Kong does not tax dividends and foreign sourced income generally, the tax sparing provision in the tax agreement may not mean much to most Hong Kong investors.
Tax efficient investment structure
In 1990, the Malaysian government enacted legislation that created a business and financial centre on the island of Labuan of Malaysia with a separate and distinct preferential tax regime. Under this preferential tax regime, Labuan companies are only taxed at a rate of 3% (compared to the normal Malaysian tax rate of 25%) on their net audited profits derived from their trading activities in Labuan or they may elect to pay a fixed annual sum of RM 20,000 (USD 6,618).
In addition, income derived from non-trading activities of a Labuan company, such as dividends, interest and rent, is exempt from tax. The normal Malaysian withholding taxes as shown in the table above are not applicable to Labuan companies.
In the CDTA, the term “Malaysia” is defined to include all territories of Malaysia without excluding Labuan. Conceptually, Hong Kong investors can set up Labuan companies to enjoy both the Labuan preferential tax regime and at the same time take advantage of Malaysia’s tax treaties with a number of countries (e.g., Singapore and Mongolia) that also recognize Labuan as part of Malaysia.
Therefore, the CDTA may offer Hong Kong investors the opportunity to use Labuan companies as a springboard for investing into those countries in a tax efficient manner. However, this kind of investment structure is by its nature complicated. In this regard you should seek professional tax advice.