Global Tax Alert (News from Americas Tax Center) | 31 October 2013
Canada-Hong Kong tax treaty enters into force
The agreement between Canada and the Hong Kong Special Administrative Region of the People’s Republic of China for the avoidance of double taxation and the prevention of fiscal evasion agreement (the treaty) entered into force on 29 October 2013. In accordance with Article 27 of the treaty, its provisions generally have effect in Canada:
- • In respect of tax withheld at the source on amounts paid or credited to nonresidents on or after 1 January 2014
- • In respect of other Canadian tax for taxation years beginning on or after 1 January 2014
Canadian tax consequences
Active business income
Generally, active business income earned in Hong Kong by a foreign affiliate of a Canadian-resident corporation should be included in the foreign affiliate’s “exempt surplus” account. Dividends paid out of exempt surplus are not subject to further taxation in Canada.
As with other treaty countries, in order for earnings to be included as part of exempt earnings, the foreign affiliate must be resident of Hong Kong under common law principles as well as under the treaty.
For purposes of computing the exempt surplus of a Hong Kong foreign affiliate of a Canadian taxpayer, the treaty, once it enters into force, will apply to a taxation year of the foreign affiliate any day of which is in the period beginning on the day the convention was signed.
Withholding tax on interest
Under Canadian domestic tax law, no withholding tax is imposed on interest paid to payees who are dealing at arm’s length with the payer. However, withholding tax at a rate of 25% typically applies to interest paid or credited to related nonresidents.
Under the treaty, interest payments made from Canada to a related nonresident person that is a resident of Hong Kong will be subject to a withholding tax of 10% of the gross amount.
Interest payments to and from the respective governments and central banks of Canada and Hong Kong are exempt from tax under the treaty.
Withholding tax on dividends
Dividend payments made to a beneficial owner that is a resident of the other contracting state will be subject to a withholding tax of 5% of the gross amount if the beneficial owner is a corporation (other than a partnership) that directly holds shares representing at least 10% of the voting power of the corporation paying the dividends. In all other cases, the withholding rate is 15%.
Withholding tax on royalties
Royalties paid from a resident of a contracting state to a beneficial owner that is a resident of the other contracting state will be subject to a withholding tax of 10% of the gross amount.
Where a Canadian-resident enterprise transacts business with an associated Hong Kong-resident enterprise in such a way that the profits that accrue to the Hong Kong-resident enterprise are less than the arm’s-length profits, the Hong Kong tax authorities can make a primary adjustment to increase the profits of the Hong Kong-resident enterprise to the arm’s-length profits.
In such a case, the Canadian tax authorities are obliged under Article 9 (Associated Enterprises) of the treaty to make an appropriate adjustment to the profits of the Canadian-resident enterprise so as to avoid double taxation. Article 9 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.
The relevant time limit under Hong Kong domestic tax law is generally six years after the year of assessment. Under Canadian domestic law, the reassessment period is generally seven years after the day of sending of a notice of an original assessment, which is based on a standard period of four years for corporations other than Canadian-controlled private corporations, plus an additional period of three years in respect of non-arm’s-length transactions with related nonresidents.
Mutual Agreement Procedure and arbitration
Under the Mutual Agreement Procedure (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 treaty, the person can seek remedy by way of the MAP. This would generally require the person to present their case to the competent authority of their resident side within three years from the date they were first notified of the actions resulting in taxation not in accordance with the provisions of the treaty.
The competent authority of which the 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 treaty provides for an arbitration mechanism. The procedure of this arbitration mechanism shall later be established by way of an exchange of notes between the contracting parties.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (Canada), Toronto
- • Yi-Wen Hsu
+1 416 943 5310
- • Mark Kaplan
+1 416 943 3507
- • Heather Kerr
+1 416 943 3162
- • Terry McDowell
+1 416 943 3600
- • Trevor O’Brien
+1 416 943 5435
- • Linda Tang
+1 416 943 3421
- • Andy Tse
+1 416 943 3024
Ernst & Young LLP (Canada), Montreal
- • Albert Anelli
+1 514 874 4403
- • Angelo Nikolakakis
+1 514 879 2862
- • Nicolas Legault
+1 514 874 4404
- • Nik Diksic
+1 514 879 6537
Ernst & Young LLP (Canada), Calgary
- • Karen Nixon
+1 403 206 5326
- • Mark Coleman
+1 403 206 5147
Ernst & Young LLP (Canada), Vancouver
- • Eric Bretsen
+1 604 899 3578
Ernst & Young LLP, New York, Canadian Tax Desk
- • Andrea Lepitzki
+1 212 773 5415
EYG no. CM3923