Background

With a view to enhancing Hong Kong’s global competitiveness in attracting corporate treasury activity, Hong Kong government introduced the new Corporate Treasury Centre Policies in June 2016.

The Inland Revenue (Amendment) (No.2) Ordinance 2016 (the “Amendment”) amended the Inland Revenue Ordinance to give tax concession to qualifying corporate treasury centres (“QCTCs”) and to allow interest reduction on interest expenses in relation to money borrowed from associated corporations outside Hong Kong.

The Amendment aims to attract multinational enterprises to establish their corporate treasury centres (“CTC”) in Hong Kong to perform treasury services for their group companies, which will improve Hong Kong’s position as an international financial hub.  Among the new policies, two important changes, namely concessionary tax rate regime and the interest reduction on interest expenses, are discussed in details below.

The Concessionary Tax Rate Regime

CTC

What is a CTC? A CTC serves as an “in-house bank” within a multinational corporation, performing functions such as intra-group financing, cash, liquidity and risk management, physical and notional cash pooling.  It helps the multinational corporation to centralise its treasury management and enhance its operating efficiency.

Eligibility

Under the Amendment, a concessionary tax rate of 50% reduction on the existing rates (i.e. from 16.5% to 8.25%) will be given to specified treasury activities of QCTCs.  To become a QCTC, a corporation is required to fulfil any one of the following criteria:

• carried out in Hong Kong, during the year of assessment, one or more corporate treasury activities and has not carried out any activity other than a corporate treasury activity (i.e. being a dedicated CTC); or
• satisfied the 1-year safe harbor rule or the multiple-year safe harbor rule; or
• has obtained the Commissioner of Inland Revenue’s determination that it is a QCTC.

However, financial institutions as defined under section 2 of the IRO, including authorized institution and any exempted associated corporation of such authorized institution under the Banking Ordinance, are not eligible to be a QCTC, and thus are not be entitled to the profit tax concession under the Amendment.

In addition to the above criteria for being a QCTC, the corporation must also fulfil all of the following three requirements:

• the central management and control of the corporation is exercised in Hong Kong; and
• the activities that produce its qualifying profits in that year are carried out in Hong Kong by the corporation or arranged by the corporation to be carried out in Hong Kong; and
• the corporation has elected in writing that the half rate concession applies to it.

Since the written election is irrevocable, a QCTC is not required to make a fresh election every year.  In the event that the half rate concession ceases to apply to a CTC, the written election previously made becomes ineffective.  To prevent abuse and protect fiscal revenue, the corporation is not allowed to re-enter the half rate regime for the year of assessment following the cessation year.  If the CTC is subsequently entitled to the half rate concession, it is required to make an election in writing again.

Qualifying Profits

Even if a corporation is qualified as a QCTC and has satisfied all the above-mentioned requirements, not all of its profits will be subject to the concessionary tax rate.  Under the Amendment, only the following three types of assessable profits of a QCTC are chargeable at the concessionary tax rate:

• assessable profits derived from its “qualifying lending transaction” (i.e. where a corporation lends money to a non-Hong Kong associated corporation in the ordinary course of its intra-group financing business); or
• assessable profits derived from its “qualifying corporate treasury service” (i.e. where a corporation provides corporate treasury service to a non-Hong Kong associated corporation); or
• assessable profits derived from its “qualifying corporate treasury transaction” (i.e. where a corporation enters into a corporate treasury transaction that is related to the business of a non-Hong Kong associated corporation).

In other words, profits derived from corporate treasury activities in relation to a Hong Kong associated corporation only will not be regarded as qualifying profits and will be chargeable at the full profit tax rate.

Deduction on Interest Expenses

Prior to the Amendment, interest deduction rules were not attractive to multinational corporations who engaged in intra-group financing business with their non-Hong Kong associated corporations, since interest expenses payable to such associated corporations outside Hong Kong were not deductible unless the corresponding interest income by the associated corporation was subject to profits tax in Hong Kong.

Under the Amendment, interest deduction is allowed on a corporation’s interest expense paid to its non-Hong Kong associated corporation provided that the following conditions are met:

• interest expenses on money borrowed from a non-Hong Kong associated corporation are incurred in the ordinary course of an intra-group financing business;
• the interest income received by the non-Hong Kong associated corporation is subject to similar tax in a territory outside Hong Kong at a rate that is not lower that the applicable tax rate to the corporation (i.e. 16.5% or 8.25%); and
• the right to use and enjoy the interest income is not constrained by a contractual or legal obligation to pass that interest to any other person, unless the obligation arises as a result of a transaction between the non-Hong Kong associated corporation and the other person dealing with each other at arm’s length.

This new rule, which is not confined to QCTCs, aims to solve the problem of the mismatch of taxability of interest income and deductibility of the corresponding interest expense, so as to attract multinational corporations to carry on intra-group financing business in Hong Kong.

Conclusion

The new CTC policies may help QCTCs reduce operating and funding costs and optimize cash and risk management, and provide more incentives for multinational corporations to consider Hong Kong as their CTC location.  Interested corporations should pay attention to the requirements in order to be qualified as QCTCs and be eligible for the half rate concession, as well as the interest deduction.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.