Income Tax Treaty between Canada and Hong Kong Special Administrative Region of the People’s Republic of China

This article was first published in the December, 2012 edition of Carswell TaxnetPro's publication Private Companies and Taxes.

On the 11^th of November, 2012, the Government of Canada signed a tax treaty (“Treaty”) with Hong Kong.  The treaty will come into force the first day of January in the calendar year following the calendar year in which the treaty is ratified.  Hong Kong continues to enjoy a high degree of autonomy since its 1997 handover to China. Hong Kong is therefore not covered under the Canada – China tax treaty.  The Treaty as will be seen further in this article has more favorable withholding rates to that of the Canada – China Treaty.    The Treaty is similar to the tax treaties Hong Kong has entered to since 2009.  In 2009 Hong Kong was almost placed on the Grey List by members of the OECD as a jurisdiction that had committed to internationally agreed tax standards but had not implemented such standards.  The standard causing grief to the OECD members was “the exchange of information standard” based on Article 26 of the 2004 OECD Model Tax Treaty.  In order to avoid the possibility of being placed on the grey list which would have led to repercussions from member OECD states, Hong Kong was required to enter into 12 comprehensive income tax treaties so as to be regarded as a fully cooperating tax jurisdiction.  Hong Kong complied and has since 2009 entered into comprehensive tax treaties with more than 22 jurisdictions which include the Netherlands, Switzerland, China and Luxemburg.

All of Hong Kong’s tax treaties are based on the exchange of information standard contained in Article 26 of the 2004 OECD Model Treaty but deviate from Article 26 with the provision that the information exchanged must not be disclosed to any third jurisdiction for any purpose.  The exchange of information is only from the date the treaty is ratified and will not apply retroactively. 

The withholding tax rates in the Treaty are as following:

·        5% for dividends where at least 10% of the shares is held by the parent company;

·        10% for dividends paid in all other cases;

·        10% for interest charged between related parties – nil for interest between unrelated parties;

·        10% for royalty withholding.

However as Hong Kong does not have a withholding tax on dividends and interest, the focus of the rates is a reduction of the 25% rate imposed by the Income Tax Act on payments made from Canada to Hong Kong.  Currently the Canada – China Tax Treaty withholding rate is 10% for interest, dividends and royalties and as such the Hong Kong Treaty would be attractive to a Chinese corporation carrying on operations through a corporation in Canada.  However a careful read of the withholding provisions is mandatory to ensure compliance with the Treaty.

Although the Treaty does not contain a Limitation of Benefits clause the wording of a Limitation on Benefits clause is found in the royalty, interest and dividend articles.  This is seldom seen in treaties negotiated by Canada.  The purpose of a limitation of benefits clause is to ensure that a treaty is not used by an entity from a different jurisdiction that is not party to the treaty.    

For Canadian corporations carrying on business in Hong Kong through a corporation the Treaty will be good news as a Hong Kong corporation will qualify upon ratification of the treaty as a foreign affiliate situated in a designated treaty country.  This would allow dividends returning to Canada from the Hong Corporation’s active surplus to be exempt from tax in Canada. 

Sunita Doobay LL.B., LL.M., TEP, TaxChambers, Toronto