The Central People's Government and the Hong Kong Government today signed an agreement on avoiding double taxation that aims to provide investors and taxpayers in the two places certainty in tax liability and offer tax savings.

The Arrangement for the Avoidance of Double Taxation on Income &  Prevention of Fiscal Evasion extends the scope of the original agreement on business profits and income from personal services both parties signed in 1998.

The new pact covers direct income, such as operating profits and employment income, and indirect income, such as dividends, interest and royalties. It also ensures the same income will not be doubly taxed in the two places.

Tax pact: State Administration of Taxation Minister Xie Xuren (left) and Chief Executive Donald Tsang sign the new arrangement; officials from both places raise a toast.

'Win-win' situation

State Administration of Taxation Minister Xie Xuren signed the new arrangement on behalf of the Central Government. Chief Executive Donald Tsang, accompanied by Financial Secretary Henry Tang and Secretary for Financial Services & the Treasury Frederick Ma, signed on behalf of Hong Kong.

At the signing, Mr Tsang described a "win-win" situation arising from the pact. Given the close economic ties between the Mainland and Hong Kong, an arrangement that provided certainty and preferential tax treatment would enable businesses and individuals to better assess their investment positions and foster closer investment and trade links between the two places, he said.

"The conclusion of a comprehensive double-taxation arrangement with the Mainland, together with the Mainland & Hong Kong Closer Economic Partnership Arrangement, will provide added incentives for international investors to enter the Mainland market through Hong Kong. It will also enhance cross-border financing arrangements and the transfer of technical know-how and patent rights between the two places. These will help promote Hong Kong's economy, enhance our competitiveness and attract overseas capital," Mr Tsang said.

Financial Secretary Henry Tang met the media after the signing to explain the new arrangement's details, and said it would help cement Hong Kong's reputation as a regional finance hub.

Under the new arrangement:

*  Top rates for withholding tax for dividends a Hong Kong resident receives from Mainland investments will be halved from 20% to 10%, and those rates for dividends a Hong Kong business receives will fall from 10% to 5%, if the Hong Kong business holds at least 25% of the capital of the Mainland enterprise. This will attract more overseas investments into the Mainland through Hong Kong.

*  Top rates for withholding tax for interest a Hong Kong resident receives from the Mainland will fall from 20% to 7%, and those for a Hong Kong business will dip from 10% to 7%.

*  Top rates for withholding tax for royalties a Hong Kong resident or business receives from the Mainland will also slide, from the respective 20% and 10% to 7%. This will help promote creativity and innovation in industry as well as cultural and artistic activities on the Mainland and Hong Kong.

*  The taxing right for gains a Hong Kong resident or business receives from the transfer of shares in a Mainland enterprise is allocated exclusively to Hong Kong. If the income does not amount to a trading receipt or is not sourced in Hong Kong, no profits tax will be charged here. Where the assets of the Mainland enterprise are comprised mainly of immovable property on the Mainland or the shares transferred are equal to or exceed 25% of the shareholding of the Mainland enterprise, the income may be taxed in both places. A tax-credit arrangement will ensure that the same income will not be taxed twice.

The pact allows for the exchange of information between the State Administration of Taxation and Hong's Inland Revenue Department, to enable both parties carry out its provisions.

As is the international norm, the exchange is limited, to ensure that the use of taxpayer information will not be abused.

Both sides need time to ratify the new arrangement. In Hong Kong, the Chief Executive in Council will make an order under the Inland Revenue Ordinance, subject to the Legislative Council's negative vetting.

If both parties rafity the pact before December 31, the new arrangement will come into effect with respect to Hong Kong taxes from the year of assessment beginning on or after April 1, 2007. With respect to Mainland taxes, it will apply to the taxable year beginning on or after January 1, 2007.