Global Watch - Mainland China/Hong Kong DTA will make it harder for individuals to claim protection under the "183-day" exemption rule 

Background
 
The Central People's Government and the Hong Kong Special Administrative Region Government first signed a limited scope double tax memorandum in February 1998.  The new double tax arrangement ("DTA") signed on 21 August 2006 will replace this and, subject to completion of the necessary ratification procedures, the new DTA will become effective beginning on or after 1 April 2007 in Hong Kong and 1 January 2007 in the Mainland China.
 
Most of the changes from the current double tax memorandum are simply to provide full scope provisions in line with the OECD model.  However, one of the key changes is in relation to the counting of days of presence in each location.  This change will make it harder for tax residents of one side to claim protection under the DTA from taxes on the other side.
 
Counting of the 183-day exemption rule
 
Under the new DTA, a resident of one side is exempt from tax on the other side if he or she satisfies all the following conditions:

1. The recipient is present on the other side for a period or periods not exceeding in the aggregate of 183 days in any 12-month period commencing or ending in the taxable period concerned; and
    
2. The remuneration is paid by, or on behalf of, an employer who is not a resident of the other side; and
    
3. The remuneration is not borne by a permanent establishment which the employer has in the other side.

Contrasted with the original DTA, the time period "calendar year" in the first condition will be replaced with "any 12-month period commencing or ending in the taxable period concerned".  This will mean that frequent travellers between Hong Kong and the Mainland China will need to monitor their travel pattern more carefully to ensure they can continue to meet this condition.  Employers may also need to review whether their current tax settlement policy with frequent travellers will require to be adjusted following this change.
 
Under the new DTA, to be fully exempt from China individual income tax in the tax year ending 31 December 2008, an individual would need to spend no more than 183 days in the Mainland China in any 12- month period between 2 January 2007 and 30 December 2009.  Likewise, to be exempted from Hong Kong salaries tax for the tax year ending 31 March 2008, an individual would need to spend no more than 183 days in Hong Kong in any 12-month period between 2 April 2006 to 30 March 2009.

Other Changes Affecting Individuals

Meaning of "resident"

In the case of the Mainland China, a resident is any person, who under the laws of the Mainland China, is liable to tax thereon by reason of his domicile or residence or any other criterion of a similar nature.  However, the definition excludes any person who is only liable to tax in the Mainland China in respect of income from sources on the Mainland China.
 
A Hong Kong resident is a person who ordinarily resides in Hong Kong (e.g., someone who has a permanent home available to him in Hong Kong), or, who stays in Hong Kong for more than 180 days during a year of assessment (1 April to 31 March) or for more than 300 days in two consecutive years of assessment (one of which must be the relevant year of assessment).  Hence, the conditions in the current memorandum that require the person to be over 18 years of age and to be liable to Hong Kong tax are no longer relevant in determining residence in Hong Kong under the new DTA.

Capital gains
 
The new DTA includes an article on capital gains, which may be relevant for individuals holding investments in the Mainland China.  Under this article, a full tax exemption in the Mainland China is available on the capital gain derived by a Hong Kong investor from the disposal of shares in a Mainland company, provided that the shares sold are less than 25% of the shareholding of the Mainland company and the assets of the Mainland company are not comprised mainly of immovable property situated on the Mainland.  However, the implementation of this article is subject to the interpretation of the tax authorities in the Mainland.
 
This article does not affect Hong Kong as there is no tax on capital gains in Hong Kong.
 
Exchange of information

The new DTA contains an "Exchange of Information" article which allows information that is necessary for carrying out the provisions of the DTA arrangement or under the respective domestic tax laws can be exchanged.  The tax authorities on both sides are not obliged to supply information which is not obtainable under the domestic laws or in the normal course of administration and which would disclose any trade, business, industrial, commercial or professional secrets etc.
 
However, in the context of individual taxpayers, information such as level of income, travel itinerary, tax assessments etc, would be regarded as information that can be readily exchanged and not otherwise restricted from being accessed by the other tax jurisdiction when requested.

"The Bottom Line" Employees who want to make use of the 183-day treaty exemption under the new DTA will need to monitor their travel pattern more closely than ever as the "183 days" time period is now based on any 12-month basis as opposed to a calendar year in the original DTA.   The new time period requires a revisit of the current tax planning strategies for employees who wish to rely on the DTA protection as all possible periods of 12 consecutive months must now be considered.   Employers may need to revisit any tax protection or equalisation scheme that they may have in place with frequent travellers between the Mainland China and Hong Kong.   With the inclusion of the Exchange of Information article in the new DTA, the respective tax authorities shall be able to exchange such information as is necessary (e.g., income details, travel history etc.) to ensure the correct application of the provisions of the DTA or of the domestic laws and this may allow the respective tax authorities to deter any possible non-compliance.