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| Jan 2009, Issue 1 |
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Investment opportunities under the Hong Kong / Luxembourg Double Tax Agreement
Hong Kong and Luxembourg signed a comprehensive double tax agreement (the "HK/Lux DTA") on 2 November 2007. At the time of writing, the ratification procedures of the agreement in both Hong Kong and Luxembourg have been completed but the agreement has not yet entered into force pending completion of the procedures on exchange of notification. When the procedures on exchange of notification are completed, the HK/Lux DTA will enter into force retrospectively from 1 January 2008 in Luxembourg and from 1 April 2008 in Hong Kong. This news flash discusses the major tax benefits available under the HK/Lux DTA to both Asian and European investors.
Asian outbound investments using the Hong Kong-Luxembourg structure
The HK/Lux DTA provides a favourable framework for Asian companies to invest in Europe in a tax efficient manner via a Hong Kong-Luxembourg holding structure. In particular, additional tax planning opportunities are available for companies in the Mainland wishing to invest in Europe as they may also enjoy the treaty benefits offered by the comprehensive double tax agreement between China and Hong Kong.
Exemption of withholding tax for dividends
The most significant benefit under the HK/Lux DTA is the beneficial withholding tax rates for dividends received by a Hong Kong company from Luxembourg companies. Under the current domestic law of Luxembourg, dividends are generally subject to a withholding tax rate of 15% with certain exceptions. The HK/Lux DTA withholding tax rate is 0% if the Hong Kong company directly holds 10% or more of the capital of the Luxembourg company, or a participation with an acquisition cost of EUR1.2 million or more. A withholding tax rate of 10% is applicable to all other cases.
The conditions for Hong Kong companies to enjoy the 0% withholding tax rate stipulated in the HK/Lux DTA are more liberal than the requirements set forth in the Luxembourg domestic law introduced by the 2009 Luxembourg tax reform that provides similar withholding tax exemption for dividends received by corporate residents in countries that have concluded a treaty with Luxembourg.
Interest and royalty payments
Under the HK/Lux DTA, interest received by a Hong Kong company from Luxembourg is not subject to withholding tax in Luxembourg while the withholding tax rate on royalties received is 3%. These provisions do not provide any added tax benefit as Luxembourg currently does not levy any withholding tax on these payments.
Summary of treaty tax rates for Hong Kong company receiving income from Luxembourg
| |
HK/Lux DTA rates |
Non-treaty rate |
| Dividends |
0% if the Hong Kong company directly holds 10% or more of the capital of the Luxembourg company, or a participation with an acquisition cost of EUR1.2 million. 10% in all other cases. |
15% |
| Interest |
0% |
0% |
| Royalties |
3% |
0% |
Tax exemption for capital gains
Capital gains are generally taxed as ordinary income in Luxembourg with exceptions such as where participation exemption applies. Under the HK/LUX DTA, a capital gain derived by a Hong Kong company from the disposal of shares in a Luxembourg company is tax exempt (regardless of the percentage of shareholding) unless the disposal is of shares in a real property holding company (i.e. more than 50% of the asset value of the Luxembourg company is derived from immovable property situated in Luxembourg). This lowers the exit cost should Asian investors wish to disposal their investments in Europe.
Hong Kong-Luxembourg as a Gateway for investing in Europe
The possible tax exemption for dividends and capital gains derived from disposal of shares under the HK/LUX DTA, together with the extensive tax treaty network of Luxembourg, present opportunities by using Hong Kong / Luxembourg companies as intermediate holding companies for investing into the European Union.
Moreover, since partial exemption is available for income derived by a Luxembourg company from the use or the right to use of certain intellectual properties for domestic income tax purposes and dividends received by a Hong Kong company from Luxembourg may be exempt from Luxembourg withholding tax, if properly structured and carefully planned, Asian investors can use Hong Kong-Luxembourg as a conduit for licensing intellectual property to countries within the European Union in a tax efficient manner under the HK/Lux DTA.
The treaty benefits under the HK/Lux DTA are more favourable than those under the double tax agreement between Hong Kong and Belgium (the "HK/Belgium DTA") signed in December 2003. For example, in order to qualify for the withholding tax exemption for dividends under the HK/Belgium DTA, a Hong Kong company has to directly hold at least 25% of the Belgian company paying the dividends for an uninterrupted period of least 12 months as at the dividend payment date. In addition, there will be a 10% withholding tax on interest and 5% withholding tax on royalties received from Belgium under the HK/Belgium DTA.
Asian inbound investments using the Luxembourg-Hong Kong structure
So far as Asian inbound investments are concerned, the HK/Lux DTA provides a reduced withholding tax rate of 3% (instead of 4.95% under the Hong Kong domestic law) for royalties received by a Luxembourg company from a Hong Kong company. European investors can therefore consider using Luxembourg as a conduit for licensing intellectual property to Hong Kong.
As Hong Kong does not impose any withholding tax on dividends paid to foreign companies and dividends / capital gains derived from sale of capital assets by Hong Kong companies are not subject to tax in Hong Kong, the Luxembourg-Hong Kong holding structure can possibly make profits repatriation and exit of investment more tax efficient for European investors wishing to invest in Asia.
In addition, under article 22 of the HK/Lux DTA, where a resident of Luxembourg carrying on business through a permanent establishment in Hong Kong derives income from that permanent establishment which may be taxable in Hong Kong under the provision of the HK/Lux DTA, that income will be fully exempt from tax in Luxembourg for the purposes of double taxation elimination, although Luxembourg may, in order to calculate the amount of tax on the remaining income of the Luxembourg resident, apply the same tax rates as if the income had not been exempted.
Other considerations
The HK/Lux DTA should create a favourable tax framework for structuring investments between Luxembourg, Europe and Hong Kong. However, investors should also bear in mind that tax efficiency is only one of the considerations that need to be taken into account for making an investment decision, other factors such as their business strategies and needs, the legal and financial infrastructure of a given location, etc. will have to be considered before a final investment decision is made. |
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