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China-Hong Kong

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New income tax arrangement between China and Hong Kong signed

Mainland China and Hong Kong Special Administrative Region (each hereinafter referred to as a "side") signed a new arrangement for the avoidance of double income taxation on 21 August 2006. The arrangement extends the scope of the agreement signed in 1998 and includes provisions on investment income. The arrangement was concluded in Chinese and generally follows the OECD Model Convention (2005).

The maximum rates of withholding tax are:

-   10% on dividends in general, and 5% where the beneficial owner is a company holding at least 25% of the capital of the paying company;
-   7% on interest received by Hong Kong residents, subject to exceptions in respect of interest received by the government or any other institutions mutually recognized by the competent governments of both sides; and
-   7% on royalties

Deviations from the OECD Model include that:

-   a permanent establishment (PE) is defined to include (i) supervisory activity in connection with a building site, construction, installation or assembly project which lasts more than 6 months, (ii) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if that nature continue (for the same or a connected project) for a total period(s) of more than 6 months within any 12-month period;
-   gains derived from the alienation of shares, other than the shares in an immovable property company, of not less than 25% of the entire shareholding of a company which is a resident of one side may be taxed in that other side; and
-   nothing in the arrangement shall prejudice the right of one side to apply its domestic laws and measures concerning tax avoidance, whether or not described as such. For this purpose, "laws and measures concerning tax avoidance" includes any laws and measures for preventing, prohibiting, avoiding or resisting the effect of any transaction, arrangement or practice which has the purpose or effect of conferring a tax benefit on any person.

Both sides generally provided for the credit method to avoid double taxation. Both sides grant a credit for the underlying tax if a company receiving dividends holds at least 25% of the shares in the paying company. The arrangement also contains a provision for exchange of information.

If the arrangement is ratified before 31 December 2006, it will become effective with respect to Hong Kong SAR taxes on or after 1 April 2007 and with respect to the Mainland China taxes on or after 1 January 2007. As a result of this new arrangement, the agreement signed in 1998 will cease to apply at the time that this arrangement becomes effective.

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