Luxembourg-Hong Kong Tax TreatyPaul Lamberts & Diederik Werdmölder
In the past few decades Luxembourg has developed into an attractive gateway for doing business in Europe, primarily thanks to its adaptive legal and tax system.
Luxembourg has been fairly prolific in signing tax treaties – 54 in place and eight pending, countries with which is has concluded agreements include Kuwait, Quatar and Bahrain. Hong Kong has been more reserved – 6 tax treaties in effect and 12 under negotiation.
Hong Kong and Luxembourg recently signed a tax treaty that opens up interesting possibilities for structuring Asia – Europe cross border holdings in an effective way. In addition, it will offer opportunities for transactions that go beyond Asia and Europe. For example, Hong Kong’s tax treaty with China creates structuring possibilities for Chinese companies that wish to invest abroad, as well as non-Chinese companies wanting to invest into China.
This article offers a brief overview of the tax regimes in Luxembourg and Hong Kong, as well as some details of the tax treaty.
Hong Kong Corporate Taxation - Basic Facts
- Corporate profits are taxed at 16.5%.
- Income derived from non-Hong Kong sources is not subject to taxation.
- HK sourced capital gains and dividends are not taxed.
- Withholding tax on dividends or interest does not exist.
Luxembourg Corporate Taxation - Basic Facts
- Corporate Income Tax rate is 28.59%.
- No withholding tax on interest or royalties to foreign companies.
- No withholding tax on dividend distributions to tax treaty countries.
- EU member state; access to EU Directives, e.g. Parent-Subsidiary Directive.
- Dividends and capital gains on shares are exempt under the Luxembourg participation exemption.
The tax treaty covers a variety of areas; however, most striking are the important effects the tax treaty has on the local taxation of dividends, interest and royalties. They are reduced to attractive rates when paid from Luxembourg to Hong Kong and vice versa.
* The 0% rate will apply if the recipient of the dividends is a company that holds at least 10% of the capital of the company paying the dividends, or if it acquired its participation for €1.2 million (US$1.6 million approx.) or more.
Another important aspect of the tax treaty is that Luxembourg will exempt capital gains realised by a Hong Kong company from the sale of shares in a Luxembourg company, unless the Luxembourg company holds more than 50% of its assets in real estate.
Taking into account the provisions of the treaty, there are a number of potential opportunities.
Entities investing into China could opt to structure their investment through Luxembourg and Hong Kong, making use of the tax treaty and local tax rules. As an example, a private equity fund (often based in the Cayman Islands) could incorporate a Luxembourg company to hold a Hong Kong subsidiary to invest into a mainland China corporation.
Upon exiting the investment, capital gains realised by the HK company are tax exempt in HK and the dividends received / capital gains realised in Luxembourg can be tax exempt as well, provided certain conditions are met1. The repatriation of profits to the fund can be done with little or no Luxembourg withholding tax payable through hybrid financing of the Luxembourg vehicle. All profits attached to these instruments can be repatriated tax exempt (Equity Certificates).
International corporate structures channeled through Luxembourg and Hong Kong for China outbound investments can be interesting as well. Let’s compare the repatriation of profits from a European acquisition by a Chinese investor:
If done direct then the dividends paid by a EU target to its Chinese parent company could result in dividend withholding tax in the EU of 10-15%.
If the acquisition is made via Hong Kong and Luxembourg the following will apply:
- dividends paid by the EU target company to its Luxembourg parent are subject to a withholding tax of 0%2;
- dividends received by the Luxembourg parent are exempt from income tax3;
- dividends paid by the Luxembourg holding company to a Hong Kong holding company are subject withholding tax of 0%;
- dividends received by the Hong Kong holding company are exempt from income tax4;
- dividends paid by the Hong Kong holding company to the Chinese parent are subject to withholding tax of 0%5.
2. Dividend distributions between group companies resident in the EU are generally exempt from withholding tax under the EU Parent Subsidiary Directive.
3. Dividends received by a Luxembourg company from a subsidiary are generally exempt under the Luxembourg participation exemption.
4. This is considered non-Hong Kong source income, which - according to the territorial tax system in Hong Kong – is not subject to corporate income tax.
5. Hong Kong does not levy withholding tax on dividends.
Similar situations may occur with acquisitions in other jurisdictions; this needs to be reviewed on a case by case basis. Please contact either Paul Lamberts in Luxembourg or Diederik Werdmölder in Hong Kong to discuss further.