Proposed Concessionary Tax Regime for Aircraft Leasing in Hong Kong
The Government introduced in March this year tax concessions for the aircraft leasing industry to foster the proposed development of Hong Kong as an aircraft leasing centre.
At present, the current tax rules in Hong Kong are a major impediment to attracting aircraft lessors to set up in Hong Kong. Aircraft owners in Hong Kong are taxed on rental income for offshore leasing activities whilst deductions for aircraft depreciation are denied. The tax treaty network of Hong Kong is also relatively limited.
The introduction of the new tax regime seeks to better position Hong Kong to benefit from the economic momentum of the emerging China aviation market, and to enable Hong Kong to compete with other aircraft leasing centres, including Ireland and Singapore.
What are the tax concessions proposed?
The tax concessions are offered to two classes of persons: 1) qualifying aircraft lessors; and 2) qualifying aircraft leasing managers.
The tax concessions operate in two parts for qualifying aircraft lessors:
- A 8.25% tax rate applies to all qualifying profits of qualifying aircraft lessors (this is half of the prevailing profits tax rate for corporations); and
- The assessable amount of leasing income of a qualifying aircraft lessor is deemed to be 20% of the gross leasing income less deductible expenditure (excluding tax depreciation).
Effectively, the profits tax payable on qualifying profits of qualifying aircraft lessors is reduced to 1.65% of the net profit (ignoring tax depreciation).
An 8.25% tax rate also applies to all qualifying profits of qualifying aircraft leasing managers.
How does an aircraft lessor qualify for the concessions?
To be eligible for the tax concessions, the aircraft lessor must be a "qualifying aircraft lessor" that satisfies all of the following conditions:
- the lessor must be a corporation with its central management and control in Hong Kong;
- the lessor must be the owner of the aircraft being leased;
- the lessor must not carry out in Hong Kong any activities other than qualifying aircraft leasing activities;
- the aircraft leasing activities must not be carried out from a permanent establishment outside Hong Kong; and
- the lessor must have elected in writing that it wishes to opt into the tax concessionary regime.
The tax concessions only apply to profits arising from leasing arrangements with non-Hong Kong aircraft operators (also referred to as "qualifying profits"). With respect of arrangements with Hong Kong aircraft operators, lessors are taxed on a gross rental basis in accordance with the ordinary tax rules.
How does an aircraft leasing manager qualify for the concessions?
The tax concessions also apply to a corporation that carries on qualifying aircraft leasing management activities for any qualifying aircraft lessor.
There is a prescribed list of management activities that constitute "qualifying aircraft leasing management activities". They are not restricted to the general administration and management of the leasing operations of a qualifying aircraft lessor, but also include financing services (including provision of finance and guarantees) in relation to the acquisition of aircraft by a special purpose vehicle wholly or partly owned by the manager or an associated corporation
To qualify as a "qualifying aircraft leasing manager", the manager must satisfy all of the following conditions:
- the manager must be a corporation with its central management and control in Hong Kong;
- the manager must ensure that at least 75% of its profits arise from, and 75% of its assets are deployed for, the aircraft leasing management business;
- the aircraft leasing management activities must not be carried out from a permanent establishment outside Hong Kong; and
- the manager must have elected in writing that it wishes to opt into the tax concessionary regime.
The new regime also imposes specific transfer pricing rules that require all qualifying aircraft lessors or leasing managers to conduct transactions with any associated persons on an arm's length basis.
Issues to consider before moving to Hong Kong
Although the new regime is intended to encourage aircraft lessors and managers to set up in Hong Kong, there are a few issues that lessors and managers should consider before making the move.
In tandem with these tax concessions, a new deeming rule will be introduced to ensure that any profits or gains received (other than gains arising from sale of a capital asset) by a corporation from an aircraft leasing business or aircraft leasing management business carried on in Hong Kong will be assessable to Hong Kong tax even if the aircraft concerned is used outside Hong Kong. This means that a Hong Kong based corporate aircraft lessor or manager will be liable to pay Hong Kong profits tax on all of its worldwide income at the full corporate tax rate of 16.5% if it does not qualify for the tax concessions.
The concessionary regime is premised on the model that a qualifying lessor or manager must be a standalone corporation set up solely for the purpose of carrying out qualifying aircraft leasing or management activities. There are a few drawbacks as a result of this:
- The lessors and managers must not derive income from any non-qualifying aircraft leasing or management activities. To achieve this, the lessors and managers must not carry out any aspect of their business through a permanent establishment outside Hong Kong. Permanent establishment includes a branch or other place of business, as well as any agent who has, and habitually exercises, a general authority to negotiate and conclude contracts on behalf of the principal. Lessors and managers will need to closely monitor all aspects of their offshore activities to avoid breaching this condition.
- If a lessor or manager fails to satisfy any one of the conditions for any reason, it will be deprived of the ability to opt back into the concessions. This is an anti-avoidance feature included to deter corporations from jumping in and out of the regime. However, as no grace period is permitted, a Hong Kong based corporate aircraft lessor or manager will become subject to Hong Kong profits tax on all of its worldwide income at the full corporate tax rate if, at any time, it inadvertently fails to meet any one of the conditions for any reason.
- Lessors and managers are restricted on their choice of vehicle and must use a corporation if they wishes to benefit from the tax concessions. This restriction may limit the appeal of the new tax regime for certain lessors and managers wishing to utilize fund or trust structures to hold aircraft assets.
- The tax concessions do not apply to finance lease arrangements (also referred to as "funding leases"). This feature has been included to prevent cross border tax treaty abuse where the Hong Kong lessor does not hold the economic ownership. However, one may question the validity of the concern for treaty abuse if all lessors and managers must have real and substantial business operations being carried on in Hong Kong.
Despite these potential drawbacks of the proposed aircraft leasing regime, the proposal is a very welcome development.
The tax concessions are expected to dramatically change the landscape for Hong Kong in positioning itself as a major leasing hub amongst other competitors such as Ireland and Singapore.
The terms of the Double Tax Agreement between Hong Kong and China offer a more favourable withholding tax rate of 5% in respect of leasing payments received from lessees in China (relative to the 6% withholding tax rate under the double tax agreements that Ireland and Singapore have with China). Given China is expected to take up a substantial portion of the anticipated increase in demand for aircraft in the next two decades, Hong Kong would present a more favourable choice from a withholding tax perspective.
Further, unlike Singapore and Ireland, Hong Kong does not impose sales tax. This removes complications associated with potential application of sales tax on leasing payments and proceeds from sale of aircraft.
These factors, together with the proposed tax concessions, are expected to elevate Hong Kong's appeal as a leasing hub for aircraft lessors. The regime is expected to help to establish Hong Kong's position as a competitive player in the global aircraft leasing market.