The Government has enacted the Inland Revenue (Amendment) (No. 3) Ordinance 2017 introducing a concessionary tax regime that seeks to promote the Hong Kong aircraft leasing industry. The legislation removes the tax impediments which have historically deterred aircraft lessors from setting up operations in Hong Kong.
We examined the new regime when it was first introduced in our Client Alert issued on 11 April 2017 (a copy of which can be found here). The final version of the legislation enacted largely mirrors the bill when it was first introduced. This briefing recaps on the key issues discussed and highlights the refinements in the final legislation.
Key features of the regime
The tax concessions offered to qualifying aircraft lessors are twofold:
- A 8.25% tax rate (which is half of the prevailing corporate tax rate) applies to assessable profits of qualifying aircraft lessors
- The assessable amount of leasing income of a qualifying aircraft lessor is deemed to be 20% of the gross leasing income less deductible expenditure
Effectively, the profits tax payable on the assessable profits of a qualifying aircraft lessor is reduced to 1.65% of its net profit (ignoring depreciation).
A 8.25% tax rate also applies to assessable profits of managers providing management services (which also include aircraft financing activities) to qualifying aircraft lessors.
The tax concessions can apply to profits derived on or after 1 April 2017.
A potentially more appealing option for operating a leasing hub than Singapore and Ireland?
Both Ireland and Singapore have established reputations as aircraft leasing hubs due to their favourable tax regimes. However, with the introduction of this new regime, Hong Kong could potentially present a more appealing option for aircraft lessors.
- Hong Kong has historically disallowed aircraft lessors from claiming deductions for tax depreciation on aircraft leased to offshore aircraft operators. To compensate for this shortcoming, the new regime deems 20% of the leasing income to be assessable income (effectively offering a "quasi depreciation deduction" equal to 80% of the assessable profits).
- While both Singapore and Ireland also permit their aircraft lessors to claim depreciation deductions (albeit at different rates), the overall depreciation deduction that may be claimed is capped at the cost of the aircraft. The Hong Kong regime, on the other hand, permits a deduction to be claimed each year at 80% of the net assessable profits. This means that an aircraft lessor of a long term lease may be able to obtain a higher overall level of deduction (which will lower the tax costs on operating profits) in Hong Kong as opposed to Singapore and Ireland.
- A blanket profits tax exemption has been introduced for any capital gain derived from the sale of an aircraft where the aircraft has been used to carry out qualifying aircraft leasing activities for a continuous period of no less than 3 years immediately before the disposition. An equivalent exemption is not available in Singapore or Ireland.
- Hong Kong does not impose sales tax on aircraft leasing payments, resulting in an overall simpler tax system than Ireland and Singapore.
- For aircraft lessors looking to target the Mainland China aircraft leasing market, the Double Tax Agreement between Hong Kong and Mainland China also offers a more favourable withholding tax rate of 5% (relative to 6% offered under double tax agreements that Singapore and Ireland have with Mainland China).
The combination of these factors should substantially increase the appeal of setting up in Hong Kong to aircraft lessors given the potential tax efficiency.
How to qualify for the regime?
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 that are managed from Hong Kong.
For this reason, certain qualifying conditions must be satisfied before an aircraft lessor or manager can become eligible for the tax concessions. There are several notable features of the regime:
- A key condition to note is that the lessor or manager must have its central management and control in Hong Kong. This requires that the entity's executive officers and senior management personnel who exercise day-to-day decision making powers are based predominantly in Hong Kong. This also means that a foreign corporation looking to take advantage of this regime cannot operate through a Hong Kong branch.
- The entity must not carry on any aircraft leasing or management activities from a permanent establishment outside Hong Kong. Permanent establishment for this purpose includes a branch, centre of management or any other place of business as well as any agent who has and habitually exercises a general authority to negotiate and execute contracts on behalf of the entity.
- An aircraft lessor must not carry on any activities other than aircraft leasing activities (finance lease arrangements are generally not permitted - specific rules are provided to determine whether a lease is a qualifying lease for this purpose). In respect of an aircraft leasing manager, the manager must ensure that at least 75% of its profits must arise from, and 75% of its assets are deployed for, the aircraft leasing management business.
- The regime is an elective regime. An aircraft lessor or manager who wishes to opt into the regime must make a written election with the Inland Revenue. Any such election is irrevocable.
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 concessionary regime. This is an anti-avoidance feature included to deter corporations from jumping in and out of the regime at will. Aircraft lessors and managers should take note that no grace period is permitted, which means 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.
When the regime was first introduced, the Government ring-fenced the tax concessions to aircraft lessors leasing aircraft to non-Hong Kong aircraft operators (i.e. aircraft operators that are liable to pay tax on their profits in Hong Kong). As this feature of the regime was potentially in breach of one of the four minimum standards of the Base Erosion and Profit Shifting (BEPS) package that Hong Kong has committed to, this feature has been removed in the final version of the legislation.
An aircraft lessor can lease to a Hong Kong aircraft operator (e.g. a Hong Kong based airline) provided that it has elected to come within the tax concession. In exchange, the aircraft lessor would not be permitted to claim tax depreciation that would otherwise be permitted. To deter Hong Kong aircraft operators from abusing the regime by entering into an intergroup aircraft leasing arrangement with a connected person, a new rule has also been introduced to reduce the amount of deduction that the Hong Kong aircraft operator can claim with respect of any payment made to a connected aircraft lessor to effectively eliminate any tax benefit gained from any such intergroup leasing arrangement.
The Hong Kong Government has recognised for some time the greater role that Hong Kong can play in the aircraft leasing space, particularly in light of the emerging Mainland China aviation market. These tax concessions are expected to change the landscape for Hong Kong in positioning itself as a major leasing hub amongst other competitors such as Ireland and Singapore.