Japan and Hong Kong signed first tax treaty

On 9 November 2010, Japan and the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”) signed the first income tax treaty between the two jurisdictions. The two governments reached a basic agreement in March 2010, and since then have been negotiating details of the text of the treaty. The brief description in government reports suggests that the treaty will follow usual OECD treaty lines, and states that the treaty will provide for reduced withholding tax rates and contain an exchange of information provision. It can be anticipated that the treaty will contain such a provision, opening the way for competent authority proceedings and APAs between Japan and Hong Kong.
The Japanese Ministry of Finance (“MOF”) announcement briefly outlines key points of the new treaty:

Reduced Withholding Tax Rates for Investment Income (Dividends, Interest and Royalties)

The following are the maximum tax rates applicable to investment income (dividends, interest and royalties) derived from the source country. 

Income

Maximum tax rates

Dividends
 (Article 10)

10% or greater shareholder

5%

Other dividends

10%

Interest (Article 11)

10%*

Royalties (Article 12)

5%

* Interest received by the governments and related entities is exempt from tax.

Dividends
Under current Hong Kong domestic tax law, no withholding tax is imposed on dividends paid by a Hong Kong company. This treatment will continue even after the enactment of the treaty, as long as Hong Kong domestic tax law remains unchanged.

Dividends paid by a Japanese company to Hong Kong shareholders are currently subject to withholding tax at various rates higher than 5%. The reduced 5% withholding tax rate will supersede Japanese domestic tax law and will benefit Hong Kong shareholders.

Anti-Abuse Clause
The treaty will include an anti-abuse clause. Based on recent Japanese tax treaty negotiating policy, this will likely take the form of a limitation of benefits provision.

Exchange of Information
The treaty will provide for the tax authorities of Japan and Hong Kong to exchange information for the purpose of ensuring the proper enforcement of their respective tax laws.