Shipping Industry 0709

Hong Kong Tax Competitiveness Series:

The Shipping Industry

TAX

2 Hong Kong Tax Competitiveness Series: The Shipping Industry

Hong Kong tax competitiveness series

1 Hong Kong Taxation Post Handover - A retrospective of the decade

2 Corporate Tax Rates

3 The Shipping Industry

Introduction This publication is the third issue in our series examining the competitiveness of

Hong Kong’s tax system. This paper focuses on the tax regime for the shipping

industry in Hong Kong, as well as on its competitiveness as an international

shipping centre.

Hong Kong is a major hub for ship owning and operating companies. In 2003,

shipping companies in Hong Kong owned more than 6 percent of the world's

merchant fleets based on tonnage, ranking Hong Kong seventh in the world.1

Hong Kong remains one of the world’s busiest container ports, a title which it has

largely held since the beginning of the 1990s.

However, Hong Kong’s competitiveness as an international shipping centre is

constantly being challenged by other notable shipping hubs such as Singapore.

In 2005, Singapore overtook Hong Kong as the world’s busiest container port. In

April this year, Hong Kong was overtaken by Shanghai and it could potentially be

overtaken by Shenzhen within the next year.

Current tax system in Hong Kong Hong Kong has traditionally been viewed as an attractive jurisdiction for ship

owning or ship operating companies with international operations. This is partly

due to Hong Kong’s "territorial" system of taxation, its relatively low corporate tax

rate of 17.5 percent and an exemption for locally registered ships.2

Hong Kong operates a special tax regime for ship owning companies under

Section 23B of the Inland Revenue Ordinance (IRO). These rules effectively

operate as a separate mini tax regime for calculating the profits of shipping

companies which are chargeable to tax in Hong Kong using a prescribed formula

(see Figure 1).

1 Report of the Hong Kong Port and Maritime Board, Study to Strengthen Hong Kong’s role as an International Maritime Centre, January 2003.

2 As of January 2006, just over 40% of the ships owned by Hong Kong based companies were registered in Hong Kong (according to the publication of the Economic Development and Labour Bureau, Summary Statistics on Shipping Industry of Hong Kong, March 2007).

© 2007 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.


Hong Kong’s current tax system effectively promotes the international shipping

industry by exempting profits from tax in certain circumstances. For example,

Hong Kong provides tax exemption on carriage income from international

operations where the ship is registered in Hong Kong (i.e., flying a Hong Kong flag)

or where the income is derived by a person eligible to claim reciprocal exemption

(i.e., derived by a shipowner who is resident in a territory outside of Hong Kong

that provides an exemption). Currently, New Zealand and the Republic of Korea are

the only countries which have been confirmed as having this reciprocal status.

Figure 1

Computation of assessable profits under Section 23B A shipping company will fall within the mini tax regime of Section 23B if:

• it is incorporated in Hong Kong or the business is normally controlled

or managed in Hong Kong

• the business is not managed, controlled or incorporated in Hong Kong,

but its ships call at any location within the waters of Hong Kong.

Computation of assessable profits

The assessable profits for companies, whether they are resident or non

resident, that fall within Section 23B, are determined using the following

formula:

Section 23B stipulates the extent to which the income derived from

chartering of ships, carriage of passengers and goods, towage operations

and dredging operations should be included as part of the Relevant sums.

For example, income derived from the carriage of passengers or goods

shipped in Hong Kong (but excluding goods in transit and re-embarking

passengers) will be included as part of the Relevant sums.

Hong Kong shipping income Assessable Total shipping

x (“Relevant sums”) = profits profitsTotal shipping income



To explain the application of Hong Kong’s specific tax rules for shipping companies,

Figure 2 contains a flowchart illustrating how two common types of shipping

income, namely carriage of passengers/goods and charter hire income, are taxed

in Hong Kong under Section 23B of the IRO.

Although the exemption provisions are generous, they are quite complex to

apply. There are also other areas which can lead to disputes over their application.

For example, the deductibility of interest expenses in Hong Kong is specifically

governed by certain provisions (which do not form part of Section 23B). Because

of the unique nature of Section 23B, it has been suggested that these specific

Figure 2

Illustration of operation of Section 23B for carriage and charter hire income

Carriage income

Charter hire income

Carriage income

uplifted in HK?

No

Yes

Ship registered

in HK? No

Yes Ship proceeding to

outside HK waters? No

Yes

Income NOT subject to tax under Section 23B

Income subject to tax under Section 23B

Ship chartered out as a whole?

Ship commencing voyage from

within HK waters?

Ship navigating within HK waters? Yes

No

Yes

Ship navigating

between HK and

Pearl River Delta?

NoYes

See flowchart for carriage

income (above)

Income NOT subject to tax under Section 23B

Income subject to tax under Section 23B

No Yes*

No

* Only half of the income will be subject to tax under Section 23B.


Hong Kong Tax Competitiveness Series: The Shipping Industry 5

deduction rules should not apply to the shipping business, but such an argument

has been rejected by the IRD. Some observers believe that the IRD position could

present a major tax disadvantage for shipping companies because it restricts the

commercial ways in which they could obtain financing in order to avoid the loss of

interest deductions.

What can be done to improve Hong Kong’s competitiveness? The Central Chinese Government's 11th Five-Year Plan gave unequivocal support

to the development of Hong Kong’s logistics industry and the maintaining of its

position as an international maritime centre. In response, the government in Hong

Kong set up a Focus Group on Maritime, Logistics and Infrastructure to consider

and develop strategic proposals and policies which could be adopted to meet

these objectives. In January this year, the Focus Group issued a report, arguing

that Hong Kong should make appropriate adjustments to its existing policies and

measures, so as to provide an infrastructure conducive to the development of the

logistics industry and improve its business environment in order to enhance the

competitiveness of the whole industry.3 In respect of taxation, the Focus Group

made two broad recommendations:

(i) introduce a Tonnage Tax system; and

(ii) increase the number of tax treaties that Hong Kong has concluded with other

countries.

Tonnage tax

The Focus Group proposed to explore the feasibility of a tonnage tax regime as an

alternative to Hong Kong’s current tax regime for the shipping business.

Tonnage tax is a special tax regime that many countries have introduced to

provide a more straightforward and preferential calculation of the taxable profits of

shipping companies. Broadly, under a tonnage tax regime, shipping companies will

determine their income according to the net tonnage per qualifying ship multiplied

by a fixed amount. Thereafter, the normal corporate tax rate will be applied on this

income to arrive at the shipping company’s tax liability. This method is simpler in

that it does not require the exact assessable income and deductible expenses to

be ascertained.

3 Report of the Focus Group on Maritime, Logistics and Infrastructure, January 2007 (http://www.info.gov.hk/info/econ_summit/eng/pdf/mli.pdf)



In short, tonnage tax is not so much a separate type of tax, but is essentially an

alternative way of computing tax liabilities for shipping companies. Further, it is

usually optional and shipping companies can elect whether or not to be subject

to the tonnage tax regime. If the shipping companies are in losses, it will not be

necessary to make such a choice. Tonnage tax has already been adopted in many

countries including Denmark, Germany, India, Ireland, Italy, Netherlands, Norway,

the UK and the US.

The attractiveness of a tonnage tax regime for Hong Kong would depend on

how the tax liability will be computed under this approach. The methodology of

calculating a tonnage tax is likely to be more simple and therefore reduce the

administrative burden on the taxpayers. In addition, if the tax liabilities of the

shipping companies under the new system are lower than those computed under

the current system (for example, because the government has set a low fixed

amount per tonnage), this would be an attractive tax incentive for conducting

a shipping business in Hong Kong. However, as this system is essentially an

alternative assessable profits computation methodology, the government could

provide the same result by making simple adjustments to Section 23B (for

example, by redefining what will constitute Relevant sums and/or exempting a

portion of the Relevant sums from the computation of the assessable profits).

Further, the introduction of a tonnage tax system would not resolve a problem

which is often faced by Hong Kong shipping companies with international

operations, namely being liable to tax in overseas countries. Therefore, it would

appear that the introduction of a tonnage tax system in Hong Kong by itself is not

likely to significantly improve the competitiveness of Hong Kong as an international

shipping centre.


7 Hong Kong Tax Competitiveness Series:

The Shipping Industry

Double tax agreements (DTAs)

The second recommendation concerns the conclusion of more DTAs with other

overseas countries.

Due to the nature of the shipping business, shipping companies could face double

taxation on their international shipping activities. Double taxation arises where

the income of a company is being taxed in more than one jurisdiction. For a Hong

Kong shipping company which conducts international shipping activities, it could

incur a tax liability in a foreign jurisdiction if its vessel calls at a port or navigates

through the waters of that jurisdiction. If the income derived from such activities is

also taxable in Hong Kong, in the absence of any DTA or reciprocal tax exemption

being available, the Hong Kong shipping company will suffer from double taxation.

Common examples of jurisdictions where double taxation could potentially arise for

Hong Kong shipping companies are India and Pakistan.

DTAs could also assist Hong Kong shipping companies to compete on more

level terms in the international shipping arena. For example, Hong Kong shipping

companies may operate in countries which impose tax on their freight income

on a deemed profit basis. This means that these Hong Kong shipping companies

could be required to pay tax in the relevant jurisdictions regardless of whether

they derive profits or sustain losses from their operations. This would reduce Hong

Kong shipping companies’ competitiveness relative to local shipping companies

that are taxed based on their actual operating results and/or shipping companies

from countries which have DTAs exempting, either wholly or partially, tax imposed

on a deemed profit basis. DTAs could also decrease the administrative burden on

Hong Kong shipping companies which would otherwise have to comply with the

relevant tax filing and reporting requirements in these countries. Some of the major

jurisdictions where Hong Kong shipping companies are experiencing this difficulty

include Russia, Indonesia, Poland, Taiwan, Australia, the Philippines, Vietnam and

Bangladesh.

Hong Kong has entered into DTAs which deal with the avoidance of double taxation

on income derived by a company operating ships in international traffic with the

following countries:



Belgium Mainland of China Thailand

Singapore Sri Lanka

Denmark Germany Korea*

Netherlands New Zealand*

Norway United Kingdom United States of America

Comprehensive double tax treaties

Airline and shipping tax treaties

Shipping tax treaties

* New Zealand and Korea have reciprocal tax exemptions granted under Section 23B of the IRO.

Hong Kong has concluded a relatively small number of DTAs, especially when

compared with our regional competitors such as Singapore (see comments

below). We believe there is a need for Hong Kong to conclude more DTAs because

such arrangements could reduce the overall tax burden of ship operators in Hong

Kong and enable them to compete on level terms in the international shipping

arena.

One of the main differences between the comprehensive DTAs and other

types of DTAs referred to in the table above lies in the scope of the business

activities they cover. The latter are often called limited scope DTAs because they

only apply to persons carrying on shipping and/or air services activities. The

government has repeatedly stated its intention to conclude more comprehensive

DTAs and has been actively negotiating with trading partners. However, many

of the potential future treaty partners are generally believed to be insisting

on more comprehensive exchange of information provisions than is the case

under those DTAs which have already been concluded. This is likely to spark

debate among different stakeholders, causing delays to the conclusion of

additional comprehensive DTAs. Therefore, while continuing its negotiations of

comprehensive DTAs, the government could also consider entering into more

limited scope DTAs covering the shipping business which generally do not require

this level of exchange of information and take less time to negotiate and conclude.

The Singapore system In the region, a major competitor of Hong Kong’s maritime industry is Singapore.

In order to attract shipping businesses, Singapore currently provides for a range of

tax incentives.

Tax exemption

Singapore has attractive corporate tax regimes for shipping companies which

include the Singapore Registry Scheme (SRS), Approved International Shipping

Enterprise Scheme (AIS), Approved Shipping Logistics Enterprise Scheme (ASL)

and Maritime Finance Incentive Scheme (MFI). The table on the next page

summarises the main features of these schemes.



Figure 3:The main features of various schemes under Singapore's corporate tax regimes

Name of scheme

Major incentives Does Hong Kong have similar provisions?

SRS Qualifying income derived by tax residents or non-tax residents from the operating or chartering of a Singapore registered ship, or operating of a foreign registered ship, in international waters is tax exempt.

Yes but SRS is more extensive by covering foreign flagged ships.

AIS Qualifying income derived by tax residents from the operating or chartering of Singapore and foreign flagged ships used for offshore oil or gas activities, or operating or chartering of foreign flagged ships, in international waters is tax exempt for a period of 10 years, which may be extended for a further 20-year period.

Yes, but AIS is more extensive by covering foreign flagged ships.

ASL Concessionary tax rate of not less than 10% on qualifying income derived from provision of freight and logistics services for a period of 5 years (to be extended to 10 years based on 2007 Budget Proposal which will be promulgated as law soon).

No

MFI Qualifying income derived by ship investment vehicle (such as shipping leasing company, shipping fund or shipping trust) is exempt from tax.

Concessionary tax rate of 10% on qualifying income derived in connection with and incidental to management of a portfolio of vessels in an approved ship investment enterprise for a period of 10 years.

No

Similar to Hong Kong, no separate application is required to qualify for tax

exemption under SRS. In contrast, to qualify for AIS, the taxpayer is required to

meet certain specified conditions. In addition to being a Singapore tax resident, it

must own a significant fleet of vessels (minimum of four vessels) and have annual

expenses in Singapore of at least SGD 4,000,000. The main feature of this regime

is that it is not predicated on having the vessels registered in Singapore but rather

requires significant spending being incurred in Singapore. Both ASL and MFI also

require separate applications to be made. The qualifying criteria for both ASL and

MFI would be similar to that for AIS.



Based on Figure 3, it is clear that Singapore currently offers more tax incentives

than Hong Kong for the shipping industry. Having said that, as the Singapore

government expects the shipping companies enjoying the tax incentives to

generate economic spin-offs to Singapore, such incentives may not be granted

unless the shipping companies are prepared to commit to significant investment

in the country.

Treaty network

As Hong Kong has concluded relatively few DTAs that operate to avoid double

taxation for shipping companies with international shipping activities, Singapore

has a clear advantage over Hong Kong with significantly more DTAs.4 This means

that shipping companies which are residents of Singapore are much less likely to

be taxed in a foreign jurisdiction.

Outlook While Hong Kong’s current tax regime provides incentives for shipping companies

(especially the exemption for Hong Kong flagged ships), it seems that Singapore’s

current tax regime is, in some respects, more attractive than that of Hong Kong. In

addition to providing an exemption for all international shipping activities, arguably

the most compelling advantage of Singapore is that it has concluded significantly

more DTAs than Hong Kong.

A critical area of concern on the competitiveness of the current tax system in

Hong Kong is the relatively low number of DTAs that Hong Kong has been able to

conclude.

This means that for shipping companies based in Hong Kong, the lack of DTAs

results in a higher tax and administrative burden when they operate in overseas

countries. This in turn affects Hong Kong shipping companies’ ability to compete in

the international shipping arena. In order to improve the competitiveness of Hong

Kong shipping companies, the government may wish to place more priority on

negotiating DTAs with jurisdictions such as Australia, Bangladesh, India, Indonesia,

Pakistan, the Philippines, Poland, Taiwan, Vietnam and Russia.

Given the difficulty that the government has encountered in concluding more

comprehensive DTAs with our trading partners, a viable alternative would be for

the government to consider entering into more limited scope DTAs for shipping in

order to improve Hong Kong’s competitiveness as an international shipping centre.

A further area which would be relevant to improving Hong Kong's competitiveness,

but not as important, is the broadening of the scope of exemptions currently

available to Hong Kong based shipping operations. A tonnage tax regime could

provide some tax incentives to the shipping industry. However, it may take more

than that to be competitive with the concessions which are currently being offered

by Singapore.

4 Singapore has already concluded over 50 comprehensive double tax treaties and a number of limited scope tax treaties with other countries.



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Publication date: September 2007

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Shipping Industry 0709