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Analysis & Insights

Tax Incentives Raise Hong Kong's Shipping Finance Profile

31 Aug 2020

New tax incentives to attract ship owners and lessors to Hong Kong will both enhance the jurisdiction's status as a key shipping leasing centre for the Asia­ Pacific region and develop Hong Kong's shipping core and maritime cluster.  The tax changes, announced by the Transport and Housing Bureau of the Hong Kong Government, reflect the long term strategy to position Hong Kong as a centre for ship finance, leasing and related maritime business establishments.

By leveraging off of Hong Kong's existing position as a strategic hub in terms of logistics, transport and supply chain management, in addition to taking advantage of its global and long established reputation as a first class international finance hub, the Hong Kong government aim to significantly enhance its standing as a global centre for maritime trade and finance.

By implementing a new tax regime for ship leasing, Hong Kong envisions potentially capturing some 12% of the global ship finance market over the next decade, according to a paper put before the Legislative Council of Hong Kong, based on analysis conducted by the Task Force on Ship Leasing, established under the Hong Kong Maritime and Port Board.  These incentives will take the form of tax concessions to various participants across the wider shipping business community including, ship owners, alternative financiers, such as finance lessors, and marine insurers.

Further to the Transport and Housing Bureau's announcements on the subject, on 17 January 2020, the Hong Kong Government published the Inland Revenue (Amendment) (Ship Leasing Tax Concessions) Bill 2020 (the "Bill").  The Bill was passed by the Hong Kong Legislative Council on 10 June 2020 with several amendments and took effect in law as the Inland Revenue (Amendment) (Ship Leasing Tax Concessions) Ordinance 2020 on 19 June 2020 (the "Amending Ordinance").

The Inland Revenue Ordinance (IRO) (Cap. 112) is amended by the Amending Ordinance with retrospective effect, so as to give profits tax concessions to qualifying ship lessors, at a 0% profits tax rate, and qualifying ship leasing managers generally at an 8.25% profits tax rate, which is roughly half the current rate of profits tax payable by businesses in the Territory, for the amounts received or accrued as from 1 April 2020.

Tax Concessions

These incentives, combined with implementation of the Base Erosion and Profit Shifting ("BEPS") Action Plan will make Hong Kong commercially attractive to owners and operators, principals, capital providers, lessors and a host of other parties with shipping interests, such as shipping funds and other private equity investors. At the same time, the project will actively encourage the growth and proliferation of shipping and maritime­ related value-added, management and support services in Hong Kong.

The concessionary tax regime for ships emulates the Government's recent initiatives in the aviation and aviation finance sector, which reduced profits tax payable by qualifying aircraft lessors and aircraft leasing managers aimed at establishing Hong Kong as an international aircraft leasing and financing hub.

Fundamentally, qualifying ship lessors and qualifying ship leasing managers will still be taxed such that issues relating to BEPS and related anti-tax avoidance will not be an issue and interest received under a finance lease will also be subject to tax, save that the taxable rate will be significantly lower than the rate of profits tax payable on other non-shipping commerce in the Territory.

In this context, it is important to differentiate between an operating lease where economic risk rests with the owner as lessor, who will expect to see the vessel returned subject to return conditions at the end of the lease and a finance lease where the charterer would expect to take ownership of the vessel at the end of the lease, whether through a lease termination payment or purchase option.

Qualifying Ship Lessors- Taxable Income Calculation and Tax Rate on Profits

In essence, taxable income for qualifying lessors operating, among other things, a charter-out business will be calculated at 20% of the gross charterhire income including any amounts payable under a residual value guarantee less deductibles, excluding tax depreciation.

Under more standard finance leases, the taxable income for qualifying lessors will be calculated as gross income from the finance lease, for example the interest or "variable charterhire" element, less deductibles.

Most importantly, the tax rate on the profits of qualifying ship lessors (i.e. those who undertake ship leasing activity as defined in the Amending Ordinance) is 0%.

Qualifying Ship Leasing Managers

Qualifying ship leasing managers who undertake defined qualifying ship leasing management  activities in the Territory will take advantage of a tax rate on their profits of 0% where the services are provided in-house (i.e. to an associate) and at 8.25%, which is half the standard profits tax rate for other commercial activities, where the qualifying management services are provided to a third-party (i.e. externally, for gain).

Qualifying ship leasing management activities is a very broadly defined concept, to include procuring and leasing ships, (i.e. not as owner), managing other ship lessors, providing alternative finance in the form of loans, providing guarantees, managing leases, arranging operation, crewing, maintenance, etc. -the list of ship leasing management activities is long.

In order to take advantage of the beneficial tax rates, the entities must fulfil the criteria and conditions imposed by the legislation.  To qualify as a ship lessor, the entity must not only be established in Hong Kong but also maintain at least two full time employees with a minimum operating expenditure of approximately US$1 million for the relevant tax-year.  Likewise, to qualify as a ship leasing manager, the Hong Kong­ based entity must maintain at least one full time employee in the Territory and have at least US$130,000 in operating costs. In both cases, the conditions must also be "adequate" in the opinion of the Inland Revenue Department itself.

Importantly, both lessors and managers must have their centre of management interests in Hong Kong, and so be both managed and controlled in Hong Kong, with all of the core income generating activities (i.e. all activities that generate a profit, also often referred to as "CIGAs") conducted in the Territory rather than in another jurisdiction.

For shipping businesses, they must conduct only the qualifying activities as defined in the Amending Ordinance, so could not, for example, run a ship leasing or management business and cargo shipping at the same time.  There are some exceptions for a qualifying ship leasing manager, in that they may still fall within the definition, if 75% of their profits arise from qualifying activities and the assets used for qualifying activities constitute at least 75% of its total assets.

A ship held for three years will be a capital asset of a qualifying entity, which will determine the tax position at the point of sale.

It is vitally important  that a shipping business interested in exploring the new tax regime further takes comprehensive tax and legal advice from specialists in Hong Kong.  There are specific measures to protect against abuse.  For example, transactions between associated entities must be at arm's length and the benefits will not bite if the arrangement is mainly designed to obtain a tax benefit under a double-tax treaty. It should be noted that the Maples Group does not practice Hong Kong law or advise on Hong Kong tax and this should not be relied on in lieu of formal tax and legal advice.

The Maples Group has a substantial presence in Hong Kong, having established operations in 1995.  We are a market leader in the provision of fiduciary and corporate services to investment funds, partnerships, structured finance vehicles and corporate entities.  Across our offices globally, the Maples Group brings in­ depth knowledge and expertise of regulatory and investor requirements and best practice. An institutional grade infrastructure coupled with a highly responsive approach to client service ensures our clients are comprehensively supported in navigating the complexities of today's global business landscape.

Through our fiduciary services business in Hong Kong and elsewhere, we can help clients to establish ship owning entities in Bermuda, the British Virgin Islands, the Cayman Islands, Delaware, England, Hong Kong, Ireland, Jersey, Luxembourg, Marshall Islands, Singapore and the UAE, to act as owners of ships registered under the flag of the British Virgin Islands, the Cayman Islands, Jersey, the Republic of Marshall Islands and other flag states. Alongside correspondent counsel, we can also assist with establishing Liberian and Panama entities and we can work with a local notary to arrange for notarial attestations and mortgage registrations with the various shipping registries in Asia.

As a full-service provider of choice in the shipping finance sector, the Maples Group routinely acts in the following capacity for our clients:

  • Company / corporation formation

  • Shipping administration (i.e. establishing ship owning / leasing platforms)

  • Sale and purchase escrow agency

  • Flag title and mortgage registration

  • Company secretarial and board support

  • Directorship services

  • Accounting, tax and agency services

  • Entity management services

  • Permanent office solutions

  • Power of attorney and proxy agent services

  • Trustee services, including security trustee for ship finance/ leasing structures

  • Liquidations

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