From October on this year, global investors will be able to trade Chinese stocks from Hong Kong for the very first time, as the former British colony is working day and night to launch an unprecedented initiative known as “Shanghai-Hong Kong Stock Connect”.
In China, Deng Ge, Spokesperson for the China Securities Regulatory Commission (“SRC”), assured the media on 8 August 2014 that “the preparation work [for the initiative] has been progressing smoothly and orderly”, responding to public enquiries whether the Commission has shunted its other projects to the bottom of its to-do list to meet the October deadline. Similar assurances have not been given by China’s State Administration of Taxation (“SAT”).
The Hong Kong and Chinese governments agreed in April that the new initiative will allow international investors to trade over 560 Shanghai ‘A’ shares via the Hong Kong stock exchange (“Northbound trading”), while mainland investors will be able to trade up to 266 Hong Kong ‘H’ shares via the Shanghai Stock Exchange (“Southbound trading”).
Trading under the initiative will be subject to a maximum cross-boundary Aggregate Quota, together with a Daily Quota. For the northbound trading, global investors from Hong Kong will be able to trade up to the Aggregate Quota of RMB 300 million worth of ‘A’ shares, with the Daily Quota of RMB 13 billion. For the southbound trading from Shanghai, on the other hand, investors will be able to trade up to the Aggregate Quota of RMB 250 billion worth of Hong Kong ‘H’ shares, with the Daily Quota set at RMB 10.5 billion.
This groundbreaking initiative will create a channel for mutual market access between the Mainland and China, paving the way for further opening up of China’s capital account and RMB internationalization, at the same time cementing Hong Kong’s role as China’s international financial centre.
Granted, the tight schedule of the complex initiative may justify all-nighters pulled by brokers, engineers, but policy makers should not take a back seat. From a tax perspective, the initiative raises some unanswered tax issues, especially in the Mainland.
Hong Kong tax
Hong Kong tax in this regard is quite straightforward as its simple territorial taxation system exempts dividends and capital gains, and offshore income. Mainland and Hong Kong investors, individual or institutional, will not be subject to either salaries tax or profits tax, but they still need to pay Hong Kong stamp duties on the transfer of Hong Kong stocks.
China tax – southbound trading
The taxation picture is a little blurred on the China side. Mainland individual investors are currently exempt from Individual Income Tax (“IIT”) on the gains of disposal of shares listed in Shanghai and Shenzhen Stock Exchanges, and subject to preferential, effective rates of 5%, 10% and 20% on dividends, depending on the holding period. It is unclear whether mainland individual investors will enjoy such tax incentives for the southbound trading.
For mainland institutional investors, their overseas dividends and gains on disposal of shares are grouped together as “investment income” subject to the normal Corporate Income Tax (“CIT”) rate.
China tax – northbound trading
For Hong Kong individual investors, it is not clear whether they will be able to enjoy the same tax incentives as their mainland counterparts under China’s domestic tax regime, i.e., exemption on the gains of disposal of shares, and preferential tax rates on dividends for their IIT liabilities. And the treaty treatments for those IIT remain another thorny issue. Alternatively, those incomes are in all likelihood to be subject to 10% withholding tax (“WHT”), instead of China IIT, as strictly taken, those Shanghai ‘A’ shares are to be held by an overseas corporate investor, Hong Kong Securities Clearing Company Limited, albeit only in name.
The same WHT will be imposed on Hong Kong institutional investors under China’s current tax regime. As with China IIT, administrative procedures for application for treaty benefits for WHT, if there will be any, have not been laid out.
Other issues with WHT range from, technicalities such as the calculation method for capital gains (on a trade by trade basis, or on a pooling basis?), deductions allowed from the capital gains (e.g., stamp duties), whether carrying forward and backwards of trading losses will be allowed, and to the more administrative ones such as who is going to be the withholding agent.
Many of the above issues are equally troubling China’s existing cross-border trading schemes of Qualified Foreign Institutional Investors (“QFII”) and RMB Qualified Foreign Institutional Investors (“RQFII”), which had hitherto been the only scheme under which foreign investors are able to tap into China’s stock markets.
WHT aside, it will also be absurd if the business tax exemption for QFII will not extend to the new initiative. The impact of the recently rolled-out China VAT reforms is also hard to assess.
Let’s hope the SAT will resolve the above issues as “smoothly” as the SRC does. The taxation tail should not wag the business dog.
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