New tax treaties may hit airlines

A number of international airlines with Hong Kong subsidiaries may be forced to down-size their Hong Kong operations because of new air service agreements slated to be signed in the next few months, tax specialists say.

Inland Revenue Department (IRD) sources have revealed Hong Kong is on the verge of signing air service agreements, incorporating provisions to halt the double taxation of airline profits, with more than 10 countries.

The development of double-tax treaties has been broadly encouraged by a tax profession looking to reduce their clients' foreign withholding tax liabilities.

But there is a growing belief among foreign airlines which fly via Hong Kong on to other cities that, ironically, air services agreements may result in higher overall tax.

Previously, the absence of double-tax agreements between Hong Kong and other countries has meant that, in many cases, only Hong Kong profits have been taxed.

This was because of Hong Kong's territorial tax basis, which has in the past ignored airline income made outside the territory.

This meant many airlines structured their businesses to pay no tax in the overseas jurisdiction, and Hong Kong tax only on profits sourced in the territory.

As a result of the imminent air service agreements, Hong Kong tax will now be paid on profits made in both the territory and the relevant airline's home country, unless profits are already subject to tax in that country.

This effectively means that if tax is not paid overseas, it must now be paid in Hong Kong.

According to Debbie Annells, tax director with Grant Thornton Byrne, an air services pact recently signed with South Korea means airlines operating through Hong Kong on Korean routes are now considering significant restructuring.

The Korean agreement is the first signed by Hong Kong to incorporate a double-taxation clause.

'The amendments to the tax legislation favour home-based carriers in Hong Kong, such as Cathay Pacific, because they have by and large paid tax wherever they have operated in the past,' she said. This is due to Hong Kong's double-tax treaties previously.

'The more air service agreements that are signed, the more international airlines stand to be affected, given the probability they will be paying more tax in Hong Kong,' Ms Annells said.

Already, a number of airlines in Asia and Australia are believed to be facing higher tax bills following the signing of the air services agreement with South Korea.

Double tax agreements were good in principle but the way that these air services agreements were being implemented 'dents the integrity of the tax system by deeming what are really offshore profits to be local'.

DEPARTURES Imminent air service agreements may not be all good news Foreign airlines could face higher taxation Hong Kong operations may be cut back