Hong Kong’s new tax regime for aircraft leasing; not just an ‘alphabet soup’!

Monday 12 June 2017

The new regime in a nutshell

On 22 March 2017, Inland Revenue (Amendment) (No. 2) Bill 2017 (the ‘Bill’), which provides for concessionary tax treatment on aircraft leasing activity, was introduced into the Legislative Council in Hong Kong. Broadly speaking, the Bill provides for qualifying profits of qualifying aircraft lessors and qualifying aircraft leasing managers:

  • To be subject to half of the normal profits tax rate (i.e. 8.25%) and
  • The taxable amount of rental income derived from leasing of an aircraft to a non-Hong Kong aircraft operator by a qualifying aircraft lessor to be equal to 20% of the tax base (i.e. gross rentals less deductible expenses, excluding tax depreciation)

This means that, as opposed to the standard profits tax rate of 16.5%, (net) aircraft leasing income will be taxed at an effective rate of 1.65%, with profits derived from the management of aircraft leasing activities to be taxed at 8.25% (by comparison, Singapore and Ireland lessors are generally subject to 8% and 12.5%, respectively).

The new regime will apply from the year of assessment 2017/18 once the Bill has been enacted. It is anticipated that the Bill will be passed into law by June 2017.  Subsequently, the concessionary tax treatment will apply (with retrospective effect) to the qualifying profits realised on or after 1 April 2017. 

Hong Kong's potential as an aircraft leasing hub

With the above proposed regime, the Hong Kong Government will have fixed the flaw of aircraft lessors not being entitled to tax depreciation on the aircraft acquired if it is leased to non-Hong Kong based airlines. Under the ‘old’ regime, Hong Kong-based aircraft lessors are basically taxed at 16.5% on the gross rental income (after deduction of operational expenses which are relatively minor compared to depreciation), rather than on the profits. 

There are many reasons supporting the choice for Hong Kong as a potential aircraft leasing hub including, but not limited to:

  • The relatively simple tax system, the absence of thin capitalisation rules (as a result of which the equity/debt funding can be determined by the lessors as they deem commercially appropriate)
  • Favourable Double Tax Agreements (DTAs), particularly with respect to (Mainland) China, Japan and Russia
  • The general expectation that China is also likely to be a huge market opportunity for aircraft leasing activities in Hong Kong in light of Hong Kong being regarded as the ‘Gateway to China’.

Where Hong Kong tax residents lease their aircraft to Chinese aircraft operators, under the pertinent DTA, the lessors are generally able to enjoy a reduced withholding tax of 5% in respect of the rental income received from the Chinese payor. By comparison, Singapore or Ireland resident lessors would need to suffer a withholding tax of 6% under their respective DTAs concluded with China. This tax saving is particularly important for Chinese airlines when they choose their vendors for new aircraft as, in practice, it is common for them to bear the Chinese withholding tax cost in this regard.

Next steps

All in all, the proposed regime is a significant step in the right direction. Along with a continued focus on the quick expansion of Hong Kong’s DTA network, it has the potential to make Hong Kong truly competitive in the global aircraft leasing market. 

Needless to say, the concessionary tax regime involves qualifying conditions and anti-abuse rules, in respect of which market players will need to get familiar with, and careful planning is needed.


Contact

For further information about the impacts of Hong Kong’s new tax regime for aircraft leasing, please contact Laure Mathieu