Hong Kong-US Tax Treaty: Does One Exist?
Without a tax treaty, US persons in Hong Kong face unique obligations. Understand how to navigate the interaction between two distinct tax systems.
No comprehensive income tax treaty exists between the United States and Hong Kong. This absence has significant consequences for individuals and businesses, as it creates a greater potential for double taxation. Without a treaty, the default tax laws of each jurisdiction apply, pitting the U.S. worldwide tax system against Hong Kong’s territorial system. The tax relationship is therefore governed by a few limited agreements and specific provisions within U.S. law designed to alleviate the tax burden on income earned abroad.
The Status of a US-Hong Kong Tax Agreement
While a comprehensive income tax treaty that would set rules for residency and reduce taxes on dividends and interest does not exist, this does not mean there are no agreements. The relationship is governed by narrower arrangements that serve specific purposes but do not provide broad relief from double taxation. The comprehensive tax treaty the U.S. has with Mainland China does not apply to Hong Kong, as they operate under different taxation systems.
The main existing pact is the Tax Information Exchange Agreement (TIEA). This agreement facilitates the sharing of taxpayer information between the U.S. Internal Revenue Service (IRS) and Hong Kong’s Inland Revenue Department (IRD) upon request. The TIEA is a tool for enforcing domestic tax laws, particularly in support of the U.S. Foreign Account Tax Compliance Act (FATCA).
Another agreement, which addressed the exemption of income from international shipping and aviation, was terminated by the United States. These limited agreements underscore that for most income types, taxpayers cannot rely on a treaty to prevent being taxed by both jurisdictions.
US Taxation of Individuals in Hong Kong
The U.S. taxes the worldwide income of its citizens and resident aliens, meaning income is subject to U.S. tax regardless of where it is earned. For an American living and working in Hong Kong, this includes salary, investment returns, and any other income sourced from Hong Kong.
To address this, a tool available is the Foreign Tax Credit (FTC). The FTC allows taxpayers to reduce their U.S. income tax liability on a dollar-for-dollar basis for income taxes paid to a foreign country. An individual claims this credit by filing IRS Form 1116, and the amount of the credit is limited to ensure it cannot offset U.S. tax on U.S. source income.
As an alternative to the FTC, individuals may be able to use the Foreign Earned Income Exclusion (FEIE). This allows a taxpayer to exclude a certain amount of income earned from foreign sources from their U.S. taxable income.
To qualify for the FEIE, a taxpayer must meet either the Bona Fide Residence Test or the Physical Presence Test. The former involves residing in a foreign country for an uninterrupted period that includes an entire tax year. The latter requires being physically present in a foreign country for at least 330 full days during any period of 12 consecutive months.
A taxpayer who elects to use the FEIE cannot claim a Foreign Tax Credit on the same income that has been excluded.
Hong Kong’s Territorial Tax System
Hong Kong’s tax system operates on a territorial or source-based principle, in contrast to the worldwide system of the United States. Under this framework, only income that arises in or is derived from Hong Kong is subject to Hong Kong tax. An individual’s citizenship or residency status is not the determining factor, as the focus is on the geographic source of the income.
The main direct taxes are Profits Tax, Salaries Tax, and Property Tax. Profits Tax applies to the profits of businesses in Hong Kong. Salaries Tax is charged on employment income for work performed in Hong Kong, with an exemption for visits of fewer than sixty days. Property Tax is assessed on owners of real estate in Hong Kong that generates rental income.
Each of these taxes is calculated separately. For salaries tax, the taxpayer pays the lower of two calculations: one using progressive rates from 2% to 17% on net income, and another using a standard rate on gross income. These Hong Kong taxes may be creditable against a U.S. person’s tax liability.
Tax Implications for Businesses
U.S.-based corporations with operations in Hong Kong are also subject to the U.S. policy of taxing worldwide income. A U.S. corporation is generally subject to U.S. tax on all its income, including profits generated by a branch or subsidiary located in Hong Kong.
The structure of the Hong Kong operation impacts its U.S. tax treatment. If a Hong Kong subsidiary is classified as a Controlled Foreign Corporation (CFC), its U.S. parent company may face immediate U.S. taxation on certain categories of the subsidiary’s earnings. This can occur under the Subpart F income rules or the Global Intangible Low-Taxed Income (GILTI) provisions, even if the profits are not distributed back to the U.S. as dividends.
Similar to individuals, U.S. corporations can utilize the Foreign Tax Credit. Corporations claim this credit on IRS Form 1118 to offset their U.S. tax liability with the Hong Kong profits taxes they have paid. The underlying principle is to provide relief from being taxed twice on the same income.