The new Hong Kong-Romania agreement for the avoidance of double taxation and prevention of fiscal evasion (the “DTA”) which was signed in 2015 came into force on 21 November 2016 after the completion of ratification procedures by both contracting states. It will apply with respect to income derived on or after 1 January 2017. The tax treaty aims to confirm the allocation of taxing rights between the two countries and reducing the effect of double taxation.
The principal clauses of the DTA include (i) a reduction to withholding tax on dividends, interest and royalties, (ii) a definition of a Permanent establishment, and (iii) an exemption on capital gains.
Withholding tax on dividends, interests and royalties
Only dividends paid by a Romanian entity to a Hong Kong resident will be affected by the DTA, since Hong Kong does not levy any withholding tax on dividends.
Under the DTA, the current applicable withholding tax rate on dividends derived by a Hong Kong resident in Romania is reduced from 16% to 3% or 5%. The 3% tax rate applies if the recipient is a legal entity which directly holds not less than 15% of the company distributing the dividends. Otherwise, the withholding tax on dividends is capped at 5% maximum. Furthermore, it should be noted that no tax on dividends is withheld on dividends paid to the Hong Kong Government, the Hong Kong Monetary Authority, the Exchange Fund or any financial institution that is wholly or mainly owned by the Hong Kong Government.
The DTA phases out the current statutory withholding tax rate on interest (16%) paid by a Romanian based entity to a Hong Kong resident, provided that Hong Kong does not levy any withholding tax on interest (which is the case at present). However, in the event Hong Kong applies a withholding tax on interest in the future, the applicable rate under the DTA would be capped at 3%.
The withholding tax on royalties paid to a resident of a contracting state is levied in the contracting state in which the royalties arise at a capped rate of 3%.
Under the definition provided by the DTA, a permanent establishment of an entity includes a building site, a construction, assembly or installation project or supervisory activities in connection with that activity, but only if the activity lasts for more than 183 days.
However, the DTA does not provide a definition of a “service Permanent Establishment”. As a consequence, consultancy services that have been rendered in a contracting state by a resident of the other contracting state, will not be taxable in the state where the services are rendered, even though such services have been carried out for more than 183 days.
Capital gains tax exemption
The new DTA provides that capital gains derived by a Hong Kong resident from the disposal of shares held in a Romanian entity will be free of tax, provided that the shares being transferred are held in a company which derives less than 50% of its asset value directly and indirectly from immovable property located in Romania. There is no tax on capital gains in Hong Kong.
As part of China’s strategy “One Belt, One Road” to connect West China with Europe and Africa, it is expected that the Hong Kong-Romania DTA will increase the trade and investment flows between the two trading partners. The treaty will put Hong Kong in a key position by playing the determining role for foreign direct investments into Romania.