Will Hong Kong’s new tax rate lure lessors?
In March 2017, the Government of Hong Kong introduced a bill to amend existing inland revenue legislation to make concessions to the off-shore aircraft leasing industry. The new rules will create a dedicated tax regime to attract aircraft leasing business to Hong Kong and establish a new professional service industry in the city. They are scheduled to enter into force in January 2019.
The Ishka view is that Hong Kong has unnecessarily impeded the development of its aircraft leasing sector in the past and welcomes another industry hub to complement Dublin and Singapore. Hong Kong is well placed to serve the Chinese domestic market. But it remains to be seen whether a 1.65% effective rate of tax will be enough to lure lessors to the city. The lack of a depreciation allowance and the comparative strength of competitive jurisdictions, especially Ireland, will remain an issue.
An effective tax rate of 1.65%
Under the new tax regime, the tax rate on qualifying profits will be 50% of the prevailing corporation tax rate of 16.5%. This rate will apply to only 20% of the usual eligible tax base of a company. The result is an effective tax rate of 1.65%. Current applicable tax rates for aircraft leasing business in Ireland, Singapore and Hong Kong are 12.5%, 5% or 10%, and 16.5% respectively. Hong Kong is clearly making a bid for leasing companies to relocate to the city.
Moreover, in April 2015, an updated double taxation arrangement between Hong Kong and mainland China reduced the withholding tax rate on lease rentals derived from aircraft from 7% to 5%. To be eligible for the concessions, lessors will have to have commercial substance in Hong Kong. incorporating the business in Hong Kong and holding board meetings there will not be insufficient.
Hong Kong may serve China better than Chinese free trade zones
China is expected to take up a substantial portion of the anticipated increase in demand for aircraft in the next 20 years. According to Boeing Capital, mainland airlines will require nearly 6,000 aircraft, valued at around $780 billion, in the years up to 2032. Hong Kong’s proximity to the mainland, developed finance markets and legal system – which includes a 1999 agreement allowing for mutual enforcement of legal arbitration across the two jurisdictions – could make it a fertile middle ground for lessors. There is a 5% withholding tax between Hong Kong and the mainland, which is lower than the payment from China to Ireland (6%) and China to Singapore (also 6%).
Chinese lessors that serve domestic market often use the Chinese free trade zones. As such they will use Chinese law, use documents in mandarin, and pay in renminbi. For some international lessors, who prefer English law and US dollars, this may preclude doing business in China.
It also precludes certain business operations that are entirely dependent on the lessor. For example, a lessor that wanted to sell shares in an SPV entity, something that would be a simple novation from an airline perspective, is very complicated in mainland China. Instead, it would be relatively straightforward in Hong Kong.
“Hong Kong would be a good intermediate place to do business that you can’t do in the Free Trade Zones, but still has good Chinese character,” says Peter Huijbers, CEO of China International Aviation Leasing Service (CALS).
Lack of tax depreciation will remain chief hurdle
Out of the top ten global aircraft lessors, all have a business presence in Ireland, eight in Singapore and only two in Hong Kong. The aim of the city’s new leasing tax strategy is to capture 18% of the global leasing business by 2020. The government anticipates a GDP boost of $55.3 billion over a 20-year period leading to direct employment for 1,640 people. Total tax income is expected at around $1.3 billion across that period, reaching $128.5 million a year by 2020.
Previous tax avoidance legislation has stymied the development of Hong Kong as a serious aircraft leasing hub. In 1992, Hong Kong amended Section 39E of the Inland Revenue Ordinance to remove the tax depreciation allowance for all leases with a foreign operator. The provision was made after tax planning schemes in the 1980s caused a drop in government revenues.
The government remains cognisant of the experience and does not intend to repeal Section 39E. The plan is to negate the unintended effects of the 1992 legislation with a lower effective tax rate. However, taking into account the lack of a depreciation allowance, Hong Kong’s effective maximum tax rate for lessors is likely to be around 4%, rather than 1.65%
“From that perspective, as long as you can’t use depreciation I think Dublin, and to some extent Singapore, are still the better choice, rather than Hong Kong,” says Huijbers.
CALS has a presence in Hong Kong and Shanghai, but is unlikely to move its core leasing business from Dublin because of this.
Dublin will remain the dominant leasing hub for the foreseeable future
Hong Kong will most likely supplement, rather than displace existing hubs in Ireland and Singapore. SMBC Aviation Capital is one international lessor that has bases in Hong Kong, Singapore, and Dublin. However, like CALS, the company is unlikely to move its leasing platform from Ireland anytime soon.
According to SMBC Aviation Capital CEO, Peter Barrett, the lessor is “committed to Ireland because of its established base and numerous benefits” including double taxation treaties, a comprehensive network of professional services firms and a favourable time zone.
Dublin has double taxation treaties with 70 countries, Singapore with 85 and Hong Kong with 36 countries. It will take some time for Hong Kong to catch up. Unlike Singapore and Dublin, Hong Kong does not impose an aircraft sales tax but the lack of a depreciation allowance is still a hurdle for lessors.
Dublin has achieved a critical mass through a developed technical knowledge base and a refined national aviation policy. Courses such as the MSc in Aviation Finance at University College Dublin – developed with industry partners including Avolon, AerCap, GECAS, KPMG, SMBC and Safran – provide a technical talent pool to feed Dublin’s hub status in the Industry.
Moreover, in Dublin a leasing platform can be established and operating within ten days, (see Ishka Insight: How to set up an aviation leasing platform in Ireland). In Hong Kong, opening a corporate bank account alone can be an onerous process. The same applies for personal visas.
In a globally competitive environment, personal taxation is also a consideration. Hong Kong remains a very expensive place to live but has an effective top rate of income tax of 15%. Part of the proposed tax changes in Hong Kong also apply a reduced 8.25% tax rate on all profits of qualifying aircraft leasing managers
Ireland’s top rate is 40%, though not to be outdone, the Special Assignee Relief Programme, part of Ireland’s national aviation policy, operates by allowing a 30% deduction from any employment income above €75,000.
Undoubtedly, a favourable tax regime will make Hong Kong more competitive over time. In the past, Hong Kong’s tax law has held its domestic leasing industry back. But whether it can dislodge the critical mass achieved by Ireland in the past two decades is unclear.
Th Hong Kong government has set moderately ambitious 20-year targets including an 18% market share of the aircraft leasing business. This will provide a useful yardstick to assess the success of the policy.
However, in the short term the absence of a tax depreciation allowance will remain a concern. This increases the effective rate of tax to somewhere near 4% — attractive but not as aggressive as first appearances would indicate. Few existing lessors based in Ireland are willing to express any desire to move their operations. Growth will likely come organically from new companies and capital from mainland China.