The increasing popularity and growth of ship leasing, particularly in China and elsewhere in Asia, has been one of the most important developments in the global maritime industry over the last decade. With increasing pressures on European and other financial institutions resulting in many banks withdrawing from providing financing to the maritime industry, ship leasing has provided a welcome source of funding to those seeking to acquire new and second-hand vessels. Hong Kong has recognised the need to attract this business in order to compete with tax-friendly schemes in Singapore and other jurisdictions and for Hong Kong to continue to operate as one of the world’s financing and maritime hubs.
On 19 June 2020, the Hong Kong government published the highly anticipated Inland Revenue (Amendment) (Ship Leasing Tax Concessions) Ordinance 2020, which contains profits tax concessions for qualifying ship lessors and ship-leasing managers (the Ship Leasing Tax Incentive), which can be found in sections 14O through 14ZB of the Inland Revenue Ordinance. In brief, profits derived from qualifying ship-leasing income are exempt from profits tax whereas profits from qualifying ship-leasing management activities are either exempt from profits tax if the services are provided to affiliated companies, or taxed at the reduced profits tax rate of 8.25% if the services are provided to unaffiliated companies (the standard profits tax rate is 16.5%). The Ordinance, which incorporates anti-abuse provisions to safeguard the integrity of the tax system and comply with the latest international tax rules (the OECD’s Base Erosion and Profit Shifting (BEPS) measures), is in effect from 1 April 2020.
Hong Kong Company Requirement
The Ship Leasing Tax Incentive is designed around a Hong Kong-based manager using separate Hong Kong-incorporated special purpose companies to own and lease ships of at least 500 gross tonnes for use outside Hong Kong waters based on operating or finance leases entered into with either affiliated or third-party lessees. The ships must be able to navigate outside Hong Kong waters. “Qualifying ship lessors” and “qualifying ship leasing managers”, as defined in the Ordinance, must be Hong Kong- incorporated companies that conduct only qualifying ship-leasing activities (with some non-qualifying activity allowed for ship-leasing managers). This precludes the regime applying to Hong Kong companies which also conduct passenger or cargo shipping businesses. Both the ship-leasing manager and the ship lessors must be centrally managed and controlled in Hong Kong where all the profit generating activities are conducted. They must make an election in writing to apply for the Ship Leasing Tax Incentive with the Inland Revenue Department (IRD), which has the authority to determine whether the pertinent conditions are satisfied. The Ship Leasing Tax Incentive does not require there to be both a qualifying ship-leasing company and a qualifying ship-leasing management company.
The minimum conditions for ship-leasing companies are that a Hong Kong-incorporated company is managed and controlled in Hong Kong, owns or leases one or more qualifying vessels and leases these vessels out on either an operating or finance lease for use outside Hong Kong waters. The ship-leasing company must (a) have an adequate number of full-time employees and (b) adequate operating expenditure. It must have at least two full-time employees in Hong Kong (which is generally sufficient for start-ups but if the company has many contracts, then possibly more employees may be required, to be determined by the IRD) and a minimum annual operating expenditure of HK$7.8 million (approx. US$1 million, which includes interest cost incurred by the ship-leasing company in owning or leasing the vessel).
What a Lease Should Be
A qualifying ship lease is a lease of a qualifying ship by the ship-leasing company to another ship lessor, a ship operator or to a ship leasing manager. It has a broad scope and includes sale and lease back. The ship must be able to ‘navigate’, so it is as yet uncertain whether floating production storage and offloading units (FPSOs), floating storage regasification units (FSRUs) or barges qualify for the regime. Guidance on this important point would be welcome, especially as Singapore’s tax incentive regime does include these types of vessels within its scope. For ship-leasing management activities, besides the requirement that they must be conducted by a Hong Kong-incorporated company managed and controlled in Hong Kong, they must have at least one full-time employee and minimum annual operating expenditure of HK$1 million (some USD 129,000). A safe harbour for qualifying ship leasing managers allows them to carry on certain non-qualifying activities, provided at least 75% of its profits arise from qualifying ship-leasing management activities and the value of assets used by the company to carry out qualifying activities are at least 75% of its total assets. Qualifying ship-leasing management activities are the setting up or management of a special purpose vehicle for owning a leased ship, arranging for the procurement or leasing of ships, and managing leases.
The Ordinance contains a deeming provision that deems a ship to be a ‘capital asset’ if it is held for three years as part of a qualifying ship leasing business. This welcome addition provides some clarity to the tax position when a ship is sold, as a gain derived from the sale of a capital asset is not subject to profits tax in Hong Kong, whereas it would generally be taxable if it is not a capital asset for profits tax purposes. For a ship sold before the three-year mark, the position will depend on the relevant facts and circumstances.
Hong Kong Tops Singapore
Hong Kong’s Ship Leasing Tax Incentive conditions are less onerous than Singapore’s. The incentive helps to promote Hong Kong as the preferred jurisdiction for ship-leasing activities. Of course, only time will tell if Chinese leasing companies and other lessors and managers take advantage of the opportunity.