Upgrading Hong Kong’s dedicated tax regime for aircraft leasing
Six years ago the Hong Kong Government sought to level the playing field with key aircraft leasing jurisdictions such as Ireland and Singapore through a new Aircraft Leasing Preferential Regime. Now it wants to update that Regime. In this article PwC Hong Kong Partner Clarence Leung and Tejaswi Nimmagadda and Nai Kwok of Tiang & Partners review the progress and conclude that enhancements to the existing regime will go a long way towards bringing new energy to Hong Kong as a key leasing hub jurisdiction.

September 2023: Despite the marked shift in global economic conditions since the onset of the pandemic, the fundamentals underpinning Hong Kong SAR’s desire to establish and promote a favourable tax regime for aircraft leasing in 2017 have encouraged the Hong Kong SAR Government to look at ways to update and improve the competitiveness of the conditions afforded to aircraft lessors and investors in Hong Kong.

The pandemic has also shown a dynamic shift in global supply chains, only furthering Hong Kong’s positioning as a global, regional and local financial, logistics and asset management hub, particularly as it lays at the doorstep of many Asian Pacific countries.
Clarence Leung

Moreover, while a number of major aircraft leasing companies have set up qualifying operating lessors and/or qualifying lease management companies in Hong Kong since 2017, the changes in tax and business landscape have also prompted the Government to re-look and update for certain topics.

In 2017, it was noted that while Hong Kong shared many of the common ingredients for success with key aircraft leasing jurisdictions such as Ireland and Singapore, the tax regime for aircraft lessors had several weaknesses which made Hong Kong less competitive than those countries. In particular, it was noted that:

1. Hong Kong-based aircraft lessors are taxed on gross rental income, rather than profits which are taxed at a rate of 16.5%;

2. Aircraft lessors are not entitled to tax depreciation on acquisition of aircraft where leased to non-Hong Kong based airlines; and

3. Hong Kong has signed double tax agreements with fewer jurisdictions than Ireland and Singapore.

The measures introduced as part of the Aircraft Leasing Preferential Regime were aimed at levelling the playing field between Hong Kong and these other key jurisdictions by addressing the first two of these weaknesses.
Tejaswi Nimmagadda

First, the headline tax rate was reduced to 8.25% and secondly, in lieu of allowing lessors to take depreciation allowances, only 20% of the net lease rentals are assessed (effectively, a deemed deduction of 80% is allowed), which reduces the tax on net lease rentals to 1.65%.

With respect to double tax agreements, while Hong Kong has signed fewer double tax agreements than Ireland and Singapore, the double tax agreement between Chinese mainland and Hong Kong had already been amended ahead of the introduction of the Regime such that it was more favourable, albeit only slightly, than Ireland and Singapore, and it was recognised by the industry that Hong Kong’s treaties with many nearby airline jurisdictions in the Asia Pacific region is, in fact, quite competitive to make Hong Kong attractive functionally as a regional hub.

Given the passage of time and upcoming overhaul of the international tax rules aimed at addressing Base Erosion and Profit Shifting concerns (BEPS 2.0), the Hong Kong Government is looking to update the Regime with a view to maintaining Hong Kong’s international competitiveness, while also respecting its commitment to implement BEPS 2.0.

What has happened in this round so far
On 22 November 2022, the Hong Kong Transport and Logistics Bureau (TLB) launched a trade consultation in relation to the Regime.
Nai Kwok

The key proposed changes are:
1. A qualifying aircraft lessor should be allowed to deduct the full cost of an aircraft for the year of assessment in which the aircraft is acquired;

2. Relaxation on anti-avoidance rules for internal transfer of aircraft from other jurisdictions to Hong Kong, provided that the depreciation allowances given to the aircraft are subject to a clawback mechanism;

3. Widening the type of leases to be covered within the concessionary tax regime;

4. Widening the scope of aircraft leasing activities in order to cover other type of aircraft leasing activities that have been developed, especially during the COVID-19 pandemic when the demand for air travel was low;

5. Allowing tax deduction of interest payable to a financier outside Hong Kong who is not a financial institution and may be an associate of the qualifying aircraft lessor;

6. Introducing threshold requirement to ensure the concessionary tax regime will meet the international standards on anti-base erosion and profit shifting; and

7. Providing clarification that the use of a ‘bare trust’ model to own an aircraft should be able to fall within the concessionary tax regime.

With the implementation of BEPS 2.0 the absence of depreciation allowance is likely to put Hong Kong aircraft lessors in a relatively disadvantaged position under the 20% tax base concession as the effective tax rate of a Hong Kong aircraft lessor should be well below the minimum rate of 15%. Although under the above proposed changes the headline rate of a qualifying aircraft lessor will still be taxed at 8.25%, the deferred tax adjustments arising on the ‘depreciation allowances’ given will be taken into account in the calculation of the covered taxes, resulting in a lower amount of top-up tax being required.

In July 2023, following the conclusion of the Consultation, the Legislative Council’s Panel on Economic Development was briefed by the Inland Revenue Department with respect to the proposed legislative changes.

We understand that the next step will involve the introduction of an amendment bill into the Legislative Counsel in the fourth quarter of 2023, with the legislative amendments having retrospective effect commencing on 1 April 2023. This will allow lessors to take advantage of the amendments immediately, without having to wait for the amendment bill to be passed prior to implementing their transactions. On the other hand, the likely retrospective effect of the amendments will require lessors and investors to immediately commence their planning for this and the upcoming financial year.

Enhancements to the existing regime that will be sustainable in the current global tax climate will be welcomed by industry and go a long way towards bringing new energy for Hong Kong as a key leasing hub jurisdiction.

Furthermore, the proposed changes are likely to provide more opportunities to a wide range of transactions that can be brought into the scope of the ‘enhanced’ regime so as to not limit the opportunities for investors to enter or broaden their exposure to the sector as a whole.

As always, the devil is in the detail and we understand that a number of submissions were made during the consultation process to ensure that the objectives of the enhancements measures are met or improved.

Other non-legislative enhancements
The Inland Revenue Department has also noted that it has already implemented, apart from the above proposals which will require legislative amendment to the Regime, a number of enhancements via administrative means. These enhancements include:

1. To recognise the Irish Stock Exchange as an exchange on which interest payments under listed debentures will be allowed for deduction. This will allow interest payable on notes which are listed on the Irish Stock Exchange to be allowed for deduction (including capital markets financings and asset backed securitisations).

2. To specifically clarify that assets held by Hong Kong leasing companies beneficially under ‘bare trust’ arrangements are eligible for tax concession under the Regime. The IRD noted that these arrangements are already allowed, as ownership covers not only legal ownership but also economic/ beneficial ownership. However, the IRD updated the Departmental Interpretation and Practice Notes to clarify this.