Understanding Hong Kong-Mainland Tax Jurisdiction Differences

Establishing a joint venture between Hong Kong and Mainland Chinese partners necessitates a fundamental understanding of their distinct tax systems. The jurisdictional differences are rooted in constitutional principles and have significant implications for cross-border operations.

Legal Independence of Tax Systems

Under Article 108 of the Basic Law of Hong Kong, the taxation system in Hong Kong is independent of, and different from, the taxation system in Mainland China. Article 106 further establishes that Hong Kong has independent public finance, and no tax revenue is handed over to the Central Government in China. This constitutional framework creates a genuine “one country, two systems” approach to taxation.

Territorial vs. Worldwide Taxation

The most fundamental difference lies in the basis of taxation. Unlike most tax systems which apply both residential and territorial jurisdiction, Hong Kong uses only territorial source jurisdiction and disregards the concept of residence. Thus, only profits sourced in Hong Kong are taxable, whereas overseas income is not taxable, regardless of the taxpayer’s residency status.

Mainland China, conversely, applies a worldwide basis of taxation for resident enterprises. Chinese tax residents are taxed on worldwide income, while non-residents are taxed primarily on China-sourced income, often contingent on having a Permanent Establishment (PE) in the Mainland.

Comparative Tax System Overview

CEPA Framework for Joint Ventures (2025 Updates)

The Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA) is the first free trade agreement ever concluded by the Mainland of China and Hong Kong. CEPA covers four critical areas: trade in goods, trade in services, investment, and economic and technical cooperation.

March 2025 Implementation

The Second Agreement Concerning Amendment to the Mainland and Hong Kong CEPA Agreement on Trade in Services (Agreement II) officially took effect on March 1, 2025, allowing Hong Kong to accelerate its integration into the overall national development. This represents a significant milestone for cross-border joint ventures.

Key Liberalization Measures for Joint Ventures

The liberalization measures under CEPA take various forms, including:

• Equity Requirements: Removing or relaxing restrictions on equity shareholding and business scope in the establishment of enterprises
• Professional Qualifications: Relaxing qualification requirements for Hong Kong professionals providing services in the Mainland
• Market Access: Easing restrictions on Hong Kong’s exports of services to the Mainland market
• Regional Focus: Most liberalization measures apply to the whole Mainland, with specific pilot implementations in the nine Pearl River Delta municipalities in the Guangdong-Hong Kong-Macao Greater Bay Area

Construction Sector Joint Venture Provisions

For construction service enterprises established as equity joint ventures or contractual joint ventures in the Mainland by two or more Hong Kong service suppliers, CEPA provides specific advantages:

• The performance of all individual enterprises both in Hong Kong and in the Mainland is taken into account when assessing the qualification of joint venture enterprises
• No restriction on the proportion of total capital contributed by Mainland partners to the registered capital
• Hong Kong engineering construction consultant enterprises are allowed to bid for consultancy services projects in joint ventures in the nine Pearl River Delta municipalities in the Greater Bay Area

Greater Bay Area Innovations

New arrangements introduced in 2025 include “Hong Kong Capital, Hong Kong Law” and “Hong Kong Capital, Hong Kong Arbitration” in the pilot cities of the Greater Bay Area to facilitate Hong Kong investors. These measures provide enhanced legal certainty and dispute resolution mechanisms for joint venture operations.

Transfer Pricing Requirements for Joint Ventures

Transfer pricing compliance has become increasingly critical for Hong Kong-Mainland joint ventures, with significant regulatory developments in 2025.

Application to Joint Ventures

The transfer pricing regime applies to joint ventures, their subsidiaries, and stateless entities operating in Hong Kong, consistent with the treatment of local constituent entities. A Hong Kong permanent establishment, including a joint venture, representative office, or branch office, can also be subject to the obligation for master and local file preparation.

2025 Regulatory Enhancements

The Inland Revenue (Amendment) (Minimum Tax for Multinational Enterprise Groups) Ordinance 2025 was enacted on June 6, 2025. This legislation:

• Applies the OECD’s global minimum tax of 15% on MNE groups with annual consolidated revenue of EUR 750 million or above
• Updates Hong Kong’s transfer pricing rules to align with the 2022 OECD transfer pricing guidelines
• Introduces stricter IRD reviews with more scrutiny on intra-group transfer prices
• Anticipates transfer pricing reviews and audits on a larger scale and more regular basis

Documentation Requirements

The transfer pricing regulatory regime mandates Hong Kong entities to prepare a three-tiered standardized documentation approach:

1. Master File: High-level overview of the MNE group’s business operations and transfer pricing policies
2. Local File: Detailed transactional information specific to the Hong Kong entity
3. Country-by-Country Report: Aggregate data on global allocation of income and taxes paid

Timeline: Companies must prepare both Master File and Local File within 9 months of their accounting year ends (e.g., by September 30, 2025, for a December 31, 2024 year-end).

Exemption Thresholds

A Hong Kong entity is not required to prepare a master file and local file if it satisfies any two of the following conditions:

• Total revenue does not exceed HK$400 million
• Total asset value does not exceed HK$300 million
• Average number of employees does not exceed 100

Cross-Border Dispute Resolution

Hong Kong taxpayers exposed to double taxation arising from transfer pricing disputes in the Mainland may seek relief through the Mutual Agreement Procedure (MAP). The first approved Hong Kong-Mainland MAP case was concluded in late 2023, representing a major milestone for Hong Kong taxpayers with related party transactions involving Mainland group entities.

Withholding Tax on Cross-Border Payments

Managing withholding tax obligations is crucial for joint ventures with cross-border payment flows between Hong Kong and Mainland China.

Double Taxation Arrangement Benefits

Hong Kong has a comprehensive Double Taxation Arrangement (DTA) with Mainland China, which provides preferential tax treatment and clarity on permanent establishment rules. The Fifth Protocol to the China-Hong Kong DTA has been effective in Mainland China since January 1, 2020, and in Hong Kong from April 1, 2020.

Withholding Tax Rates

Tax Residency Certificate

By providing a Tax Residency Certificate to the Mainland China tax authorities, a Hong Kong company can reduce the withholding tax rate from the standard 10% to the preferential rates under the DTA. This certificate:

• Allows joint ventures to enjoy reduced withholding tax rates on dividends, interest, and royalties
• Simplifies cross-border capital flow with regions having foreign exchange controls, such as Mainland China
• Makes international fund transfers and payments easier for joint venture operations

Hong Kong’s Withholding Tax Framework

Hong Kong is widely recognized for its business-friendly tax regime, characterized by the absence of withholding tax on dividends and interest paid from Hong Kong. However, when receiving payments from Mainland China, the Mainland’s withholding tax rules apply, making the DTA benefits particularly valuable for joint ventures.

Anti-Avoidance Measures

The Fourth Protocol to the DTA includes measures to prevent abuse. A main purpose test was introduced to ensure that treaty benefits are not exploited. Entities failing this test and shown to have primarily intended to exploit treaty benefits will not have access to those benefits.

Joint Venture Tax Compliance Checklist

Permanent Establishment Considerations

Joint venture structures must carefully manage permanent establishment (PE) risks in both Hong Kong and Mainland China. A PE in either jurisdiction can trigger tax obligations on business profits attributed to that PE.

Hong Kong PE Rules

Hong Kong’s territorial tax system means that only Hong Kong-sourced profits are taxable. However, maintaining a PE in Hong Kong may indicate that profits are Hong Kong-sourced. The DTA with Mainland China provides specific definitions and thresholds for what constitutes a PE.

Mainland China PE Risks

For Hong Kong companies operating through joint ventures in Mainland China, the joint venture itself typically constitutes a separate legal entity subject to Mainland tax. However, if the Hong Kong parent conducts additional activities in the Mainland beyond the joint venture, it may create a separate PE exposure.

Practical Tax Planning Strategies

Optimizing the Joint Venture Structure

Joint ventures should consider the following structural elements:

• Equity vs. Contractual Joint Ventures: Under CEPA, both structures qualify for preferential treatment, but contractual arrangements may offer greater flexibility in profit distribution
• Holding Company Considerations: Using a Hong Kong holding company can provide access to DTA benefits and territorial tax advantages
• Service Company Structures: Separate service companies for specific functions can optimize transfer pricing and substance requirements
• Intellectual Property Management: Strategic location of IP ownership considering both withholding tax and operational efficiency

Transfer Pricing Planning

Effective transfer pricing strategies for joint ventures include:

• Establishing clear functional analysis documenting value creation in each jurisdiction
• Implementing advance pricing arrangements (APAs) for certainty on complex transactions
• Aligning transfer pricing policies with commercial substance and business operations
• Maintaining robust comparability analysis supporting arm’s length pricing
• Documenting intangible contributions and cost-sharing arrangements

Cash Repatriation Efficiency

To minimize tax leakage on profit repatriation:

• Obtain Hong Kong Tax Residency Certificate to access 5% dividend withholding tax rate
• Structure financing arrangements to utilize the 7% interest withholding tax rate where beneficial
• Consider timing of distributions to optimize cash flow and tax efficiency
• Evaluate service fee arrangements as alternative or complementary to dividend distributions
• Plan for foreign exchange controls and approval processes in Mainland China

Recent Regulatory Developments

BEPS 2.0 and Global Minimum Tax

The implementation of the 15% global minimum tax from 2025 affects large multinational joint ventures. The Inland Revenue (Amendment) (Minimum Tax for Multinational Enterprise Groups) Ordinance 2025 requires MNE groups with annual consolidated revenue of at least EUR 750 million to:

• Calculate effective tax rates on a jurisdictional basis
• Pay top-up tax if the effective tax rate falls below 15%
• File additional reporting, including GloBE Information Returns
• Assess impact on Hong Kong’s competitive 8.25%/16.5% corporate tax rates

Enhanced IRD Scrutiny

From 2025, the Inland Revenue Department is conducting transfer pricing reviews and audits on a larger scale and more regular basis. Joint ventures should prepare for:

• Requests to submit Form IR1475, summarizing key transfer pricing information
• Detailed inquiries into intra-group pricing methodologies
• Substance requirements supporting profit allocation
• Contemporaneous documentation demonstrating arm’s length nature of transactions

CEPA Continuous Evolution

The CEPA framework continues to expand, with cumulative customs duty concessions exceeding RMB 10.2 billion (approximately USD 1.39 billion) by the end of 2024. Joint ventures should monitor ongoing negotiations for further liberalization measures across service sectors where Hong Kong enjoys competitive advantages, including financial services, construction, and testing and certification.

Common Pitfalls and How to Avoid Them

Inadequate Transfer Pricing Documentation

Pitfall: Failing to prepare contemporaneous transfer pricing documentation or relying on generic policies not tailored to the joint venture’s specific circumstances.

Solution: Engage transfer pricing specialists early in the joint venture formation to establish policies and documentation protocols. Ensure annual updates reflect changes in business operations and market conditions.

Misunderstanding Territorial Source Rules

Pitfall: Incorrectly assuming all activities of a Hong Kong entity are automatically Hong Kong-sourced or that all Mainland activities escape Hong Kong taxation.

Solution: Conduct detailed source analysis considering the location where contracts are negotiated, concluded, and performed. Document the commercial substance supporting source positions.

Neglecting Tax Residency Certificate Requirements

Pitfall: Making dividend or interest payments from Mainland to Hong Kong without obtaining a Tax Residency Certificate, resulting in the higher 10% withholding tax rate.

Solution: Apply for the Tax Residency Certificate from Hong Kong’s Inland Revenue Department well in advance of planned distributions. Process can take several weeks.

Overlooking CEPA Benefits

Pitfall: Structuring joint ventures without considering available CEPA liberalization measures, potentially missing opportunities for equity flexibility or market access advantages.

Solution: Review sector-specific CEPA provisions during joint venture planning. Consult with advisors familiar with both CEPA requirements and implementation practices in target Mainland regions.

Insufficient Substance

Pitfall: Creating tax-driven structures without adequate commercial substance, exposing the joint venture to anti-avoidance challenges and potential denial of treaty benefits.

Solution: Ensure each entity in the structure has genuine commercial purpose, adequate resources, qualified personnel, and decision-making authority commensurate with its functions and risks.