For many years (since its introduction in 1992) it was widely understood that Section 23B, which taxes the profits of a ship-owner carrying on business in Hong Kong, applied to income earnt from the chartering of ships. The section defines “business as an owner of ships” to mean “a business of chartering or operating ships”. This view continued to be widely held until the annual meeting between the IRD and the Hong Kong Institute of Certified Public Accountants (HKICPA) in 2016, where the IRD put forward its view that the section could only apply to the operators of shipping, and that “leasing rental derived from a pure ship leasing business carried on in Hong Kong should be chargeable under section 14.”
This view was so controversial that the HKIPCA took the unprecedented step of issuing an additional note after the meeting, setting out an alternative view. Nonetheless, the die was cast and the government set about introducing a new law to exempt income everybody had always thought was already exempt. The new rules were drafted around the IRD’s dichotomy of “pure leasing” and “operating”. In particular, the new rules expressly state that the exemption for ship leasing cannot apply to anyone who is an operator of a ship or who has income arising from any source other than qualifying ship leasing income.
Part of the problem is that the bifurcation of activities is not nearly so clear as the IRD would have us believe. Many ship owners have a fleet of ships that they deploy from time to time in various ways as market conditions dictate; they do not necessarily confine their activities solely to bare-boat charters or solely to voyage charters or the conveyance of goods. Furthermore, there are a large number of arrangements which could be considered to involve both leasing and operating, and a clear definition of the dividing line is therefore critical in understanding the position of individual taxpayers.
The new rules define a lease as being an arrangement under which the right to use a ship is granted by the owner of a ship to another person for a term exceeding one year. This follows the definition in the accounting standards. Therefore, a time charter in excess of a year (including a wet lease) will be a lease, but one for less than a year will not. Both will be deemed Hong Kong sourced by virtue of the deeming provision.
A ship operator is defined to provide “services for the carriage by ships of passengers, cargo or mail”. This differs significantly from the definition used in Section 39E, which relates to the person “responsible for defraying all or a substantial portion of the expenses of operating the ship”.
This leaves some questions regarding the treatment of wet leases. It is an issue on which the IRD has given conflicting views to date. Are ship operators limited to those who expressly charge for the uplift of passengers, cargo or mail, in which case anyone earning profits from charging time-based charter-hire should not be operating the ship within the meaning of the law? If so, ship owners who currently operate a mix of time charters for more than a year, time charters of less than a year and voyage charters may find themselves excluded from the exemption. Alternatively, is it the case, as the IRD has more recently suggested, that a wet lease goes beyond being a “pure leasing activity” because it involves providing the master and crew. In this case, no wet leasing activity would qualify for the new exemption and it would be necessary to move any ships on bare lease into a separate company.
The IRD’s latest responses indicate that “the eligibility for s.23B or the new regime hinges on whether the person is a ship operator carrying out chartering activity incidental to the business of operating ships; or the person is a ship lessor carrying out ship leasing activities solely. This is a question of fact to be considered with regard to all relevant circumstances of each case, including the functions performed and risks assumed by the person. However, the new regime only applies to leases (other than a sublease which is an operating lease) with a term exceeding one year. In order to be eligible to elect for the new regime, a ship owner or ship operator carrying out other businesses may set up a standalone corporation as a special purpose vehicle engaging solely ship leasing activities.”
This response overlooks the large number of ship operators for whom chartering is hardly an incidental activity. Urgent clarification on this dividing line is required, although wherever it falls, a number of ship owners will need to restructure their operations (and possibly change their commercial activities) if they are to ensure that their various activities, which are not supposed to be taxed in Hong Kong, are in fact not taxed in Hong Kong.
It is also noted that the interaction of Section 23B and the new deeming rule (section 15(1)(o)) is not expressly stated in law. Whereas section 15(1)(o) deems income from any granting of a right to use a ship anywhere in the world to be Hong Kong sourced, Section 23B sets out a formula for calculating the assessable profits arising to anyone carrying on business as an owner of ship in Hong Kong. This formula has the effect of excluding profits arising from ships navigating in or to international waters. It is clearly possible for a company to be taxable under both sections, and while Section 23B as the more specific provision ought to take priority, it would have been helpful for this to be made clearer.
