Launch of Stock Connect
On November 17, 2014, the much anticipated cross-border stock trading pilot program, the Shanghai-Hong Kong Stock Connect (Stock Connect) was officially launched, linking the Shanghai Stock Exchange (SSE) with Hong Kong Exchanges and Clearing Ltd. (HKEx). The Stock Connect program was initially jointly announced on April 11, 2014 by the China Securities Regulatory Commission (CSRC) and the Securities & Futures Commission of Hong Kong (please refer to our prior alert).
Under the Stock Connect pilot program, Hong Kong investors can buy and sell designated stocks listed on the SSE through Hong Kong brokers. Chinese mainland investors (including institutional investors or wealthy individuals who have a minimum of RMB500,000 in their securities accounts) can buy and sell designated stocks listed on the HKEx through Chinese securities companies. Currently, almost 600 companies traded on the SSE and nearly 300 companies trading on the HKEx have been approved for the pilot program. Going forward, it is expected that regulators will consider expanding the list of eligible companies and relax trading quotas, perhaps rolling out the trading link to other exchanges, such as the Shenzhen Stock Exchange.
Tax Regime for Stock Connect
A major hurdle for the launch of Stock Connect was the different tax rules applied in Hong Kong and mainland China. Shortly before the launch of the program, regulators in Mainland China issued new tax rules, which became effective on November 17, 2014 to address the issues. Matters that are not addressed in the new regime will be determined according to existing tax rules in Hong Kong and mainland China.
The Notice Regarding Tax Policies Related to the Shanghai-Hong Kong Stock Connect Pilot (Stock Connect Tax Rule), which was jointly issued by the Ministry of Finance (MOF), the State Administration of Taxation (SAT) and the CSRC on November 14, 2014, sets forth the following tax policies:
Mainland Chinese Corporate Investors
- Mainland Chinese corporate investors will be subject to Enterprise Income Tax (EIT) in China on gains from the sale of publicly traded stocks on the HKEx through Stock Connect. Additionally, they will be subject to EIT on dividend income from those stocks. Those gains and dividends must be included in the investors' gross income for EIT purposes.
- However, mainland Chinese corporate investors are exempted from EIT on dividends from H shares (stocks issued by Chinese domestic enterprises and publicly traded on the HKEx) if they have held those shares for at least 12 consecutive months.
- Mainland Chinese corporate investors can also claim a Foreign Tax Credit (FTC) in mainland China for foreign income tax which they have paid in connection with dividends arising from Hong Kong publicly traded shares, other than H-shares.
Mainland Chinese Individual Investors
- Gains derived by mainland Chinese individual investors from the sale of publicly traded stocks on the HKEx through Stock Connect are exempted from individual income tax (IIT) from November 17, 2014, until November 16, 2017.
- Mainland Chinese individual investors will be subject to the normal 20% IIT on dividends from stocks publicly traded on the HKEx through Stock Connect. However, they can claim an FTC on foreign withholding tax which they have paid on those dividends. In these circumstances, a mainland Chinese investor must submit a legitimate foreign tax payment receipt to mainland Chinese tax authorities.
Mainland Chinese Securities Investment Funds
- These funds will be subject to the same IIT rules for dividends derived from investments in Hong Kong publicly traded stocks through Stock Connect.
Hong Kong Investors
- Hong Kong corporate and individual investors are temporarily exempted from mainland China income tax on gains from the sale of A-shares (publicly traded stocks issued by Chinese domestic companies and denominated in Chinese renminbi yuan on Chinese stock exchanges) listed on the SSE through Stock Connect.
- Hong Kong investors will be subject to the normal 10% withholding tax in China on dividends from A-shares until Hong Kong Securities Clearing Co. Ltd. provides China Securities Depository and Clearing Corp. Ltd. with detailed information about such investors, including their identity and stock holding period. The tax will be withheld and paid by the Chinese publicly traded companies that pay the dividends.
- However, if Hong Kong investors are tax resident in a third country and are eligible for a lower dividend withholding tax rate under an income tax treaty between the third country and China, they can apply to the tax authorities in mainland China for treaty benefits. Those Hong Kong investors will then receive a tax refund upon approval by relevant tax authorities
- Hong Kong corporate and individual investors are temporarily exempted from business tax on gains from the sale of A-shares on the SSE through Stock Connect. Similarly, mainland Chinese corporate and individual investors are exempted from business tax on gains from the sale of publicly traded stocks on the HKEx through Stock Connect.
Consistent with the current rules in Hong Kong and mainland China, Hong Kong investors will pay stamp duty in mainland China on the purchase, sale, inheritance, or donation of A-shares that are publicly traded on the SSE, while mainland Chinese investors will be subject to stamp duty in Hong Kong on the purchase, sale, inheritance, or donation of stocks publicly traded on the HKEx.
On November 14, 2014, MOF, SAT and CSRC jointly issued the Notice Regarding the Exemption of Corporate Income Taxes on Stocks and other Equity Investments Under QFII and RQFII Programs(QFII/RQFII Tax Rule), which aims to provide the existing QFII/RQFII programs with tax treatment equal to the policies applicable to Stock Connect. The QFII/RQFII Tax Rule clarifies that effective November 17 2014, profits derived from investing in mainland Chinese stocks and assets under the QFII and RQFII programs are temporarily exempted from paying EIT, provided that the relevant QFII or RQFII does not have a taxable presence or permanent establishment in the mainland China or the above-mentioned profits derived from the stock investments are not attributable to the taxable presence or permanent establishment.
It is generally agreed that Stock Connect will benefit both the mainland China and the Hong Kong stock markets. There is even speculation that the new program could eventually lead to the creation of the world's third largest stock exchange.