On 5 December 2016 the Shenzhen-Hong Kong Stock Connect cross-border share trading mechanism commenced operation. This complements the Shanghai-Hong Kong Stock Connect mechanism, in place since November 2014, and enables international investors to trade selected A-shares, listed on the Shenzhen Stock Exchange (SSE), via the Hong Kong Stock Exchange (HKSE). It also allows qualified mainland investors to trade in HKSE-listed shares via the SSE.
To facilitate cross-border investment activity, and in a similar manner to Shanghai-Hong Kong Stock Connect, preferential Chinese tax treatments have been clarified. On 5 November 2016, Ministry of Finance, State Administration of Taxation and China Securities Regulatory Commission issued Circular 127 announcing temporary exemptions from Chinese income taxes and Value Added Tax (VAT) for trading gains arising to foreign investors on SSE-listed shares, where transacted through Shenzhen-Hong Kong Stock Connect. Going the other direction, temporary income tax and VAT exemptions are also provided for the trading gains of Chinese investors arising from HKSE-listed shares, where transacted through Shenzhen-Hong Kong Stock Connect.
The preferential Chinese income tax treatments under Circular 127 are set out below. Details of the equivalent measures under Shanghai-Hong Kong Stock Connect are set out in China Tax Alert Issue 29 (November 2014):
Circular 127 provides that foreign investors, both corporations and individuals, which purchase and sell SSE-listed A-shares via Shenzhen-Hong Kong Stock Connect, are temporarily exempt from China VAT. Chinese investors, buying and selling shares through the HKSE via Stock Connect, are similarly exempted from China VAT.
When the tax rules for Shanghai-Hong Kong Stock Connect were clarified in 2014, the equivalent tax exemption provision had applied to business tax (BT). BT was replaced with VAT for all financial services sector transactions from May 2016, and so Circular 127 addresses itself to VAT implications. Previous clarifications had already transitioned the Shanghai-Hong Kong Stock Connect BT exemption to a VAT exemption.
Circular 127 provides that the stamp duty treatment of share transfer transactions in both directions (i.e. both dealings in shares on the SSE and on the HKSE) will be as normal, with no exemptions provided. However, stock borrowing arrangements designed to cover short sales are noted to be stamp duty exempt. This treatment covers not just transactions relevant to Shenzhen-Hong Kong Stock Connect, but is also extended to transactions relevant to Shanghai-Hong Kong Stock Connect (this exemption was not a feature of the 2014 tax guidance).
A summary of tax implications for Hong Kong and foreign investors and PRC investors are set out below:
|Investors via Stock Connect||PRC IIT/CIT||PRC VAT||Stamp Duty (SD)|
|Foreign investors in SSE shares||Indiv./ Corp||Temp. exempt||WHT at 10% (subject to DTA relief)||Temp. exempt
||PRC SD applies(0.1% for seller on A-share transfer). Exemption for certain stock borrowing.|
|PRC investors in HKSE shares||Indiv.||Temp. IIT exempt for 3 years||IIT at 20%||Temp. exempt
||HK SD applies. Exemption for certain stock borrowing.|
|Corp.||CIT at 25%||CIT at 25% (other than H shares)||Taxable or exempted (existing rules)
The launch of Shenzhen-Hong Kong Stock Connect provides another important pillar for the arrangements facilitating cross-border investment in listed securities, to and from China. The two Stock Connect programs sit alongside the existing Qualified Foreign Institutional Investor (QFII) and Renminbi QFII (RQFII) programs, whose tax treatment was clarified in 2014 with Circular 79 which provided for exemption of investment disposal gains.
As was previously the case with the 2014 Circular 81 tax guidance for Shanghai-Hong Kong Stock Connect, Circular 127 provides important support for the effective operation of Shenzhen-Hong Kong Stock Connect. The clarified rules bring a number of benefits:
The tax guidance for Shenzhen-Hong Kong Stock Connect has, as with the 2014 guidance for Shanghai-Hong Kong Stock Connect, provided for the inbound investment CIT/IIT and VAT exemptions to be “temporary” in nature. No time limit has been placed on these and it remains to be seen, as with the 2014 exemptions, for how long these are kept in place. Some commentators refer to the 3-year IIT exemption granted to Chinese individual investors as perhaps indicative of the lifetime of the exemptions for the foreign investors. However, under Chinese tax law “temporary” exemptions frequently do run for very extensive periods - the existing IIT exemption for Chinese individuals trading A-shares, granted in 1998 and still in force, might be referred to in this regard.