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Mainland-Hong Kong Bond Trading Framework Recommended

by Mary Swire, Tax-News.com, Hong Kong

02 December 2016


Hong Kong's Financial Services Development Council (FSDC) has released a report proposing the establishment of a "Bond Market Connect," which would promote the development of bond trading between Mainland China and Hong Kong.

The FSDC's Chairperson, Laura M Cha, said: "The bond market in Hong Kong has ample potential for growth. Following the connection between the Mainland and Hong Kong on the stock market [through the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect], there is room for Hong Kong to further capitalize on the opportunities brought about by the connection in the bond market between the two places."

The report studies the possibility of establishing a linkage between the bond markets in the Mainland and Hong Kong for retail investors. This is seen to be particularly beneficial at a time when the Mainland's demand for foreign fixed-income products is growing rapidly.

It recommends a mechanism to allow mutual market access for both Mainland and Hong Kong retail investors to each other's bond market, both over-the-counter (OTC) and exchange-traded.

For the OTC bond market, trading could be achieved through opening and maintaining a special trading account with designated banks by the investors. For the exchange-traded bond market, arrangements similar to those under the Stock Connect trading mechanisms could be applied.

Currently, foreign retail investors can only invest in the Mainland's bond market indirectly through Qualified Foreign Institutional Investors (QFIIs) and Renminbi Qualified Foreign Institutional Investors (RQFIIs) funds registered in Hong Kong and focused on the Mainland's bond market. They can also invest in Hong Kong bond funds under the Mainland-Hong Kong Mutual Recognition of Funds (MRF) scheme.

All such funds are subject to a withholding tax of seven percent on interest received from debt instruments in the Mainland under the double taxation agreement between the Mainland and Hong Kong. QFIIs and RQFIIs are not subject to withholding tax on capital gains from trading debt securities.

On the other hand, investments in Hong Kong's bond market by Mainland investors can presently only be made through QDII and RQDII funds, or through Hong Kong bond funds that are sold in the Mainland under the MRF scheme.

Individual Mainland investors are exempt from income tax on capital gains from the transfer of units in recognized Hong Kong funds sold in the Mainland during the three-year period from December 18, 2015, to December 17, 2018. However, they are subject to Mainland income tax of 20 percent on distributions by the funds. Corporate investors are subject to corporate income tax on both capital gains and distributions.

The report suggests that specific procedures for the Bond Connect scheme will be required in both the Mainland and Hong Kong to address how tax rules are applicable to investors under the scheme. For example, a withholding system will need to be established in the Mainland for bond interest payable to foreign investors so as to create an efficient tax compliance and collection platform.

Similarly, it recommended that Hong Kong taxation rules and the Inland Revenue Department's practice should also be reviewed and amended as appropriate to facilitate the growth of listed and unlisted bonds markets in Hong Kong.

TAGS: capital gains tax (CGT) | compliance | tax | investment | tax compliance | capital markets | investment funds | corporation tax | China | withholding tax | Hong Kong | tax breaks | individual income tax | Invest

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