Where treaty access between Hong Kong and Mainland China stands now

The Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation on Income – referred to throughout this analysis as the Arrangement – is the primary instrument governing treaty access between Hong Kong and Mainland China. It has been amended several times since it first took effect, and its current architecture reflects pressure from international anti-avoidance standards as much as bilateral commercial logic. The principal risk for cross-border groups today is not the headline withholding rate; it is whether the structure through which income flows satisfies the Arrangement's beneficial-ownership and substance conditions, and whether the Inland Revenue Department and the Mainland tax authorities will reach the same conclusion on both sides of the boundary.

This analysis sets out the commercial stakes, the governing instrument, the comparative read across the two systems, and where the risk sits in practice. It is written for general counsel, tax directors, and principals of cross-border groups with exposure to both jurisdictions.

What is commercially at stake for cross-border groups?

The Arrangement matters because the default withholding position on dividends, interest, and royalties flowing from a Mainland entity to an offshore recipient can be materially higher than the reduced rates available under the Arrangement. For groups that have structured their Mainland exposure through a Hong Kong holding entity, the difference in annual cash flow can be significant. That differential is the commercial reason why treaty access is sought and why tax authorities scrutinise it.

The scrutiny has intensified. Mainland authorities have made beneficial-ownership review a routine step in withholding-tax applications rather than an exceptional one. In our cross-border tax practice, we see groups that structured their Hong Kong holding entities years ago now discovering that those structures no longer satisfy the current administrative standards, even where the legal form has not changed.

What changed was the interpretive standard, not the entity. The concept of beneficial owner (the person with the right to use and enjoy the income, not merely the legal recipient) has been tightened progressively under Mainland administrative guidance. The current approach looks through entities that are insufficiently active, insufficiently capitalised, or insufficiently capable of bearing risk and making decisions. A Hong Kong company that acts only as a conduit – receiving dividends and immediately passing them up the chain – is unlikely to survive that scrutiny.

The question, then, is not whether a group has a Hong Kong entity in the structure. The question is whether that entity has the attributes that satisfy both the Arrangement's text and the administrative framework that has grown around it. That question is harder to answer than most international counsel expect when they first encounter the Hong Kong–Mainland interface.

What does the Arrangement actually provide, and how does it interact with Mainland domestic law?

The Arrangement provides reduced withholding-tax rates for dividends, interest, and royalties paid by a Mainland resident enterprise to a Hong Kong resident that qualifies as the beneficial owner of that income. The reduced rates represent a ceiling, not an automatic entitlement. Access is conditional on the recipient satisfying the Arrangement's definition of beneficial owner and, more recently, the principal-purpose test introduced by the multilateral instrument.

Hong Kong's own position is simpler on paper. The Inland Revenue Ordinance operates on a territorial basis: profits tax applies to profits that arise in or are derived from Hong Kong. Hong Kong does not impose withholding tax on dividends, interest, or royalties paid to non-residents in the general case. The tension is therefore largely on the Mainland side, where domestic withholding-tax rates apply and treaty relief must be claimed by the Mainland-side payer or through a refund application by the recipient.

The Mainland side of this interface is governed by a layered system. At the top sits the Arrangement itself, which has domestic legal force in the Mainland through its incorporation into Mainland tax law. Below that sits a series of State Taxation Administration circulars – administrative guidance issued without forming part of the Arrangement's text – that set out how beneficial ownership is assessed and what documentary evidence is required. These circulars are not part of the Arrangement, but in practice they determine whether a claim succeeds.

The practical consequence is that a Hong Kong adviser and a Mainland tax adviser may each give technically correct advice on their own system while missing the way the two systems interact. In our cross-border tax practice, this is the single most common point of failure we see when reviewing historical structures: the Hong Kong legal analysis was sound, the Mainland legal analysis was sound, but the combined position at the interface was not.

For a structured assessment of your group's treaty access position across both jurisdictions, write to us at info@lockhartyip.com.

How does the beneficial-ownership standard actually work across the boundary?

Beneficial ownership under the Arrangement is assessed by the Mainland authorities at the point of a withholding-tax application or a refund claim. The assessment draws on Mainland administrative guidance that specifies factors relevant to the analysis. These factors include: whether the entity has decision-making functions in respect of the income; whether it bears the economic risk associated with the underlying investment; whether it has sufficient personnel and premises in Hong Kong to carry out its stated functions; and whether there are obligations to pass the income on to a third party.

A Hong Kong holding company will generally satisfy these factors if it has a genuine management and decision-making presence in Hong Kong, employees or directors with relevant expertise and authority, bank accounts controlled from Hong Kong, and investment decisions that are actually taken at the Hong Kong level. That is not a difficult standard to meet if the structure was designed with substance in mind.

It becomes difficult when the Hong Kong entity was inserted after the fact to access the treaty, when its only function is to hold shares in the Mainland entity, or when its directors act purely on instructions from a parent elsewhere. These are the fact patterns that Mainland authorities identify and challenge.

The look-through analysis that follows a beneficial-ownership challenge is itself a cross-border question. If the Mainland authorities conclude that the Hong Kong entity is not the beneficial owner, they look to the next entity up the chain. If that entity is in a jurisdiction with no favourable arrangement with the Mainland, the default domestic rate applies to the entire flow, not just the increment.

What foreign counsel frequently underestimate is that the look-through is not limited to the immediate parent. The Mainland approach can examine the full ownership chain until it reaches a person or entity that satisfies the beneficial-ownership standard. A structure with five layers between the Mainland entity and the ultimate parent can produce a cascade of questions that no single adviser is positioned to answer across all jurisdictions simultaneously.

Where does the principal-purpose test sit in this analysis?

The Mainland incorporated the principal-purpose test into its treaty network through its implementation of the multilateral instrument (the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, known as the MLI). The principal-purpose test denies treaty benefits where it is reasonable to conclude that one of the principal purposes of an arrangement or transaction was to obtain those benefits, unless granting those benefits would be in accordance with the object and purpose of the treaty provision.

The Arrangement itself was not modified by the MLI directly, because the Arrangement is a bilateral arrangement rather than a convention between sovereign states in the ordinary sense. However, the Mainland has applied the policy position embedded in the principal-purpose test to its administration of Arrangement benefits, and the trend in Mainland administrative practice has been to align treaty access with international anti-avoidance standards regardless of whether the specific bilateral instrument has been formally modified.

This creates a structural risk for groups that established their Hong Kong holding entities primarily or substantially to obtain the Arrangement's reduced rates. If the evidence of that intent is clear – whether from internal documents, from the timing of the structure, or from the absence of any commercial activity at the Hong Kong level that is unrelated to tax – the principal-purpose test can be applied to deny treaty access even where the entity otherwise satisfies the beneficial-ownership conditions.

The interaction between the beneficial-ownership standard and the principal-purpose analysis is where the most complex disputes now arise. A group can satisfy beneficial ownership – the entity has genuine substance, decision-making, and economic risk – but still fail the principal-purpose analysis if the contemporaneous documentation shows that the driving reason for the structure was the reduced withholding rate. That is a difficult position to defend retrospectively.

If an earlier structure or treaty access application has produced an adverse result or stalled before completion, a second read of the position can identify the specific vulnerability and the options still available. Write to us at info@lockhartyip.com to discuss.

The comparative read: how Hong Kong and Mainland approaches differ in practice

Hong Kong and Mainland China share a common objective in the treaty access context – avoiding double taxation and preventing treaty shopping – but their administrative approaches differ in ways that matter operationally.

The Inland Revenue Department's approach to treaty access under the Arrangement is primarily concerned with the Hong Kong side of the equation: whether the Hong Kong entity is a Hong Kong resident for the purposes of the Arrangement, and whether the income it receives from the Mainland falls within the scope of the Arrangement. The IRD does not, as a routine matter, conduct the same kind of beneficial-ownership analysis that the Mainland side applies to outbound withholding. Its principal tool on the inbound side – income flowing into Hong Kong from the Mainland – is the foreign-sourced income exemption (FSIE) regime, which conditions the exemption of specified foreign-sourced income on the recipient meeting economic-substance requirements in Hong Kong.

The FSIE regime, which has been in force from 1 January 2023 as amended, applies to specified foreign-sourced income received in Hong Kong by a multinational enterprise entity. The income types covered include dividends, interest, royalties, and gains on disposal of equity interests. The substance conditions under the FSIE regime overlap substantially with the conditions that satisfy the beneficial-ownership standard on the Mainland side. A group that builds genuine Hong Kong substance to satisfy FSIE will generally also be in a stronger position on the Mainland's beneficial-ownership analysis.

That alignment is not accidental. Both regimes reflect the international consensus that income channelled through intermediate entities must be associated with genuine economic activity at that level. The difference is procedural: the FSIE regime is assessed by the IRD as part of the Hong Kong profits-tax return process, whereas the Mainland's beneficial-ownership analysis is conducted by the relevant local tax bureau as part of the withholding-tax approval or refund process, often years after the income has been paid.

The temporal gap is itself a risk. A group that receives a dividend from its Mainland entity in one year may not face a Mainland challenge to its treaty access until two or three years later, when the initial claim is selected for review. By that point, the composition of the Hong Kong entity's board, its bank account activity, and its internal records must all be capable of demonstrating substance at the time the income was received – not merely at the time of the audit. Contemporaneous documentation is not a formality. It is the substance of the defence.

Micro-scenario A: the passive Hong Kong holdco revisited

A European industrial group with a wholly owned Mainland operating subsidiary had used a single-purpose Hong Kong holding company to receive dividends from the Mainland at the Arrangement's reduced rate for several years. The Hong Kong entity had one director resident in Europe, a registered address in Hong Kong, and no local employees. All investment decisions were taken at the European parent level.

When the Mainland subsidiary applied to its local tax bureau for approval to distribute a larger dividend at the reduced rate, the bureau initiated a beneficial-ownership review. The review identified that the Hong Kong entity had no independent decision-making capacity, no local management, and no economic activity beyond holding the Mainland shares. The bureau applied the default domestic rate to the distribution and issued an assessment for the incremental tax on prior distributions within the available review period.

We were engaged following the initial adverse determination. Our analysis identified that the structure, while legally valid, had been designed with no attention to the Mainland's administrative guidance on substance. The remediation strategy – which required changes to the Hong Kong entity's governance, personnel, and banking arrangements – could not operate retroactively. The group faced a significant historic exposure alongside the cost of restructuring for future distributions.

Micro-scenario B: the FSIE and Arrangement interaction in a regional treasury structure

A Southeast Asian group restructuring its Greater China operations planned to route Mainland subsidiary dividends through a Hong Kong treasury entity that would also receive interest income from group entities in Singapore and the United Kingdom. The group's advisers had correctly identified that the Hong Kong entity would need to satisfy the FSIE regime's substance requirements for the non-Hong Kong income.

Our desk was brought in to review the interaction between the FSIE substance conditions and the Arrangement's beneficial-ownership standard. The analysis identified a gap: the FSIE regime's substance test for dividends focuses on the holding function, while the Mainland's beneficial-ownership guidance requires evidence of active management of the investment at the Hong Kong level. A treasury entity optimised for FSIE compliance – focused on cash management and intercompany lending – would not automatically satisfy the Mainland standard for equity-dividend flows.

The solution was to bifurcate the functions within the Hong Kong entity: specific governance arrangements for the Mainland equity holding were documented separately from the treasury function, with Hong Kong-based personnel given defined authority over investment decisions in respect of the Mainland subsidiary. The structure was implemented before the first distribution, and the contemporaneous documentation was prepared at that point. The result was a coherent position under both regimes.

Where the risk sits now: our analytical read

The risk in the Hong Kong–Mainland treaty access context has migrated over the past decade. It no longer sits primarily in the legal text of the Arrangement. The rates, the definitions, and the formal conditions are well understood by advisers on both sides. The risk now sits in three places: administrative interpretation, documentation, and timing.

Administrative interpretation. The Mainland's beneficial-ownership guidance has evolved through successive circulars, and there is no guarantee that the current standard will remain stable. Groups that received favourable determinations under an earlier administrative framework may find those determinations reconsidered when distributions are reviewed in subsequent years. The standard applied is the standard in force at the time of the challenge, not at the time the structure was established.

Documentation. The quality of contemporaneous records at the Hong Kong level – board minutes, investment committee papers, banking mandates, correspondence demonstrating independent decision-making – determines whether a beneficial-ownership or principal-purpose challenge can be defended. Structures that were established without attention to this documentation trail are exposed even where the commercial substance is genuine, because the evidence of that substance may no longer be recoverable.

Timing. The gap between the receipt of income and any Mainland audit means that groups are managing a retrospective exposure at the same time as a prospective structuring question. That dual exposure requires different analytical responses: the historical position needs to be assessed for defensibility and, where necessary, supplemented with available evidence; the forward-looking position needs to be built to the current standard from the outset.

There is also a systemic question about the Pillar Two minimum tax. The Hong Kong minimum top-up tax and the income inclusion rule, effective for fiscal years beginning on or after 1 January 2025 for in-scope multinational enterprise groups with consolidated revenue at or above EUR 750 million, add a further layer of analysis for larger groups. The interaction between Pillar Two and the Arrangement is not yet settled in administrative practice on either side. For in-scope groups, the treaty access question and the Pillar Two position need to be assessed together, not sequentially.

The territorial basis of Hong Kong profits tax – 8.25% on the first HK$2,000,000 of assessable profits and 16.5% above that threshold for corporations under the two-tier system – remains one of the most competitive positions in the region. The absence of capital gains tax, withholding tax on dividends, and VAT reinforces the structural logic of using Hong Kong as a holding centre. But that logic depends entirely on the treaty access position being maintained. A structure that loses Arrangement benefits on Mainland-source dividends may find that the after-tax cost of the Hong Kong layer exceeds its benefit.

Related practices

• Holding Structures – entity and ownership planning above Mainland operating companies
• Corporate Counsel – ongoing governance support for Hong Kong intermediate holding entities

Decision matrix: matching the situation to the appropriate approach

The right response to a treaty access question depends on the specific combination of facts. The matrix below describes the principal situations we see in practice and the appropriate analytical response to each.

Situation: an existing Hong Kong entity with minimal substance, receiving Mainland dividends at the reduced Arrangement rate, with no prior Mainland challenge. Instrument: the Arrangement's beneficial-ownership standard and Mainland administrative guidance. Route: immediate substance review and documentation audit, followed by remediation of the Hong Kong entity's governance and function before the next distribution cycle. Timing: before the next application, not after. Risk: historic exposure on prior distributions within the applicable review period.

Situation: a new structure being designed to hold a Mainland subsidiary acquired through an M&A transaction. Instrument: the Arrangement, the FSIE regime, and the Mainland's current beneficial-ownership guidance. Route: integrated design of the Hong Kong entity's substance, documentation, and governance from the outset, with the beneficial-ownership standard set as the minimum threshold for the FSIE substance analysis. Timing: before the first distribution, not after the structure is established. Risk: low if designed correctly; high if the substance question is deferred.

Situation: a group within Pillar Two scope restructuring its Greater China holding layer. Instrument: the Arrangement, the Pillar Two minimum top-up tax, and the FSIE regime. Route: joint analysis of the treaty access position and the Pillar Two effective-rate calculation at the Hong Kong level, to ensure that the substance built for treaty access does not trigger unexpected top-up tax consequences. Timing: before the restructuring is implemented. Risk: the interaction between the two regimes is not yet administratively settled; a conservative position should be documented.

Situation: a group that has received an adverse beneficial-ownership determination from a Mainland tax bureau and is within the objection period. Instrument: the Arrangement and the applicable Mainland domestic procedure for objection and administrative reconsideration. Route: immediate documentation review to identify available evidence of substance; preparation of a structured factual response; assessment of whether the objection or a separate application under the mutual agreement procedure (MAP – the treaty mechanism by which the competent authorities of the two sides resolve disputes on treaty application) is the more appropriate route. Timing: the objection period is strictly enforced; action is needed immediately. Risk: the factual record at the Hong Kong level determines the outcome; a weak record may not be recoverable.

Objection handler: what international groups commonly misread about this interface

A recurring assumption in our cross-border tax practice is that the Arrangement functions in the same way as a standard OECD-model double-taxation convention between two independent jurisdictions. That assumption produces avoidable errors.

The Arrangement operates within the one country, two systems constitutional framework. Hong Kong is not a party to the Mainland's network of tax treaties with third countries, and the Mainland's bilateral tax arrangements with other jurisdictions do not extend to Hong Kong. A group that has historically relied on a third-country treaty with the Mainland – routed through a European or Southeast Asian holding company – cannot simply reroute through Hong Kong and assume that the Arrangement provides equivalent access. The Arrangement has its own text, its own administrative framework, and its own enforcement history.

A second common error is to treat the beneficial-ownership analysis as a one-time determination. In our experience, groups that obtained a favourable determination on an initial distribution sometimes treat that determination as a permanent clearance. It is not. The Mainland's beneficial-ownership analysis is applied to each application. A change in the Hong Kong entity's governance, personnel, or banking arrangements between applications can affect the outcome of the next review even where the legal structure has not changed.

A third error concerns the interaction between Hong Kong and Mainland advisers. Groups with experienced local advisers on each side sometimes proceed without anyone co-ordinating the cross-border interface. Each adviser gives correct advice on their own system, but no one addresses the gap at the boundary. That co-ordination function is where the analytical value sits. See also our analysis of the treaty access briefing and our overview of treaty access between Hong Kong and the United Kingdom for comparative perspectives on how this interface differs from other bilateral arrangements. The full scope of our tax advisory practice is set out at our Tax Positions practice page.

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• Tax Positions
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This publication is general information and does not constitute legal advice. For advice on your situation, contact info@lockhartyip.com.