Unofficially, the Stamp Office recognises that the transmission of Hong Kong shares by virtue of certain foreign law mergers of legal personality does not give rise to a charge to ad valorem stamp duty. This article summarises the technical and procedural aspects of this extra-statutory relief and identifies certain practical issues and difficulties relevant to the practitioner.
The Charge to Hong Kong Stamp Duty
Ad valorem stamp duty is charged on non-exempt transfers of Hong Kong stock. Hong Kong stock means stock, the transfer of which is required to be registered in Hong Kong. This category includes shares in both Hong Kong incorporated companies and companies incorporated overseas but listed in Hong Kong. The current rate of ad valorem stamp duty on the transfer of Hong Kong stock is an aggregate of 0.2 percent (0.1 percent payable on each of the bought note and the sold note) of the higher of the consideration for the transfer or the value of the stock, which is typically computed by reference to the net asset value of the company as set out in its latest set of audited accounts.
It is crucial to remember that stamp duty is charged on instruments and not transactions. In order for a charge to stamp duty to arise, there must exist an instrument falling into one of the heads of charge to stamp duty in the Stamp Duty Ordinance.
Generally, a liability to stamp duty arises on the buying and selling of Hong Kong stock in the course of commercial or investment transactions; however, transfers operating as voluntary dispositions inter vivos (eg, outright gifts) or made for the purpose of effectuating a transaction whereby the beneficial interest in Hong Kong stock passes otherwise than on sale or purchase (eg, a settlement on trust) are likewise chargeable to stamp duty. The heads of charge to stamp duty in the First Schedule of the Stamp Duty Ordinance (Cap. 117) are drafted widely to include all instruments effectuating a transfer of beneficial interest in Hong Kong stock.
This leaves open the question of whether a transmission (as opposed to a transfer) of Hong Kong stock occurring by operation of a statutory merger under the laws of a jurisdiction outside Hong Kong would trigger a liability to stamp duty. Consider, for example, a scenario in which two UCITS (Undertakings for Collective Investments in Transferable Securities) funds, each organised as a body corporate, merge in the European Union, and the merging company holds shares listed on the Hong Kong Stock Exchange. Here, the primary question is whether the merger operates to transfer the Hong Kong stock in question, such that the operation of the merger triggers a charge to stamp duty.
In the absence of binding authority on this question, the correct position remains uncertain, and this has been a matter of concern for companies seeking to merge where one or both parties to the merger hold Hong Kong stock either directly or indirectly through a custodian. In order to effect a change in the holder of shares in the share register of a Hong Kong company or of a company listed on the Hong Kong stock exchange, the relevant company secretary requires, as a matter of corporate law, a duly stamped or adjudicated instrument of transfer. Absent such documentation, a merged company cannot be registered as the legal owner of Hong Kong stock transmitted to it by virtue of the merger. Thus, certainty as to the stamp duty implications of an instrument effecting a merger which thereby operates to transmit Hong Kong stock from one company (for example, the merging company) to another (in this case, the merged company) is of vital importance in structuring transactions with a view to managing tax risks.
The Position of the Hong Kong Stamp Office
The Stamp Office is understood to have adopted the non-binding position that a merger of legal personality between two bodies corporate does not give rise to a transfer in beneficial interest in the transmission of any underlying Hong Kong stock. Under s. 27(5) of the Stamp Duty Ordinance, no ad valorem stamp duty is chargeable on any transfer of Hong Kong stock made for nominal consideration under which no beneficial interest passes in the stock transferred.
The Stamp Office currently accepts that the transmission of Hong Kong shares from a merging company to a merged company by way of universal succession involves no change in the beneficial ownership of Hong Kong stock, provided that the transmission in question takes place by operation of law. In other words, where it is the statutory merger regime that legally effects the transmission of the assets and liabilities of the merging company to the merged entity, not the contractual instruments governing the merger alone, no ad valorem stamp duty is chargeable. That is, the Stamp Office considers that such mergers should fall within the ambit of the s. 27(5) exemption.
From a technical standpoint, the Stamp Office’s apparent position in this matter is the better view. In the event of a merger of legal personality, there is, as such, no passage of beneficial interest in the underlying assets transmitted by virtue of the merger. This is because the merged entity resulting from the merger is the legal successor to both parties to the merger and the transmission of the underlying assets takes place under the operative provisions of the statutory regime and is not therefore effectuated by an instrument of transfer. Thus, no beneficial interest is strictly speaking transferred by virtue of any instrument chargeable to stamp duty because the entity resulting from the merger succeeds to the full legal personality of its constituent parts.
In this regard, it is crucial to distinguish between a merger of legal personality and a mere contribution of assets. A merger of legal personality should in principle present most, if not all, of the following elements:
- the transmission by way of universal succession of all the assets and liabilities of the merging company to the merged company, such that the merged company is in every respect the legal successor of both parties to the merger;
- creditors of the merging company become creditors of the merged company and are able to sue the merged company directly for recovery of a debt incurred by the merging company prior to the merger;
- the merging company (ie, the absorbed company) ceases to exist, but is not otherwise wound up or liquidated; and
- members of the merging company are, by virtue of the merger, automatically and by operation of law entitled to a pro rata allocation of shares in the merged company representing their continuing interest in the successor entity.
This is distinct from a mere transfer or contribution of assets, where the subject-matter of the transaction is the underlying assets of the company and not the company itself.
Applying for Relief
Before relief is sought, it must first be determined whether the applicable statutory merger regime is capable of falling within the scope of the s.27(5) exemption and, to this end, legal advice in both Hong Kong and the relevant merger jurisdiction should be sought. Whether a specific merger is eligible for relief will need to be ascertained on a case-by-case basis. We would expect that in each case the relevant precondition for any successful application for relief should be that the merger is a merger in the strict sense, and not a business or share acquisition or other form of asset transfer.
Assuming this first hurdle is overcome, the instruments effecting the merger in respect of which relief is claimed should be submitted to the Stamp Office together with an application that they be adjudicated to confirm that no stamp duty is payable. When so adjudicated, the relevant instruments of transfer would enable the company secretaries of the Hong Kong companies the shares of which are to be transmitted by virtue of the merger to register the change in the registered holder in each relevant register of members. Although the Stamp Office has not published official guidance on s. 27(5) relief in connection with mergers, and considers each application on its own merits, one would expect the following documents to be required to substantiate eligibility for relief:
- a certified true copy of the merger agreement;
- a certified true copy of the merger certificate showing the effective date of the merger;
- a copy of the latest annual return of the merging company;
- a copy of the public record (eg, Gazette in the merger jurisdiction) publishing the merger;
- copy of documentary evidence showing that the merging company has ceased to exist (ie, has been dissolved) as a result of the merger; and
- certified copy documentation showing the universal transfer of all assets and liabilities of the merging company to the merged company.
There remains, however, a practical risk in relying on this concessionary regime in restructuring companies holding Hong Kong stock. Because the application of s. 27(5) relief to mergers is not directly supported by decided authority in Hong Kong, applicants will in the first instance be reliant on the Stamp Office’s practice and its flexibility in applying an abstract and general principle to different corporate merger regimes. In practice, the Stamp Office could freely resile from its policy, and adopt an entirely different position without prior notice, thereby requiring the applicant taxpayer to evaluate judicial avenues of redress in order to obtain relief.
A Note of Caution
This current state of affairs arising from a lack of binding authority and published guidance is unsatisfactory and may complicate planning for corporate restructuring where the underlying assets are partially or wholly composed of Hong Kong stock and the general stamp duty relief granted under s. 45 of the Stamp Duty Ordinance to associated companies is not available.
Practitioners accordingly look forward to the Legislature amending the Stamp Duty Ordinance to provide legal certainty as to the stamp duty implications of mergers of legal personality. Whilst the Hong Kong tax regime, by virtue of its exemplary elegance and adaptability, has doubtless served the jurisdiction well, it remains vital that it guarantee fiscal certainty for inbound investors in Hong Kong securities. In the interim, published guidance in this matter by the Stamp Office should be a welcome bridging measure.