On August 19, 2020, the U.S. Department of State announced¹ that it had notified Hong Kong authorities of the termination, with immediate effect, of the United States — Hong Kong Exchange of Diplomatic Notes entered into in August of 1989. The Diplomatic Notes provided the basis upon which each country would exempt from tax shipping income earned from the transport of cargo to or from their respective ports.

As a result of this action:

1. Hong Kong shipping companies that operate in the tramp trade will no longer be able to claim exemption under Code Section 883 from the 4% tax imposed by the United States on the gross U.S. source income earned from the transport of cargo to or from U.S. ports (“U.S. source shipping income“); and
2. Hong Kong shipping companies that operate in the liner trade (e.g., container ships) and that have a U.S. office involved in the earning of U.S. source shipping income, will no longer be able to claim exemption under Section 883 from (i) the 21% corporate tax imposed by the United States on the net U.S. source income (i.e., income less deductions) earned from the transport of cargo to or from U.S. ports and (ii) the 30% branch profits tax further imposed on the remaining net-after tax amount (i.e., an all-in top marginal effective tax rate of 44.7%).

Conversely, United States shipping companies engaged in the tramp or liner trade will no longer be able to claim exemption from the profits or freight tax imposed by Hong Kong in connection with the transport of cargo to or from Hong Kong ports.

The announcement regarding the Diplomatic Notes is part of a series of steps that the United States has taken with respect to Hong Kong and the People’s Republic of China (PRC), including enacting the Hong Kong Autonomy Act and sanctioning top officials in Hong Kong and the PRC for actions undermining Hong Kong’s autonomy and democratic processes. Notably, the U.S. Department of State announced in late May 2020 its determination under the Hong Kong Policy Act that Hong Kong no longer had a high degree of autonomy from mainland China, due in part to the new national security law. This announcement, and subsequent actions taken (including those relating to Hong Kong’s preferential treatment from the PRC under certain U.S. export control laws), have had a substantial impact on the United States’ relations with Hong Kong and the PRC, and companies doing business in the region. For prior Seward & Kissel alerts on the United States’ sanctions with respect to Hong Kong, please see here and here.

We will continue to closely monitor developments in this space. If you have any questions or concerns about the tax implications of these changes, please contact Derick Betts (212-574-1662), James Cofer (212-574-1688), or Brett Cotler (212-574-1269). If you have any questions or concerns about U.S. sanctions, please contact Bruce G. Paulsen (212-574-1533) or Andrew S. Jacobson (212-574-1477) at Seward & Kissel’s Sanctions Practice Group.