US-HK Tax Treaty Director Fees: Allocation of Taxing Rights for Hong Kong Company Board Members

The 2025 US-HK Tax Treaty renegotiation cycle, while not yet formally announced, has placed the treatment of director fees under renewed scrutiny. For US citizens and Green Card holders serving on the boards of Hong Kong-incorporated companies, the allocation of taxing rights between the two jurisdictions is a matter of growing practical significance. The US Internal Revenue Service (IRS) has, in recent examination cycles, shown increased interest in the characterisation of payments to US-person directors of foreign entities, particularly where the fees are paid by a Hong Kong company but the director performs services remotely from Hong Kong or elsewhere. The 2024 US Model Treaty, published by the US Treasury Department, signals a hardening stance on the source taxation of director fees, potentially narrowing the scope for Hong Kong to claim exclusive taxing rights. This article examines the current legal framework under the 1994 US-HK Tax Treaty (the Treaty), relevant provisions of the Internal Revenue Code (IRC), and practical planning considerations for US-person directors of Hong Kong companies.

The Treaty Framework: Article 16 and the Allocation of Taxing Rights

Article 16 of the US-HK Tax Treaty (the “Directors’ Fees” article) governs the allocation of taxing rights over remuneration received by a resident of one Contracting Party (e.g., the US) for services rendered as a director of a company resident in the other Contracting Party (e.g., Hong Kong). The operative rule is that such fees may be taxed in the Contracting Party where the company is resident. This means Hong Kong, as the source jurisdiction, has the primary right to tax director fees paid to a US-person director of a Hong Kong company.

The Scope of Article 16: What Constitutes a “Director’s Fee”

The Treaty does not define “director’s fees” exhaustively, but the term is understood to encompass all forms of remuneration—fixed fees, attendance fees, committee chair fees, and equity-based compensation—paid to a person in their capacity as a member of the board of directors. The Commentary on the OECD Model Tax Convention (on which Article 16 is based) confirms that the term includes “fees, attendance fees, and other similar payments.” The Hong Kong Inland Revenue Department (IRD) has historically adopted a broad interpretation, consistent with the OECD Commentary, applying Article 16 to any payment linked to the directorial function, regardless of where the services are physically performed. This is a critical distinction from the general “employment income” rules under Article 15 (Dependent Personal Services), which allocate taxing rights based on the physical place of performance.

The Interaction with Article 15 (Dependent Personal Services)

A common point of confusion arises when a US-person director also serves as an employee of the same Hong Kong company. The Treaty provides a clear hierarchy: Article 16 applies to “directors’ fees and similar payments,” while Article 15 applies to “salaries, wages, and other similar remuneration” derived from employment. If a director receives a fixed monthly salary for executive duties (e.g., CEO or CFO functions), that income is governed by Article 15. The taxing right under Article 15 generally lies with the state of residence (the US) unless the services are performed in Hong Kong. However, if the same individual also receives a separate annual director’s fee for board membership, that fee is governed by Article 16, giving Hong Kong the right to tax it. The IRD has, in practice, scrutinised the segregation of these payments. In a 2021 internal guidance note (IRD Circular No. 1/2021), the IRD stated that where a single payment is made for both directorial and executive functions, the burden of proof lies with the taxpayer to demonstrate the portion attributable to directorial services. Failure to do so may result in the entire payment being treated as a director’s fee under Article 16.

US Tax Implications for the US-Person Director

For a US citizen or Green Card holder resident in Hong Kong, the Treaty’s allocation of taxing rights to Hong Kong does not eliminate US tax liability. The US taxes its citizens and residents on their worldwide income, regardless of geographic source. The Treaty merely provides a mechanism for avoiding double taxation, typically through the foreign tax credit (FTC) mechanism under IRC § 901.

The Foreign Tax Credit (FTC) and the “Basket” System

Director fees are treated as “general category” income for FTC purposes under IRC § 904(d)(1)(I). This means the US-person director can claim a credit against their US tax liability for Hong Kong salaries tax paid on the director fees, subject to the overall limitation (IRC § 904(a)). The limitation is calculated as the US tax on the director fees divided by the US tax on total foreign-source income. A critical nuance: Hong Kong salaries tax is levied on a territorial basis—only income arising in or derived from Hong Kong is subject to tax. If the US-person director performs board meetings physically outside Hong Kong (e.g., in Singapore or the US), the IRD may not assess Hong Kong tax on that portion of the fees. In that scenario, the director would have no Hong Kong tax to credit, and the fees would be fully taxable in the US without a corresponding foreign tax credit. The IRS Form 1116 (Foreign Tax Credit) requires the taxpayer to compute the FTC separately for each income category, and the “general category” basket has a 10-year carryforward period for unused credits (IRC § 904(c)).

The Foreign Earned Income Exclusion (FEIE) and Director Fees

The FEIE under IRC § 911 excludes up to USD 126,500 (2024 tax year) of foreign earned income from US gross income, provided the taxpayer meets either the bona fide residence test (IRC § 911(d)(1)(A)) or the physical presence test (IRC § 911(d)(1)(B)). However, director fees are generally considered “earned income” under IRC § 911(d)(2)(A) only if they are derived from the performance of personal services. The IRS has consistently held that director fees are earned income for FEIE purposes. This means a US-person director who is a bona fide resident of Hong Kong can exclude up to the FEIE cap from US tax, provided the fees are not paid by a US employer or by a foreign employer that is a controlled foreign corporation (CFC) with a US shareholder who is not eligible for the FEIE. The interaction with the FTC is important: the FEIE is an exclusion, not a credit. If the director claims the FEIE on director fees, they cannot also claim a foreign tax credit on the same income (IRC § 911(d)(6)). The director must elect between the two mechanisms annually, and the choice should be driven by the relative tax rates in Hong Kong and the US. Given that Hong Kong’s maximum salaries tax rate is 15% (standard rate) or 16% (progressive rate) as of the 2024/25 assessment year, while the US top marginal federal rate is 37% (2024), the FTC is generally more beneficial for directors with fees exceeding the FEIE cap.

Practical Compliance and Reporting Obligations

The US-person director of a Hong Kong company faces a layered compliance burden, encompassing both Hong Kong and US filing requirements.

Hong Kong Filing: Profits Tax vs. Salaries Tax

The IRD treats director fees as “income from employment” subject to salaries tax under Section 8(1) of the Inland Revenue Ordinance (Cap. 112). The Hong Kong company is required to file an Employer’s Return (IR56B) for each director, reporting the total director fees paid during the basis period. The director must then file an individual tax return (BIR60) and report the fees as “salaries” income. The IRD does not distinguish between executive and non-executive directors for this purpose. A common planning point: if the director is also a shareholder, the company may consider paying dividends instead of director fees. Dividends are not subject to Hong Kong salaries tax (Section 26 of the IRO) and are not subject to Hong Kong profits tax. However, dividends are not “earned income” for US FEIE purposes, and they are generally taxed as ordinary income in the US (IRC § 61(a)(7)). The director must weigh the Hong Kong tax savings (zero on dividends) against the US tax cost (no FEIE, and a potential higher effective rate if the dividends push the taxpayer into a higher bracket).

US Reporting: FBAR, FATCA, and Form 5471

The US-person director must comply with the following reporting requirements:

• FBAR (FinCEN Form 114): If the director has signature authority over, or a financial interest in, a Hong Kong bank account held by the company, and the aggregate value of all foreign financial accounts exceeds USD 10,000 at any time during the calendar year, the director must file an FBAR. The penalty for non-willful failure to file can reach USD 12,921 per violation (31 CFR § 1010.820).

• FATCA Form 8938: If the director holds specified foreign financial assets (including shares in the Hong Kong company if it is not a publicly traded entity) exceeding USD 200,000 on the last day of the tax year or USD 300,000 at any time during the year (for a married taxpayer filing jointly), Form 8938 must be attached to the US tax return. The threshold for a US citizen living abroad is higher: USD 400,000 on the last day or USD 600,000 at any time during the year.

• Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations): If the director is a US shareholder (defined as owning 10% or more of the voting stock) of a Hong Kong company that is a controlled foreign corporation (CFC) under IRC § 957(a), Form 5471 must be filed. The form requires detailed financial statements of the Hong Kong company, including its income, deductions, and subpart F income. The penalty for failure to file Form 5471 is USD 10,000 per form per year (IRC § 6038(b)(1)), with an additional USD 10,000 for each 30-day period of continued failure after IRS notice, up to a maximum of USD 50,000.

The Statute of Limitations and IRS Examination Risk

The general statute of limitations for US tax assessments is three years from the filing date (IRC § 6501(a)). However, if the taxpayer omits more than 25% of gross income, the statute extends to six years (IRC § 6501(e)(1)(A)). For director fees, the IRS has a particular interest in cases where the director fails to report the income on a timely basis or mischaracterises it as foreign-source income eligible for the FEIE when it is, in fact, US-source income. The IRS’s 2023-2024 “Dirty Dozen” list of tax scams explicitly included “improper use of the foreign earned income exclusion,” signalling increased enforcement. Directors who have not filed FBARs or Forms 5471 should consider the IRS’s Streamlined Filing Compliance Procedures, which allow for the submission of delinquent returns with a reduced penalty risk, provided the failure was non-willful.

Actionable Takeaways

1. Verify the characterisation of your director fees: Ensure that any payments for executive services are clearly segregated from director fees in the Hong Kong company’s board minutes and payroll records, to avoid the IRD reclassifying all remuneration as director fees under Article 16.
2. Elect between the FEIE and the FTC annually: For the 2024 tax year, if your director fees exceed USD 126,500, the foreign tax credit is likely more beneficial than the foreign earned income exclusion, given Hong Kong’s lower tax rate.
3. File Form 5471 if you own 10% or more of the Hong Kong company’s voting stock: The USD 10,000 per-form penalty for non-compliance makes this a high-priority filing, even if the company has no subpart F income.
4. Monitor the physical location of board meetings: If you attend board meetings physically outside Hong Kong, document the location and duration to support a claim that a portion of the fees is not subject to Hong Kong salaries tax, and therefore not eligible for a foreign tax credit.
5. Review your FBAR and FATCA filing obligations annually: The thresholds are low (USD 10,000 for FBAR), and the penalties for non-willful non-compliance are significant. Engage a CPA familiar with US-HK cross-border issues to prepare these filings.

本文不構成稅務建議。涉及個人稅務情況請諮詢持牌會計師或稅務師。 This does not constitute tax advice. Consult a licensed CPA or tax advisor for your specific situation.