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Hong Kong Budget Preview


By Tax-News.com Editorial
February 11, 2014


The Hong Kong Government is expected in its 2014/15 Budget, due to be announced by Financial Secretary John Tsang on February 26, to continue increasing expenditure on a range of social welfare initiatives while maintaining its commitment to fiscal discipline. However, as this Budget Preview highlights, concern is growing that the competitive edge provided by Hong Kong’s territorial tax regime is being blunted as new regional competitors rise.


The Economic Backdrop

The Hong Kong economy grew moderately in the first half of 2013, by 3.1% in real terms over a year earlier. However, while the domestic sector was said to have held up well, growth was below the 10-year average trend of 4.5%, dragged down by weak and unsteady merchandise export performance. Current estimates for 2013 as a whole suggest an economic growth rate in the region of 2.5% to 3.5%. Far from spectacular, but still representing an improvement over GDP growth of 1.5% recorded in 2012. Going forward, merchandise trade performance is still expected to be constrained by the faltering recovery of the advanced economies, although Hong Kong’s close relationship with the Chinese economy is expected to be a key stabilising force.


The Fiscal Situation

Under the Basic Law agreed with China at the handover of Hong Kong’s sovereignty from Britain to China, it is incumbent on the government of the Special Administrative Region (SAR) to produce balanced budgets, and it looks as if a modest surplus will be achieved this year.

The 2012-13 Annual Report of the Inland Revenue Department (IRD), published September 2013, showed that the IRD collected a new record in taxes of HKD242.1bn (USD31.2bn) during the year, although the annual increase in revenue collections declined to only 1.6 percent, compared to the 14 percent growth seen in 2011-12.

Nevertheless, on December 31, 2013 the Government announced in its financial results for the eight months to the end of November that there was a surplus of HKD15.6bn in November, reducing the deficit for the eight-month period to HKD23.7bn. Expenditure for the period amounted to HKD264bn, with revenue of HKD240.3bn.

The improved financial results in November were mainly due to the collection of profits tax.

PwC forecasts that Hong Kong's Government will record a HKD22.3bn budget surplus in the 2013/14 fiscal year, against the small deficit of HKD4.9bn originally forecast by the Government.

The Government has however amassed considerable fiscal reserves, which stood at HKD710.2bn as at November 30.

Revised estimates for the current financial year will be published along with the 2014-15 Budget on February 26.


2013/14 Budget

Despite Hong Kong’s slowing economy, last year’s Budget was a rather tame affair, continuing a trend which has seen the Government provide more financial support for low- and middle-income earners, with targeted tax cuts for certain business sectors. Even so, the HKD33bn provided to individual taxpayers and small- and medium-sized enterprises (SMEs) was well under half the HKD88bn in similar measures included in the previous year’s Budget.

Last year, Tsang announced eleven one-off measures (although many followed on from previous Budget announcements), notably a continuation of the policy of reducing salaries tax and tax under personal assessment by 75% (subject to a ceiling of HKD10,000); reducing profits tax for 2012/13 by 75% (also subject to a ceiling of HKD10,000); and waiving business registration fees for the 2013/14 year.

Tsang also outlined measures to aid Hong Kong’s financial sector. With the total value of fund assets under management in Hong Kong at more than HKD9 trillion, ranking second in Asia, he promised to provide a clear and competitive tax environment with a view to attracting more funds of various types to base in Hong Kong, to broaden the variety and scope of its fund business.

To attract more private equity funds to domicile in Hong Kong, he extended the profits tax exemption for offshore funds to include transactions in private companies, which are incorporated or registered outside Hong Kong and do not hold any Hong Kong properties nor carry out any business in Hong Kong.

With many large enterprises in Asia keen to run their own captive insurance companies to insure against their business risks, and to attract more enterprises to form such captive insurance companies in Hong Kong, Tsang also reduced the profits tax on the offshore insurance business of captive insurance companies.


Competitiveness

Although Hong Kong’s economic future appears assured as a result of its position as the gateway for investment flows into and out of China and other emerging economies in the region, there are concerns ahead of the 2014/15 Budget that the SAR is losing its competitive edge.

The Government is therefore being urged to dip into its considerable fiscal reserves to provide tax cuts for businesses and investors.

Jeremy Choi, PwC Hong Kong Tax Partner, says that the Government should start to address these concerns by undertaking a review of the tax system to ensure Hong Kong stays competitive and continues to attract more business.

To provide a sustainable business environment, especially for Hong Kong manufacturing companies, he recommended that the Government should relax the restriction imposed by Section 39E of the Inland Revenue Ordinance on depreciation allowances for plant and machinery used outside of Hong Kong. To help the business sector, PwC also suggests the introduction of a group tax loss relief measure.

PwC proposes, as a timely relief for small and medium-sized enterprises, a reduction in profits tax from 16.5 percent to 10 percent for companies with taxable profits below HKD500,000, while it also recommends that bands for the salaries tax should be widened from HKD40,000 to HKD48,000 and, to alleviate the tax burden on the middle class, the mortgage interest deduction period should be extended from 15 years to 20 years, with a rise in the maximum interest deductible from HKD100,000 to HKD150,000 per annum.

With regard to Hong Kong's position as a leading international financial center, Peter Yu, PwC Southern China and Hong Kong Tax Leader, pointed out that: "Hong Kong is facing arising challenges as well as opportunities from the continuing internationalization of the renminbi; new offshore RMB businesses operating in Taiwan and Singapore; and the development of the financial industry in the free trade pilot zones in Mainland China."

He noted that "the Financial Services Development Council (FSDC) has already recognized in its earlier report that Hong Kong's leading position as an international financial center needs to be further strengthened."

PwC urges the Government to adopt the initiatives proposed by the FSDC, including its proposals for tax exemptions and anti-avoidance measures on private equity funds, and to promote Hong Kong's bond market by introducing a profits tax exemption for all short and medium term bonds.

However, Hong Kong isn’t just facing stronger competition from established financial centres in the region like Singapore. The development of new free zones in China, including in Shanghai and Qianhai, also have the potential to pull business away from the city. With this in mind, the Hong Kong Institute of Certified Public Accountants (HKICPA) says that the SAR “should prepare for the potential changes and thoroughly consider how its tax policies can be made to attract and facilitate business growth, in addition to introducing more immediate budget measures to help businesses and the community.”

The Institute’s 2014-15 budget proposals call for the establishment of a tax policy group within the Government to assess Hong Kong’s competitiveness and monitor international developments in tax administration. The document also laments a lack of clear guidance on key tax issues, especially in the area of transfer pricing.

The HKICPA makes a number of specific tax recommendations, notably:

  • Reducing profits tax to 15% for companies whose gross income does not exceed HKD5m, in line with the rate for unincorporated businesses
  • Waiving the business registration fee
  • Introducing a tax exemption for onshore funds
  • Introducing additional tax incentives for the insurance sector
  • Introducing a tax exemption for private equity funds
  • Granting a “super deduction” for R&D expenditure in Hong Kong
  • Offering unilateral tax credits for withholding tax on royalties where no double taxation agreement exists.
  • Allowing approved treasury companies to qualify for deductions of interest paid to associates.

Of course, it remains to be seen if the Government takes any of these suggestions on board. Given its previous statements on the profits tax though, the Government is unlikely to provide tax cuts for small businesses, in the interests of maintaining simplicity. This view was reiterated by Secretary for Commerce and Economic Development Gregory So in December 2013, when he said that providing profits tax concessions to specific enterprises would deviate from the fairness principle of Hong Kong's tax system. He pointed out that, in any case, in the 2011-12 fiscal year, almost 90 percent of registered corporations did not need not pay any tax. Only 94,900 corporations, accounting for 11 percent of registered corporations, paid profits tax, he revealed.

So said that the Government "will continue to closely monitor the changes in the economic situation and the needs of our enterprises and review our support measures for SMEs from time to time in order to provide them with timely and adequate support."

Any additional support for small firms in the 2014/15 Budget however, is likely to come in the form of non-tax measures, such as improving SMEs’ access to credit.


BEPS

Another concern of local tax experts leading up to the 2014/15 Budget is the potential for the OECD’s Base Erosion and Profit Shifting (BEPS) project to force unwelcome changes to Hong Kong’s tax system.

In reply to a question in the Legislative Council in November 2013, Secretary for Financial Services and the Treasury, Professor K C Chan confirmed that the IRD has no imminent plans to change its current practices with regard to BEPS and transfer pricing.

Chan confirmed that the Hong Kong Government has been closely monitoring the latest developments, and that it will embark on studies and engage local stakeholders for appropriate follow-up actions in due course. However, he noted that IRD's current methodologies and practices adopted for dealing with transfer pricing issues follow the guidance principles provided in the OECD Transfer Pricing Guidelines, and that the regime has been operating well since implementation in 2009. Therefore, the IRD has no plans to change its current practices Chan confirmed, although it will closely monitor international developments in this respect, including the OECD's discussions, with a view to assessing the need for introducing corresponding measures and consulting local stakeholders in due course.

For tax practitioners and the wider business community in Hong Kong, this is a worrying statement which smacks of complacency on the part of the Government. The objective of the OECD’s BEPS Action Plan is to curb the ability of multinationals to use low-tax jurisdictions like Hong Kong to help reduce their exposure to tax in the “high-tax” countries, and therefore the OECD’s recommendations are expected to have some impact on the SAR’s domestic tax rules. Moreover, China has already indicated its support for the action plan and, according to HKICPA “Hong Kong needs to be prepared for the repercussions, in a holistic manner.”

“Hong Kong should develop a position on BEPS,” says the Institute. “It needs to consider the implications, including how this initiative could affect its territorial tax system. In this way, Hong Kong would be less likely to find itself having to defend its low-rate, source-based, tax system at a later date. Where appropriate, Hong Kong should take the opportunity to voice concerns.”

Shortly after Chan’s statement on BEPS in the Legislative Council, he announced the adoption of Hong Kong's Phase 2 peer review report by the Global Forum on Transparency and Exchange of Information for Tax Purposes (the Global Forum).

The Global Forum is charged with in-depth monitoring and peer review of the implementation of the standards of transparency and exchange of information (EoI) for tax purposes. The peer review is undertaken in two phases – Phase 1 reviews assess the quality of a jurisdiction's legal and regulatory framework for EoI, while Phase 2 reviews look at the practical implementation of that framework.

As one of the Global Forum's over 100 member jurisdictions, Hong Kong's Phase 1 review was completed in October 2011, with its Phase 2 peer review report now being accepted on November 22, 2103.

"We are very pleased to note that both Phase 1 and Phase 2 reviews have duly recognized Hong Kong's commitment to meeting the international standard on tax transparency," Chan said.

However, the upcoming budget will be keenly watched for any new measures detailing Hong Kong’s response to the drive for more international tax transparency and to counter BEPS.


“Unleashing” Hong Kong’s Potential

The Government has given away few clues as to what will be included in the 2014/15 Budget. However, Chief Executive C Y Leung declared in his 2014 Policy Address in January 2014 that competitiveness concerns are being taken seriously, and that the Government would focus on promoting economic development to help “unleash Hong Kong's full potential.”

"We should capitalise on, consolidate and enhance our existing advantages, strengthen co-operation with the Mainland and overseas economies in every aspect, and foster diversity and robust growth in our industries," Leung said.

Although his speech did not contain specific proposals on tax, Leung said the Economic Development Commission (EDC), the Financial Services Development Council (FSDC) and the Consultative Committee on Economic and Trade Co-operation between Hong Kong and the Mainland “are working at full speed.”

“The FSDC has submitted its first set of reports to the Government,” he confirmed. “The reports discuss in detail Hong Kong's future positioning and strategic development as an international financial centre and put forward proposals in respect of Renminbi business, asset and wealth management and real estate investment trusts.”

For professional services, the EDC's Working Group on Professional Services has made proposals that cover five main themes:

  • Promote liberalisation of professional services by securing more liberalisation measures and concluding more free trade agreements;
  • Promote alignment of the professional systems of the Mainland and Hong Kong;
  • Strengthen competitiveness and enhance brand building of Hong Kong's professional services;
  • Assist Hong Kong's professional services sector to explore business opportunities overseas and access emerging markets and key economies; and
  • Foster the comprehensive development of cross-sectoral professional services and examine the feasibility of providing resource support and advisory services at strategic footholds all over the world.

"Hong Kong ranks highly in global competitiveness and benefits from the many opportunities flowing from economic development in the Asia-Pacific region, the preferential treatment accorded by our country and the momentum provided by the Mainland's rapid development," Leung said.

The Chief Executive added that the Government had started preparations for the National 13th Five-Year Plan. "We have initially identified some issues for study and will submit them to the National Development and Reform Commission for consideration after consulting the relevant sectors and committees," he concluded.


Welfare

Despite the Government’s commitment to tight fiscal discipline, it is expected to increase the amount it spends on welfare and other social objectives. Indeed, Leung’s 2014 Policy Address contained major initiatives designed to support those in need, and to “nurture the next generation.”

"In line with our strategies to promote economic development and improve people's livelihood, these initiatives embody the principle of my Manifesto that the Government must be appropriately proactive and seek change while maintaining overall stability," Leung said. "It demonstrates the determination of the current-term Government to tackle the root of the entrenched problems in our society.”

"In particular, it shows our commitment to alleviating poverty, caring for the elderly, supporting the disadvantaged, nurturing the youth and enhancing the quality of public healthcare services,” he added.


Conclusion

The Chief Executive said that implementing the social initiatives he outlined in his 2014 Policy Address would require a substantial increase in recurrent expenditure. This suggests that unless the Government is planning to raid its fiscal reserves, there will be little room this year for the sort of tax cuts that PwC and the HKICPA are calling for. So will we see the pattern of one-off tax relief measures provided in recent budgets repeated this year? If a recent blog post by John Tsang is anything to go by, probably not. At least not quite on the same scale anyway. According to Tsang, these “sweeteners” were introduced in economically difficult times, when Hong Kong was struggling to recover from the financial crisis. Now that things have improved, such measures will be gradually cancelled, he disclosed. “Judging from the current situation, this day should be coming very soon,” Tasng wrote. All will be revealed on February 26.

 

Tags: tax | Hong Kong | business | China | services | budget | insurance | Tax | interest | trade | captive insurance | private equity | offshore | transfer pricing | investment | G20 | Singapore | environment | multinationals | agreements | Taiwan

 

 

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