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Hong Kong Budget Review

By Editorial
March 4, 2013

On February 27, Hong Kong Financial Secretary John Tsang gave his annual Budget speech, in which he pledged to “share the city's prosperity” and provide a cushion against an uncertain economic environment. However, it can be said that behind the rhetoric was a budget of little substance, leading to fears that the Special Administrative Region of China may be losing its competitive edge.

Hong Kong Tax Background

A great deal of Hong Kong’s economic success is undoubtedly attributable to a policy of low taxation. A big advantage is that tax is levied on a territorial basis, meaning that taxes are only charged on income arising from or derived in Hong Kong itself. Furthermore Hong Kong does not levy capital gains taxes, withholding taxes, annual net worth taxes or sales tax, although recent budgetary constraints forced the government to actively consider the latter some years ago. Despite the government's efforts to convince taxpayers of the merits of a sales tax, the proposal was deeply unpopular with Hong Kong's public and is no longer on the agenda.

The main tax encountered by business entities in Hong Kong is profit tax which is charged at a standard rate of 16.5% (15% for unincorporated businesses).

Property tax is also relatively low, and charged at 15% of the annual assessed rental income of the property. Corporations can set it off against profits tax. Hong Kong does buck the world trend somewhat by retaining stamp duty on the transfer of shares and market securities (charged at 0.2%) although it is the intention of the government to eventually phase out stamp duty altogether. Stamp duty on property transactions rises on a graduated scale to a maximum of 4.25%.

Hong Kong has, however, seen property taxes rise in response to surging house prices as the government attempts to avert a real estate market bubble. In late December 2012, Hong Kong gazetted legislation imposing Buyer's Stamp Duty (BSD) on residential properties acquired by non-Hong Kong permanent residents. The Stamp Duty (Amendment) Bill 2012, tabled at the Legislative Council on January 9, 2013, will be applicable to all residential properties acquired on or after October 27, 2012.

The BSD will be charged at a flat rate of 15% for all residential properties. It will be levied on top of the existing stamp duty and the Special Stamp Duty (SSD), where applicable, on any such property acquired by any person or entity, except a Hong Kong permanent resident.

The legislation also extends the SSD coverage period and adjusts its rates. SSD was introduced in November 2010 and is designed to curb short-term holding and resale of real estate in Hong Kong. Under the latest changes, the duty will have three levels of regressive rates for different holding periods. It will apply at 20% of the amount or value of the consideration if the residential property has been held for six months or less; 15% for properties held for between six and 12 months; and at 10% for those held for more than 12 but less than 36 months.

Personal income taxes are also low by world standards and constitute a major draw for foreign residents. Income tax, known in the SAR as “salaries tax,” is based on the previous year's income. It is charged at either 15% of assessable income after deductions, or at progressive rates to 17% (March, 2013), whichever is lower. The territorial nature of Hong Kong’s tax system means that there is much scope to reduce taxation on various forms of income derived from foreign jurisdictions.

Hong Kong until 2006 levied an estate tax, charged at a maximum of 15% on estates valued over USD1,350,000 (HKD10.5 million); but it was abolished in that year.

The 2013 Budget

Despite the continued slow growth in Hong Kong’s economy, Tsang produced measures to help those on lower incomes, middle-class taxpayers and small- and medium-sized enterprises (SMEs) worth HKD33bn (USD4.25bn).

Overall though, the 2013 budget was a cautious affair. The government has built up a huge fiscal buffer, and Tsang has been the subject of some criticism for not going far enough to help individual and business taxpayers, notably by refusing to lower the tax burden on a permanent basis. Generally though, the continuation of the Government’s prudent fiscal polies has earned it measured praise.

The Financial Secretary said Hong Kong's gross domestic product (GDP) growth for 2012 as a whole was only 1.4%, much lower than the average 4.5% growth rate over the past ten years. While he forecast a modest improvement in the economy in 2013, with annual GDP growth of 1.5% to 3.5%, that could be knocked off course by, what he called, “wars on three fronts, namely 'currency', 'trade' and 'geopolitics'. As a highly open and small economy, Hong Kong will be impacted by the development of these wars."

The Government is therefore to adhere to fiscal discipline, without the greater tax breaks that had been requested by some commentators, maintaining Hong Kong’s revenue ratio at about 20% of GDP and its revenue reserves at approximately 34% of GDP.

The revised estimate for government revenue in 2012/13 is HKD445.5bn, HKD55.2bn higher than the original estimate – largely due to increases in earnings and profits tax, as well as in stamp duty and other property revenue due to the buoyant real estate market. For government expenditure, the revised estimate is HKD380.6bn in the last fiscal year, so that an overall surplus of HKD64.9bn is expected.

Total government expenditure is budgeted to reach HKD440bn for 2013/14, an increase of 15.6% compared with the revised estimate for 2012/13 and some 21.7% of GDP, while total government revenue will be HKD435.1bn (with earnings and profits tax, estimated at HKD189.4bn, remaining Hong Kong’s major source of revenue).

Hong Kong will, consequently, expect a small fiscal deficit in the coming fiscal year, but revenue reserves are still estimated to reach HKD729.1bn by end-March 2014, the equivalent to 20 months of government expenditure.

In his Budget, Tsang proposed eleven one-off measures, including waiving property rates for 2013/14 subject to a ceiling of HKD1,500 per quarter for each rateable property, so that around 75% of properties will be subject to no rates in the year; granting each residential electricity account a subsidy of HKD1,800; and paying two months' rent for public housing tenants.

Salaries tax and tax under personal assessment for 2012/13 (and payable this year) will be reduced by 75%, subject to a ceiling of HKD10,000; the basic and additional child allowances will be increased from the current HKD63,000 to HKD70,000 for each child; and the deduction ceiling for self-education expenses will be raised from HKD60,000 to HKD80,000.

For SMEs, "in the face of the unstable external economic environment and increasing operating costs,” Tsang will waive the business registration fees for 2013/14, to benefit 1.2m businesses; and reduce profits tax for 2012-13 by 75%, subject to a ceiling of HKD10,000.

"SMEs are an important pillar of Hong Kong’s economy and employment market,” Tsang added. “They form the majority of enterprises in Hong Kong and employ over 1.2m people or half the private-sector workforce. In the face of persistently weak export markets and a challenging external environment, we shall assist SMEs to help them raise capital and tap new markets."

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. He pointed out that Hong Kong-domiciled funds will drive demand for professional services, such as fund management and investment advice as well as legal and accounting services.

To attract more private equity funds to domicile in Hong Kong, he proposed to extend 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.

In addition, while investment funds established in Hong Kong can only take the form of trusts at the moment, he believed that, as an international financial center, Hong Kong should provide a more flexible business environment for the industry to meet market demand. To attract more traditional mutual funds and hedge funds to domicile in Hong Kong, the Government is therefore considering legislative amendments to introduce the open-ended investment company.

To expand the distribution network of Hong Kong's fund industry, the Securities and Futures Commission is also studying with Mainland China’s authorities an arrangement for the mutual recognition of funds. The arrangement could attract more funds to establish in Hong Kong and foster the development of those professional sectors engaged in the registration, investment management and sales of funds.

Finally, as the Government has seen that many large enterprises in Asia are 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 proposed to reduce the profits tax on the offshore insurance business of captive insurance companies, such that they will enjoy the same tax concessions as those currently applicable to reinsurance companies.

Budget Reaction

Tsang was always likely to garner praise from the financial sector for his proposals to enhance the attractiveness of Hong Kong’s fund management regime. Darren Bowdern, Tax Partner, KPMG China, for example, described these measures as “excellent news for the Hong Kong fund’s industry.”

“The existing tax exemption for offshore funds is not effective for private equity funds and has resulted in key fund personnel needing to follow onerous operating protocols if their fund is to be based in Hong Kong,” he observed. “This has left Hong Kong at a competitive disadvantage to Singapore who has had broad based exemptions for funds in place for a number of years and which has been successful in attracting new Funds and Fund platforms to Singapore.”

“KPMG has been extensively involved, in conjunction with the leading fund industry bodies, in lobbying the Government for the types of changes announced. It is pleasing to see that the Financial Secretary has reacted quickly with changes that clearly demonstrate a commitment to promoting a strong funds industry in Hong Kong. However we also advise the Government to proceed with the proposed consultation process as soon as possible,” he added.

 “This will provide certainty to new funds being established in the region. As with all changes, there will be some important details to be sorted out during the consultation process. In particular, ensuring that a proposed carve out which appears to be aimed at the Hong Kong property industry, does not result in Hong Kong based Funds falling foul of the revised tax exemption through the mere holding of offshore investments through a Hong Kong SPV,” he explained.

KPMG China also welcomed the Government’s plan to introduce open-ended investment company vehicles in order to encourage traditional mutual funds and hedge funds to domicile in Hong Kong. This in turn will result in larger numbers of funds using Hong Kong as a platform to invest in Mainland China, and further strengthen Hong Kong’s status as an international financial hub.

In other areas KPMG China believes the Government could introduce further concessionary measures. “People living in Hong Kong feel the impact of rising inflation which has adversely affected their living and businesses,” said Jennifer Wong, Partner, KPMG China. “However the relief measures do not significantly benefit the middle class and SMEs. The overall scale is also smaller than last year. The Government continues to offer relief for salaries tax, profit tax and rates, but all with a reduced cap, which is disappointing.”

With fiscal reserves equivalent to 36% of GDP KPMG China believes the Government can do more. The firm points out that in the recent Policy Address, Chief Executive C Y Leung highlighted his aims to promote Hong Kong as a hub for intellectual property development. However, while it was announced in the Budget that the Secretary for Commerce and Economic Development will lead a working group to study the overall strategy for promoting Hong Kong as a hub for intellectual property trading, no solid measures were proposed. 

Wong warns Hong Kong may further lose its ground to Singapore in terms of the development of intellectual property. “Singapore in comparison provides tax incentives and subsidies as well as a jumbo deduction of up to 400 percent for R&D activities. Hong Kong will lose out in terms of competitiveness to Singapore if we sit and wait.”

Meanwhile, PwC observed in its reaction to the 2013 Budget that, with its usual array of “one-off” tax and spending measures, budget policy is becoming somewhat predictable, and the firm suggested that the Government has missed an opportunity to review how Hong Kong’s tax system is positioned in the modern business environment.

“While generally welcomed, some of these ‘one-off’ benefits are very familiar,” the firm noted. “A possible concern is whether there is public expectation that these ‘one-off’ handouts have become recurring payments.  Will there be a negative reaction if these handouts are not made in the future?  Furthermore, will benefits that are recurring limit the flexibility of future Administrations to deliver initiatives that meet the needs of Hong Kong and its people?”

“From a tax perspective, other than handing out the above-mentioned benefits, the Government has not addressed many important requests from the business community, which includes a comprehensive review of the tax system,” the firm continued. “It has been more than 40 years since the last fundamental review.  Tax competitiveness is a critical component towards Hong Kong sustaining its position as a major regional financial and business center.”

“Other areas yet to be addressed include super-deductions for research and development expenditure to support innovation and technology. Providing tax incentives and a more certain tax regime to support the growth of the fund management and private equity industries are also needed.  This is the current Administration’s final budget and their reluctance to address these issues may arise from not wanting to commit the next Government to future spending.”

While PwC believes that the Government has made a conscious effort to address community concerns, it suggests that the 2013 Budget only provides band-aid measures and lacks vision or strategic planning for the long-term development of Hong Kong. 

“Such an appraisal does not come as a surprise as this is the final budget of the current Government,” the firm said. “Further, the fiscal reserves as at 31 March 2012 are expected to be a staggering HKD662.1bn - 22 months of Government expenditure.  Many in the community will question whether the Government needs to maintain such large fiscal reserves. The Government could have been ‘bolder’ in its approach to painting a long-term picture of Hong Kong's future as a regional business, tourism and cultural center.”


Tsang noted in his budget speech that it is simply impossible for a finance minister to cede to every budget request from all sections of the community, and in this assessment he is of course correct. He also argued that cutting income tax for small firms, which make up the bulk of companies registered in Hong Kong, would merely complicate the existing system rather than act as a tax incentive. Besides, he observed, under the current system, only 10% of companies in Hong Kong actually pay profits tax.

However, there is a feeling that Hong Kong’s administration has become somewhat complacent, and is relying too much on its low-tax, pro-business reputation. No other jurisdiction is as well placed as Hong Kong to reap the benefits of China’s growing influence in the world economy, and for this reason its future economic health looks pretty secure. But other Asian financial centers, especially Singapore, seem to be fighting much harder at the moment to attract investment, and the difference is beginning to show.


Tags: inflation | gross domestic product (GDP) | services | legislation | tax incentives | hedge funds | sales tax | private equity | captive insurance | intellectual property | stamp duty | offshore | insurance | environment | Singapore | investment | budget | China | business | tax | Hong Kong



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