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What Drives Investment to Hong Kong?

By Editorial
January 25, 2016

As the Hong Kong Government sets out the task of expanding the territory's role as a major international financial center in 2016, this feature looks at the factors continuing to make Hong Kong such an attractive business and trading hub.

Hong Kong: A City? A Colony? Or a Country?

Most people think of Hong Kong as merely a city. And they are half right. But the city of Hong Kong, home to an estimated 7.1m people in 2015, makes up only a part of the territory of Hong Kong, which at 1,100 square kilometres is about six times the size of Washington D.C. This territory comprises Hong Kong Island and the adjacent islets, Stonecutters Island, the Kowloon Peninsula on the mainland and the New Territories. The New Territories comprise approximately 90 percent of the land surface area of Hong Kong and consist of a portion of the Chinese mainland.

Nevertheless, it is also true that Hong Kong was, until quite recently, was a colony. Occupied by the British in 1840, Hong Kong was formally ceded to the British Empire the following year. It remained a largely self-governing British possession until 1997, when the territory's sovereignty was formally handed over to the People's Republic of China.

Thus, Hong Kong is now a Special Administrative Region (SAR) of the People's Republic, rather than an independent country in its own right, although the constitution governing China's relationship with Hong Kong does grant the territory a great deal of autonomy over its internal affairs.

One Country, Two Systems

A legal framework based on English common law, and a laissez faire economic system – ingredients which are the very foundation of Hong Kong's success as a regional trading entrepôt and global financial center – would seem the very antithesis of the one-party communist system established in China. However, Beijing has realized that it has much to gain from maintaining the status quo in Hong Kong, and as is touched upon later in this feature, the territory is playing a major role in the internationalization of the Chinese economy.

Hence, the guiding principle of the constitution setting out China's legal relationship with Hong Kong, known as the Basic Law, is "one country, two systems," under which China agreed prior to the handover that Hong Kong's capitalist system would remain unchanged until the year 2047. Thus whilst defense and foreign affairs are the exclusive domain of China, Hong Kong is autonomous in all other matters. The handover agreement also provided for the territory to maintain its British legal system save in so far as those laws contravene the Basic Law and with the Court of Final Appeal of Hong Kong replacing the Privy Council as the final and highest court of record.

Although there have been one or two cases in which Beijing has seemed to over-rule Hong Kong courts, particularly as regards citizenship issues, by and large the transition from colony to Special Administrative Region has been successful. However, the people of Hong Kong have been very dissatisfied with the lack of independence and vigor shown by their leaders in moving towards democracy in the SAR, as demonstrated by the Occupy Central protests in the latter half of 2014. It remains to be seen whether proposed electoral reform will really satisfy the Hong Kong population's demand for universal suffrage, something so at odds with the Chinese system.

Hong Kong's Financial Center – The Pearl of The Orient

Low-value manufacturing used to be the mainstay of Hong Kong's economy, but this industry has now largely decamped to neighboring Chinese provinces, with the territory's economy now based largely on re-exporting and services, particularly financial services.

Banking is a major constituent of Hong Kong's substantial financial services industry. Tokyo aside, Hong Kong is Asia's largest banking hub in terms of external transaction volume.

Hong Kong is also recognized as the leading fund management center in Asia with the industry defined by its international and offshore characteristics, and it has become a popular choice for hedge fund managers, especially since the government granted an income tax exemption to offshore funds owned by non-resident entities administering a fund in Hong Kong. According to the Hong Kong Securities and Futures Commission, the combined fund management business in Hong Kong reached a record high at the end of 2014 of almost HKD17.7 trillion (USD2.3 trillion), up 10.5 percent. Assets managed in Hong Kong increased by nearly 18 percent to a record level of HKD6.85 trillion.

Hong Kong has also established itself as the favored base for multinational companies looking to expand into Asia-Pacific markets. As at June 1, 2015, the number of business operations in Hong Kong with parent companies overseas and in Mainland China had reached an all-time high of 7,904, up 4.2 percent on the previous year. In terms of source country or territory, the annual survey by Invest Hong Kong and the Census & Statistics Department showed that the United States topped the list with 1,368 companies in Hong Kong, followed by Japan (1,358), mainland China (1,091), the UK (631), and Taiwan (413). By sector, import/export trade, wholesale, and retail topped the list (3,482 companies, or 44.1 percent of the total), followed by finance and banking (1,438 companies, or 18.2 percent). More than 1,400 of the operations were regional headquarters and almost 2,400 were regional offices. The 7,904 businesses employed a record of 422,000 people - up 4.3 percent on the previous year.

The importance of Hong Kong on the world economic stage is reflected in the huge volumes of foreign direct investment (FDI) inflows and outflows reported every year. Indeed, Hong Kong ranked second in global FDI inflows, according to the United Nations Conference on Trade and Development's World Investment Report covering 2014, receiving USD103bn in FDI in 2014, an annual increase of 39 percent. This placed Hong Kong second only to Mainland China (USD129bn) and ahead of the United States (USD92bn), the United Kingdom (USD72bn), and Singapore (USD68bn). Hong Kong was also placed second in terms of FDI outflows (USD143bn), after the United States (USD337bn), and ahead of the Mainland (USD116bn), Japan (USD114bn), and Germany (USD112bn).

Recent local incorporation statistics also attest to the fact that Hong Kong remains a hotbed of entrepreneurial activity. According to statistics released by the Hong Kong Companies Registry in January 2016, the total number of local companies registered under the Companies Ordinance at the end of 2015 was 1,288,666, up nearly 16,000 from last year.

Hong Kong's stock market is a crucial component of the jurisdiction's financial center, and its status as the gateway for inward investment to, and outward investment from, China has secured its position as the stock market for Chinese firms seeking to list abroad. In 2014 mainland Chinese companies constituted about 50 percent of the firms listed on the Hong Kong Stock Exchange and accounted for about 60.1 percent of the Exchange's market capitalization.

The Hong Kong Stock Exchange also set new trading records in 2015, when the market capitalization of HKEx's securities market exceeded HKD31 trillion for the first time, peaking at HKD31.6 trillion on May 26, 2015. As of December 15, 2015, there were 1,854 listed companies on the Main Board and Growth Enterprise Market.

Crucially, The Hong Kong Government believes that there are tremendous opportunities ahead for Hong Kong's financial center as China continues to liberalize its currency, the renminbi (RMB). The “offshore" RMB market was effectively born in Hong Kong in 2003, and by the end of March 2015 the combined value of deposits and certificates of deposits in Hong Kong had grown to about RMB1.1 trillion (USD167bn).

Currently, the RMB is the fifth-most-used payment currency in the world, and about RMB6.3 trillion, or 95 percent, of mainland China's total RMB trade was settled by Hong Kong banks.

According to Hong Kong's Secretary for Financial Services and the Treasury, K C Chan, Hong Kong is currently pushing for the use of the RMB as an investment currency.

What About Tax?

Of course, many of these economic feats probably wouldn't have been achieved if it wasn't for Hong Kong's fiscal advantages. Not for nothing was Hong Kong ranked as the most fiscally-free place in the world by the Fraser institute in 2015, and the most economically free by the Heritage Foundation for the 20th consecutive year.

Unlike most onshore jurisdictions, income tax in Hong Kong is levied on a "territorial" basis, which means that income tax is due on locally-sourced income only. What's more, a number of taxes that are levied in other jurisdictions do not exist in Hong Kong; for example, there are no capital gains taxes, no withholding taxes, no sales taxes, no VAT, no annual net worth taxes and no accumulated earnings taxes on companies which retain earnings rather than distribute them.

While corporate income tax (known as Profits Tax), at 16.5 percent, is higher than in the classic “offshore" jurisdictions, it is still substantially lower than in most OECD countries, even accounting for the fact that corporate tax rates around the world have fallen in recent years.

Hong Kong also offers tax concessions to certain types of business. Special concessionary rates of profits tax which are substantially less than the standard rates apply to the following businesses or sources of income:

  • Trading profits and interest income derived from debt instruments issued in Hong Kong with an original maturity of up to seven years will be chargeable to tax at a concessionary rate, being 50% of the normal profits tax rate, while those with a maturity period of seven years and above qualify for a 100% concession.

  • The re-insurance of offshore risks is taxed at a concessionary rate, being 50% of the normal profits tax rate.

  • Life insurance businesses are assessed at 5% of the value of the premiums arising in Hong Kong.

  • An entity whose business is to grant rights to use a trademark, copyright, patent or know how pays a flat profit tax of 30% of 16.5% (4.95%, or 4.5% for an unincorporated business) of the payment received with all related expenses being non tax deductible. If the recipient of the payment is a related offshore licensing company the Hong Kong company must withhold and hand over 4.95% of the fee paid over.

  • Income from the international operations of shipping companies is exempt from tax unless the ships are operating in Hong Kong waters or proximate to the same in which case only that proportion of income earned in Hong Kong is subject to local tax of 16.5%. Shipping profits meeting the conditions of the double taxation agreement with the USA are exempt from profits tax in Hong Kong.

  • Irrespective of whether or not the company is managed and controlled from Hong Kong assessable profits are the proportion of income arising within Hong Kong (from the uplift of passengers and freight locally) to the proportion of worldwide income. Under a number of international aircraft double taxation agreements the government has agreed to include income arising abroad for taxation in Hong Kong where that income is exempted abroad under the agreement. Likewise profits meeting the conditions of the double taxation agreements are exempt from profits tax locally. The rate is 16.5% of assessable profits.

  • The sale of goods on consignment from Hong Kong on behalf of a non-resident is subject to a tax of 1% of the turnover without any deductions unless the non-resident can produce accounts to show that he would have paid less profit tax than consignment tax in which case a normal rate of tax will apply. The selling of goods on consignment is deemed to be the equivalent of creating a permanent establishment.

  • An entity whose business is to rent out a film, tape or sound recording for use in any cinema or television program pays a profit tax of 30% of 16.5% (4.95%, or 4.5% for an unincorporated business) of the payment received with all related expenses being non tax deductible.

Personal taxation is also low by international comparison. Income tax, known in Hong Kong as Salaries Tax, is paid at either a flat rate of 15 percent, or on a progressive scale between 2 percent and 17 percent. Taxpayers may elect to choose to pay tax under either of these systems, depending on which one gives them the lower tax liability. Individuals are only assessed on annual employment income which is defined as wages, salaries, bonuses, commissions, payments by the employer into a pension fund for the employee and gratuities. Non-employment source income such as share dividends and capital gains realized on the sale of shares are not taxable in the territory. In addition, the definition of income does not include either a pension from a source outside Hong Kong or compensation for loss of employment.

Recent And Future Tax Developments

In comparison to other jurisdictions however, Hong Kong does not offer much in the way of tax incentive schemes. The attitude of the Government has been that Hong Kong's low, simple, territorial tax regime is incentive enough to establish business operations in Hong Kong, and this is something that foreign investors seem to like. However, this isn't to say that the Government ignores the needs of key business sectors, and it proposes targeted concessions for certain types of company on a fairly regular basis.

In a recent example, the Government gazetted a legislative bill on December 4, 2015 which aims to enhance the existing interest deduction rules for the intra-group financing business of corporations and introduce a concessionary profits tax rate for qualifying corporate treasury centers. And last July, Hong Kong's Government brought into effect the promised extension of the profits tax exemption for offshore funds to private equity funds.

Furthermore, Chief Executive Leung Chun-ying announced in his 2016 Policy Address that the Government will continue "to create a favorable tax environment to consolidate Hong Kong's status as a premier asset management hub in the Asia-Pacific region," so taxpayers can probably look forward to additional tax concessions in the months and years ahead.

Tax Agreements

Until recently, Hong Kong tended not to sign comprehensive agreements with other jurisdictions for the prevention of double taxation, preferring instead to sign more limited agreements covering income from aviation and shipping activities. This, however, is changing.

As C Y Leung explained in his Policy Address, the Government is interested in expanding its network of comprehensive double tax agreements (CDTA) with a view to protecting and facilitating business co-operation between Hong Kong and the so-called “Belt and Road" countries, a Chinese Government economic development project, which is primarily aimed at integrating trade and investment among around 60 Eurasian countries.

Hong Kong signed its 34th CDTA, with Russia, on January 18, 2016.

The international community's increasing demand for global tax transparency is another reason why Hong Kong is entering into more CDTAs with the most up-to-date standards for information exchange included. Legislation is also pending that would implement the new international standard for automatic exchange of financial account information in tax matters, otherwise known as the Common Reporting Standard (CRS).

Under the standard, a financial institution (FI) is required to identify financial accounts held by tax residents of reportable jurisdictions, meaning those who are liable to tax by reason of residence in the jurisdictions with which Hong Kong has entered into an arrangement. FIs are required to collect the accounts' reportable information and send it to Hong Kong's Inland Revenue Department, which will exchange it with partner jurisdictions annually.

However, Hong Kong will only conduct information exchange with jurisdictions that have signed comprehensive avoidance of double taxation agreements or tax information exchange agreements with Hong Kong on a bilateral basis. What's more, subject to the passage of the bill, which was gazetted on January 8, 2016, the CRS will be implemented on a reciprocal basis with partners who meet standards on privacy protection and the confidentiality of information exchanged, and on ensuring proper use of the data.

The Closer Economic Partnership And Free Trade

Foreign companies are also flocking to Hong Kong to take advantage of the Closer Economic Partnership Arrangement (CEPA) between the SAR and the People's Republic, which has substantially liberalized trade in goods and services between the two locations. According to InvestHK almost one-third (31 percent) of the 303 companies it assisted in 2010 indicated that the CEPA was one of the considerations in their decision to locate in Hong Kong.

The first CEPA agreement was signed in June 2003 for implementation in 2004, and the Central and Hong Kong governments have since signed nine supplements to the agreement. The most of recent of these is Supplement X to the CEPA, which was signed on August 29, 2013, by Hong Kong's Financial Secretary, John C Tsang, and the Chinese Vice-Minister of Commerce, Gao Yan. It provides for a total of 73 services liberalization and trade and investment facilitation measures, strengthens co-operation in areas of finance, trade and investment facilitation, and further promotes the mutual recognition of professional qualifications in the two places. It brings to 403 the total number of liberalization measures for trade in services under CEPA, since its signing in 2003.

Hong Kong is in fact already one of the world's freest economies. no tariffs on imported goods, and it levies excise duties on only four commodities, including spirits, tobacco, fuel oil, and methyl alcohol. However, in his policy speech, Leung confirmed that Hong Kong will pursue free trade agreements (FTAs), investment promotion and protection agreements, double taxation agreements, and air services agreements with its major trading partners.

In particular, he said, Hong Kong would step up its engagement with the Association of Southeast Asian Nations (ASEAN). The FTA negotiations with ASEAN are expected to be concluded this year. While key issues in those negotiations include the reduction of tariffs and the liberalization of trade in services, the Government is also seeking to protect investments made by Hong Kong businesses in ASEAN member countries.

The Government is also to continue to explore the possibility of joining other FTAs signed, or to be signed, by Mainland China; to negotiate with Macao on the establishment of a closer economic partnership arrangement; and to continue or begin talks with Russia, Chile, the United Arab Emirates, and Mexico on investment protection agreements.

A Future Secured by Beijing?

Although Hong Kong experienced rapid economic growth in the post-war period, first as a low-value manufacturing center, then as a services-orientated economy, largely as a result of its historic association with the United Kingdom and its light-tough tax and regulatory regime, its economic future is now inextricably linked to mainland China. But, if anything, this has served to make Hong Kong's future as a flourishing, cutting-edge finance and business hub even more secure, at least for the foreseeable future.


Tags: Hong Kong | tax | business | China | agreements | investment | trade | services | Tax | offshore | currency | United States | Invest | interest | banking | Japan | Russia | United Kingdom | financial services | manufacturing | insurance



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