Hong Kong: tax reform | ACCA Global
ACCA - The global body for professional accountants

Hong Kong’s population is not getting any younger, so the inevitable rise in social welfare and healthcare costs, plus revenue shortfall, means there is an urgent need for tax reform

Esther An

This article was first published in the June 2014 China edition of Accounting and Business magazine.

In an article written in Hong Kong’s South China Morning Post on 27 February, the day after Financial Secretary John Tsang announced his 2014-15 Budget, Marcellus Wong, a senior tax adviser with PricewaterhouseCoopers Hong Kong, argued that new types of indirect tax must be explored as Hong Kong’s population ages and puts pressure on the territory’s long-term fiscal sustainability.

‘A narrow tax base has long been a notable problem of Hong Kong’s tax system. Profits tax, salaries tax, stamp duty and land premiums account for more than 65% of estimated government revenue in 2014-15. These sources are sensitive to economic change and tend to fluctuate more dramatically than the economy itself,’ he wrote.

The Hong Kong Government’s estimated surplus of HK$12 billion for 2013-14 and forecast surplus of HK$9 billion for 2014-15 were, Wong added, ‘a result of its efforts to adhere to the fiscal discipline of keeping expenditure within the limits of revenue’. But he warned that, with an ageing population, growth in the economy and government revenue will slow down while public expenditure on social welfare and healthcare will inevitably rise. Indeed, the fiscal working group of which he is a member has cautioned that a structural deficit will occur within seven to 15 years, according to projections based on economic growth trends and demographic changes under different expenditure-growth scenarios.

A chorus line

Wong’s is just one of a growing refrain of calls for financial reform to Hong Kong’s tax regime, but also changes to the way the territory competes against other economies in Asia Pacific, namely Singapore, Korea and Indonesia, that are snapping at its heels.

‘To keep Hong Kong competitive, we have to stay ahead. One of our major challenges since the handover to mainland China in 1997 has been our economic structure. Hong Kong needs a long-term solution to address growing pressures on government expenditure,’ Wong said. ‘One of the most effective solutions of course is to grow the economy and resolve these challenges. Ultimately, we would like Hong Kong to become more competitive.’

A paper by EY has also added to the pressure for Hong Kong to reform vis-à-vis the city’s competitiveness when compared to Singapore. Highlighting the approaches of using tax incentives to both promote and diversify their economies, the paper served to highlight the Hong Kong Government’s lack of action on earlier promises to boost innovation and technology as key economic drivers. For example, while Chief Executive CY Leung pledged in his 2014 Policy Address to provide both financial assistance and hardware and software support to enterprises engaging in innovation and technology, in the 2014-15 Budget the Financial Secretary did not respond to calls to grant super-tax deductions or tax credits for expenditure incurred on research and development activities in order to promote these sectors.

As if to reinforce this inaction, in contrast the Singapore Government has actively promoted the development of its innovation and technology industries through various tax incentives, including the enhanced Productivity and Innovation Credit (PIC) scheme announced in its 2013 budget. Under this scheme, Singapore businesses that spend a minimum of S$5,000 in qualifying PIC investments in a year of assessment, including expenditure on research and development activities, receive a dollar-for-dollar matching cash bonus. The maximum amount of the cash bonus granted is S$15,000 over three years of assessment starting from 2013, and is on top of the existing PIC benefit of 400% super-tax deduction up to S$400,000 in expenditure for each PIC qualifying activity or, in place of the super-tax deduction, a cash payout of a certain amount.

Tax incentives have long divided opinion in Hong Kong, which prides itself on a level playing field for all companies and its famed laissez-faire economy. But that has not stopped calls from various industry and professional bodies to use incentives to promote and diversify its economic development, everything from incentivising the city’s development as an aircraft-leasing centre to becoming an operational base for global traders engaged in certain ex-Hong Kong trading activities.

The Hong Kong Government has, of course, made some steps in the right direction with the Financial Secretary recently announcing the appointment of a taskforce to attract more treasury functions to Hong Kong through reviewing the requirements under the tax legislation for interest deductions for corporate treasury activities, and to clarify the criteria for such deductions. And let’s not forget the bold steps made to counter regional competition following the 2013-14 Budget where two broad reforms were proposed: first, to extend profits tax exemptions to offshore private equity funds; and second, to allow Hong Kong funds to set up as open-ended investment firms instead of trusts, as required under existing rules.

Support for action

‘The Hong Kong business environment is facing stiff challenges from Singapore and Shanghai, so anything the Government can do that makes Hong Kong more attractive to the business community is helpful,’ said Fergus Wong, vice chairman of ACCA Hong Kong.

‘Attracting more foreign business to Hong Kong would also have an economic multiplier effect, whereby companies would engage business support services and, with the right incentives, work with Hong Kong universities and invest in areas such as R&D [research and development].’

In its submission to the Financial Secretary for the 2014/15 Budget, ACCA Hong Kong suggested various tax policies to ensure a business-enabling environment, including: super tax deduction of 200% for qualifying R&D expenditure for promoting development of high-tech products and products with significant intellectual property contents; relax the condition for tax deduction of R&D expenditure to encourage research and development; a concessionary profits tax rate for regional headquarters’ activities so as to enhance Hong Kong’s attractiveness to foreign investors; and a super deduction for eligible costs of plant and machinery used in environmental protection.

Speaking on the widespread support for tax incentives for specific industries – maritime and related sectors, financial services, environmental and green industries, and intellectual property trading – Florence Chan, regional business tax services leader for financial services in Asia Pacific, EY, noted that incentives have less chance of succeeding as a standalone measure, requiring other initiatives such as tax reform to complement their potential impact.

‘The majority of people with knowledge of taxation are supportive of tax incentives but look at it from the government perspective; perhaps it faces other considerations such as fairness to different sectors.

Tax incentives alone can’t solve the problem,’ she said.

The Taxation Institute of Hong Kong’s ‘Study on the Competitiveness of the Hong Kong Tax System’, released in January, reviewed the territory’s existing tax system and identified three areas – modernising the tax law and system; enhancing tax competitiveness; and future direction for tax reform – through which the competitiveness of its tax system might be enhanced. A total of 13 recommendations under these three areas tackled improving certainty, fairness and tax administration by, for example, introducing specific transfer-pricing legislation (see sidebar), allowing carry-back of tax losses for two years and carrying out a comprehensive review of the tax assessment process, interest and penalty regime, and administration of field audit and investigation cases.

ACCA Hong Kong also recommended: group loss relief which fulfils the fundamental principle of equity; that tax loss of a business be allowed to be carried back in order to relieve loss-making companies from financial pressure while encouraging profitable operations to reinvest in Hong Kong operations; and that concessionary profits tax rate be given to new businesses with qualifying conditions within a limited timeframe in order to support these businesses in their start-up stage.

PwC’s Marcellus Wong is cautiously optimistic that the easily implementable measures, such as those to enhance competitiveness, will yield short-term results because they will more likely secure support from the territory’s Legislative Council. ‘If we can demonstrate immediate revenue with the introduction of specific incentives that don’t cost Hong Kong in terms of revenue loss or the erosion of the tax base, anything that will bring in additional business, revenue and jobs will be easier to sell politically,’ he noted.

However, it is unlikely that legislative amendments to modernise the tax regime to provide more certainty and improve administration will occur in anything but the longer term given the bipartisan political environment in which the Government must attempt to table and pass legislation.

EY’s Chan is sanguine. ‘Enhancing overall tax competitiveness is more of a long-term goal and the government needs to do a more holistic review of the current tax system in order to raise the competitiveness of Hong Kong to a higher level. This would have to be a public consultation,’ she noted. In the meantime, and on the back of calls from the Taxation Institute of Hong Kong, ACCA and professional bodies in Hong Kong, she urges the government to consider setting up a tax policy unit to take a more holistic view of the current Hong Kong tax system.

Kate Watson, journalist

Last updated: 5 Jun 2014