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Hong Kong economy

Tax reform in Hong Kong can drive new engines of economic growth

Ayesha Lau says that as global tax rates fall, Hong Kong’s traditional advantages are eroding, and tax policies should now be used to encourage sectors where the economy has room to expand

PUBLISHED : Tuesday, 24 October, 2017, 11:49am
UPDATED : Tuesday, 24 October, 2017, 7:14pm

In her manifesto for the election, Chief Executive Carrie Lam Cheng Yuet-ngor proposed a competitive new direction for tax policies to strategically support economic growth. Her maiden policy address echoed this new direction, announcing two important tax measures: a two-tiered profits tax and a super-deduction for research and development expenditures.

It is indeed timely to examine Hong Kong’s tax policy. Traditionally, Hong Kong has adhered to two principles for its tax system – a low tax rate and simplicity. In the past decade or so, most countries have reduced tax rates. The average corporate tax rate in Asia has fallen from 29 per cent in 2006 to 21 in 2017. The UK corporate tax rate has fallen from 30 per cent to 19. Even the US, under President Donald Trump, has announced its plan to reduce the federal corporate tax rate to 20 per cent. Hong Kong’s standard 16.5 per cent rate is still on the low side but its competitive advantage is no longer as significant.

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Simplicity is important for a good tax system if, in addition to having few deductions and exemptions, it means clarity in tax laws and certainty in practical application, plus low compliance and administrative costs. But with transactions becoming more complex and sophisticated, a seemingly simple tax system may result in uncertainty and uncompetitiveness.

Numerous studies have consistently shown tax as a key factor in attracting business, funds and talent to a jurisdiction. Many countries around the world make use of the tax system to support growth of specific new industries. The tax system is a powerful tool to drive economic growth. Hong Kong’s new directions for taxation should include a more proactive use of its tax system to support growth, rather than merely using the tax system to collect government revenue.

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It is a virtue for an individual or households to keep expenditures within income constraints. But a government can do the opposite by controlling its income within the needs of expenditure; a government should only collect taxes and other revenue up to the level required to fund needed public expenditures, because its objective is to maximise people’s welfare, using fiscal and taxation policies as tools, and not to maximise revenue or fiscal surplus.

A government should only collect taxes and other revenue up to the level required to fund needed public expenditures

Analyses presented at Monday’s Government Tax Summit showed Hong Kong’s economy at a turning point. The four traditional key industries – trading and logistics, financial services, tourism and professional services – are still the main pillars of the city’s economy and employment, but their combined share of gross domestic product declined from 60.3 per cent in 2007 to 57.2 per cent in 2016, and their share of employment has not grown in recent years.

Hong Kong needs new growth areas. There are a number of broad long-term directions such as development into a comprehensive full-service global financial centre, an international innovation hub and an international cultural and creative arts centre. There are also ample opportunities for Hong Kong’s economy arising from the “Belt and Road Initiative” and the Greater Bay Area scheme.

However, to capture these opportunities, strategies and implementation plans must be put in place. These include adopting the right tax policies.

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The policy address announced the two-tier profits tax and the tax deduction for qualifying research and development expenditures. Other tax measures for immediate consideration include group tax loss relief, expansion of the offshore funds tax exemption, a tax incentive for regional headquarters, shortening the statutory period within which tax affairs are finalised, more double tax agreements – including with belt and road countries – and adding a personal tax exemption clause in double tax agreements for researchers.

Earlier this year, a tax policy unit was set up under the Financial Services and the Treasury Bureau. Coupled with the chief executive’s new direction, it is hoped that more attention will be devoted to tax policies so that Hong Kong’s economic growth can benefit fully from the support of its tax system.

Ayesha Macpherson Lau is managing partner of KPMG Hong Kong and was a panel speaker at the Government Tax Summit on October 23