Hong Kong 2018-19 Budget Insights
Forward-looking tax measures to promote Hong Kong’s economic development
In today’s budget, the Financial Secretary detailed those tax measures which have been adopted by the government based on the findings of the Tax Policy Unit (TPU) and their review of the merits of each.
The TPU was established last year under the Financial Services and Treasury Bureau with a view to examining the international competitiveness of Hong Kong’s tax regime and fostering the development of the innovation and technology sector in particular.
Proposed two-tiered profits tax rates regime
In response to the international trend of reducing corporate income tax rates as a means of attracting foreign investment and businesses, Hong Kong will, subject to legislative approval, introduce a two-tiered profits tax rates regime effective from the year of assessment 2018-19.
Under the proposed regime, the rate of tax for the first HK$2 million of profits of corporations and unincorporated businesses (UBs) will be reduced by half (i.e., reduced from 16.5% to 8.25% for corporations and from 15% to 7.5% for UBs). The remainder of the profits will continue to be taxed at the normal applicable rates.
To ensure that the proposed regime primarily benefits small and medium enterprises and startups, and in order to prevent income splitting, the bill contains restrictive provisions prescribing that “connected entities” can only elect a single entity as eligible for the proposed two-tiered profits tax rates regime for a given year of assessment.
Proposed super tax deductions for expenditure on qualifying research and development (R&D) activities
As regards the proposed super tax deductions for expenditure on qualifying R&D activities, the Financial Secretary announced that the relevant bureaus had consulted the views of stakeholders and are formulating draft legislation. The Government aims to submit the draft legislation to the Legislative Council as soon as possible, with a view to implementing the proposal in 2018.
Under the proposal, the first HK$2 million of eligible R&D expenditure will enjoy a 300% tax deduction and the remainder a deduction at 200%.
While we welcome this initiative as a means of spurring innovation and technology in Hong Kong, the Financial Secretary may need to give further thought to certain features of the proposed legislation.
Firstly, it is understood that the proposed super tax deductions would only apply to expenditure incurred for R&D activities undertaken in Hong Kong. Furthermore, the super deductions may not cover R&D activities which have been subcontracted out, whether undertaken inside or outside Hong Kong.
As a practical reality, enterprises may often find it necessary to subcontract out their R&D activities to be undertaken by a service provider inside or outside Hong Kong, including those undertaken under cost-sharing arrangements in a group context. This is particularly the case given that Hong Kong may lack sufficient talent with the necessary skills and expertise to conduct certain types of R&D activities. Under the proposed regime, such enterprises would not be able to enjoy the proposed super tax deductions for expenditure on R&D.
It may also be worth considering the introduction of an additional provision into the proposed legislation granting taxpayers an option to convert their super tax deductions into a cash subsidy or refundable tax credit.
Such an option would in particular encourage enterprises not currently making profits (and for whom super tax deductions would be of no current value) to continue to undertake R&D activities.
We hope that the Financial Secretary will take the above into consideration when finalizing the draft legislation.