Whilst the Government’s continuing efforts to conclude comprehensive double tax agreements are commended, the Financial Secretary announcing ongoing discussions with 14 potential jurisdictions, some commentators might prefer the Government to concentrate its efforts in concluding agreements with members of the Regional Comprehensive Economic Partnership (RCEP), a body which Hong Kong is trying to join, whose members account for almost 70% of Hong Kong’s total trading volume.
The Financial Secretary mentioned the perennial concerns over revenue collection due to Hong Kong’s narrow tax base. Whilst noting that now was not the time to increase salaries tax or profits tax, the Financial Secretary viewed the implementation of the minimum 15% corporate tax rate (as required under Hong Kong’s international commitments) as enabling Hong Kong to collect an additional estimated HK$15 billion per year by way of a “top-up” tax. Taxpayers whose effective tax rate is less than 15%, will no doubt be hoping their “top-up” tax will be employed to fund non-tax measures to their benefit. Whilst the Financial Secretary noted that the Government would continue to explore different ways to broaden revenue sources, some listeners would perhaps have preferred the Financial Secretary to outline a structured approach to such exploration and a forecast timeline for the implementation of alleviating measures.
The Financial Secretary’s proposal to provide tax concessions for eligible family investment management entities managed by single family office will have been welcomed. The absence of any tax incentives for funds however, by amending the definition of “specified transactions” such that bond funds whose principal income is interest would be tax exempt, may have caused some disappointment.
Taken together, in preparing this last budget of the current administration, the Financial Secretary has dared to be different, proposed some novel approaches to seek common prosperity, and tried to ensure that Hong Kong remains on a path that will lead to success, although that path may indeed have twists and turns.
International tax developments and their impact on the competitiveness of Hong Kong
BEPS 2.0 proposals – implementation in Hong Kong
The Organisation for Economic Co-operation and Development (OECD)/Group of Twenty (G20) announced in July 2021 an international tax reform framework consisting of a two-pillar solution to tackle perceived base erosion and profit shifting (BEPS) risks arising from the digitalization of the global economy (commonly known as BEPS 2.0 proposals). Thereafter, in October 2021, the OECD/G20 issued a detailed implementation plan for the agreed components of the BEPS 2.0 proposals.
In fact, in view of the potential impact of BEPS 2.0 on the competitiveness of Hong Kong’s business environment, the Financial Secretary set up the Advisory Panel on BEPS 2.0 (Advisory Panel) in June 2020.
The Advisory Panel has completed its analysis on the potential impact of BEPS 2.0 on businesses operating in Hong Kong. The Advisory Panel made the following recommendations on the guiding principles and measures that Hong Kong should adopt in response to the new international tax requirements:
- Hong Kong should implement Pillar One by adhering to the tax framework endorsed by the international community and by participating in the new multilateral convention, as this would help affected businesses eliminate double taxation and reduce compliance costs.
- Hong Kong should implement Pillar Two by amending our existing tax regime to apply the GloBE rules1 in full as stipulated by the OECD to implement the global minimum tax, and the relevant amendment should only apply to in-scope MNE groups with ETR below the global minimum tax rate.
- The Government should protect Hong Kong’s taxing rights and minimize the compliance burden of businesses operating in Hong Kong.
- Any consideration to change the territorial source principle of taxation should not be made lightly, the source principle being crucial to the competitiveness of Hong Kong’s tax system. Although revising the territorial source principle of taxation can raise the ETRs of some MNE groups operating in Hong Kong beyond the global minimum tax rate, the Advisory Panel considers that this is not a precise and targeted enough measure to respond to the global minimum effective tax rate.
- Hong Kong should keep up the efforts in improving its business environment and enhancing its competitiveness, with a view to attracting MNE groups to invest and operate in Hong Kong.
In today’s budget speech the Financial Secretary indicated that he will submit a legislative proposal to the Legislative Council in the second half of 2022 to implement the global minimum tax rate and other relevant requirements in accordance with the international consensus.
At the same time, the Financial Secretary also stated that he will also consider introducing a domestic minimum top-up tax (DMT) in Hong Kong starting from the year of assessment 2024-25. Based on his rough estimates, such a DMT would yield an additional tax revenue of about HK$15 billion per year.
Domestic minimum top-up tax in Hong Kong
A DMT regime is not part of the model rules of Pillar Two, the adoption of a DMT by a jurisdiction being optional. Understandably, the purpose of a DMT under consideration is to bring the ETRs of the Hong Kong constituent entities of an in-scope MNE group to the required minimum of 15% where such entities would otherwise be subject to tax at a rate lower than 15% under the main or normal tax regime of Hong Kong.
In other words, any top-up taxes that will be required to be paid under Pillar Two in respect of the Hong Kong constituent entities of an in-scope MNE group for their economic activities in or from Hong Kong would be collected by Hong Kong under such a DMT. By so doing, Hong Kong would not cede its taxing rights over such Hong Kong constituent entities to overseas jurisdictions which might otherwise collect such top-up taxes under the IIR (effective in 2023 at the earliest) or the UTPR (effective in 2024 at the earliest).
In addition, the introduction of a DMT in Hong Kong could significantly reduce the compliance burdens on both in-scope Hong Kong, and non-Hong Kong-headquartered MNE groups, by ensuring they are not subject to the UTPR in multiple overseas jurisdictions in respect of their Hong Kong operations.
In his consideration of introducing a DMT in Hong Kong, the Financial Secretary may need to consider whether such a DMT should be levied on both in-scope Hong Kong, and non-Hong Kong-headquartered MNE groups, and if only levied on the former, whether the playing field would be level.
The introduction of a DMT in Hong Kong could affect the tax competitiveness of Hong Kong vis-à-vis our competitors. As such, stakeholders should convey their views on the issues to the Government.
Observations
Under Pillar Two, in-scope MNE groups, which account for 90% of global corporate income taxes according to an OECD study, will be subject to the global minimum ETR of 15%, wherever they operate, thereby ensuring a more level playing field in terms of taxation among jurisdictions.
As such, in-scope MNE’s may find the tax exemptions and low preferential tax rates offered by jurisdictions such as Hong Kong, Ireland, and Singapore would be less attractive. In short, jurisdictions will have to rely more on non-tax factors to compete for investment and business in the BEPS 2.0 era.
It was therefore reassuring today to hear the Financial Secretary speak of Hong Kong’s existing non-tax competitive credentials, including its rule of law and its central geographic location as a business hub for the Asia-Pacific region, especially its proximity as a gateway to mainland China.
Furthermore, entities that do not belong to an in-scope MNE group will continue to be attracted by Hong Kong’s existing tax incentives relating to various industries e.g., tax exemption for funds and reduced tax rates for corporate treasury centers, insurance and reinsurance, aircraft and ship leasing and management businesses.
Proposed tax concessions for family offices set up in Hong Kong
According to the recent “Asset and Wealth Management Activities Survey” issued by the Securities and Future Commission (SFC), Hong Kong’s private wealth management assets under management recorded a year-on-year increase of 25% to HK$11,316 billion for 2020, with non-residents comprising a major source of inflows2.
Hong Kong, which has a well-developed capital market, legal system, and a large number of Ultra-High-Net-Worth families, is well positioned to be a family office hub.
Last year, Invest Hong Kong established a dedicated FamilyOfficeHK team to promote family office business in the city and develop this sector.
However, many single-family offices do not qualify as a collective investment scheme nor being bona fide widely held nor being managed by SFC-licensed persons. As such, these family offices do not qualify for the tax concessions under the existing tax exemption regimes for funds in Hong Kong.
To further enhance Hong Kong’s tax attractiveness as a hub for asset and wealth management, the Financial Secretary announced in today’s budget speech that an amendment bill will be introduced to provide tax concessions for qualifying family offices in Hong Kong.
The Financial Secretary indicated that he will consult the sector on the detailed proposal as soon as possible and aim to submit legislative amendments to the Legislative Council within the current legislative session. It is expected that the relevant tax concessions will come into effect in the year of assessment 2022-23.
We welcome the proposed tax measures which will help Hong Kong compete with other family office hubs such as Singapore and Switzerland.
Proposed tax measures to enhance Hong Kong’s position as an international maritime centre
The 14th Five-Year Plan3 promulgated in March 2021 supports the development of Hong Kong’s maritime and logistics services sector towards high-end and high value-added services, with a view to enhancing Hong Kong’s status as an international transportation hub.
With this in mind, Hong Kong has already enacted legislation offering tax exemption or half-rate tax concession to ship leasing and marine insurance businesses, in June and July 2020 respectively.
To further enhance Hong Kong’s position as an international maritime centre, the Financial Secretary also announced in today’s budget speech that similar tax concessions will be introduced in the first half of 2022 to cover other related sectors of the maritime industry, possibly including ship managers, agents, and brokers.
The aim is that a more complementary cluster of industry players can be attracted to Hong Kong such that the role designated for Hong Kong under the 14th Five-Year Plan can be fulfilled.
One point to note is the requirement under the BEPS international tax rules that any existing or new tax incentives offered by Hong Kong will require the relevant taxpayers to have business substance in Hong Kong.
Substance requirements for a jurisdiction usually refer, on a single company basis, to the number of full-time qualified employees in the jurisdiction and the level of operating expenditure incurred.
As such, we hope the Government will consult widely with the industry on how the substance requirements are to be set for the proposed tax measures, especially for the situation where the business substance is centralized in a company that, in a group context, serves many special purpose operating companies that are eligible for the tax concessions.
Summary
It was reassuring to hear the Financial Secretary speak of Hong Kong’s existing non-tax competitive credentials, including its rule of law and its central geographic location as a business hub for the Asia-Pacific region, especially its proximity as a gateway to mainland China.