8 minute read 23 Feb 2022
Rainbow over Hong Kong skyline

A Budget for a "profoundly different world" — Hong Kong 2022-23 Budget insights

Authors
Agnes Chan, BBS

Senior Advisor, Chairman Office, EY Greater China

Contributor to public and business agenda. Leading business and tax advisor in Hong Kong. Named one of China’s Top 10 Outstanding Female Entrepreneurs in 2015.

Paul Ho

Partner, Financial Services Tax, Ernst & Young Tax Services Limited

Advisor to local and multinational financial services clients. Team builder. Advocate of Diversity and Inclusiveness. Likes hiking and cooking.

8 minute read 23 Feb 2022

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In delivering the last budget of the current administration, the Financial Secretary noted the need for social harmony and stability and proposed a number of novel measures, some of which could be regarded as attempts at social engineering with a view to achieving the goal of common prosperity often cited by policymakers on the Mainland. The implementation of several of today’s proposals may indeed involve twists and turns which the Financial Secretary noted were the basis of every fascinating story.

The standard fare of candies and giveaways was once again on offer. Hong Kong’s embattled residents and taxpayers will no doubt be grateful for the salaries and profits tax rebates, transport fare subsidies, help with their electricity bills and the receipt of e-vouchers, although some economists may question the extent of any multiplier effect. One new item for individuals was a tax deduction for residential rents up to a maximum of HK$100,000, the twist being that the deduction cannot be claimed in addition to a claim under an employer’s rental reimbursement, claims under the latter perhaps being more beneficial for many taxpayers.

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There was good news on rentals for small and medium-sized enterprises, the Financial Secretary announcing new legislation to prohibit landlords from terminating tenancies for failure to settle rents on schedule, the relief being for between three to six months. The twists and turns here may include reconciling an existing rental contract with the moratorium on eviction, and the nature of the “close communication” which the Hong Kong Monetary Authority will have with the banking sector as regards banks handling of any payments due from landlords who are affected by a reduction in rental income. 

The Financial Secretary’s proposal to amend the rating system was perhaps another attempt to engineer common prosperity. Whilst no change is proposed to the present 5% rate for properties with rateable value of HK$550,000 or below, domestic properties with rateable value over HK$550,000 would be charged at progressive rates up to 12% on rateable value exceeding HK$800,000. The Financial Secretary noted that such an approach can better reflect the “affordable users pay” principle adding that the change to the rating system will involve significant modifications of the information technology (IT) system.

Innovation and Technology (I&T) industry was a key area addressed by the Financial Secretary in today’s Budget, especially the need to attract new talent to Hong Kong, a point perhaps unfortunately highlighted when the Financial Secretary had to pause the delivery of his Budget speech — due to an IT issue. Some commentators would perhaps have liked to see a broadening of the proposals to attract talent to include areas in addition to I&T and health service providers.

 

Issuance of electronic consumption vouchers

HK$10,000

to each eligible Hong Kong permanent resident and new arrival aged 18 or above.

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.

  • Pillar One

    Pillar One of the BEPS 2.0 proposals targets multinational enterprise (MNE) groups with global turnover above EUR20 billion and profitability above 10%, with the turnover threshold to be reduced to EUR10 billion subject to a review beginning seven years after implementation. Pillar One seeks to ensure a fairer distribution of profits and taxing rights among jurisdictions with respect to MNEs.

  • Pillar Two

    Pillar Two of the BEPS 2.0 proposals targets MNE groups with annual consolidated group revenue exceeding EUR750 million, applying a global minimum effective tax rate (ETR) to these MNEs of 15%. Pillar Two seeks to put a floor on competition among jurisdictions over corporate income tax rates.

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. 

  • Show article references#Hide article references

    1. Global anti-Base Erosion (GloBE) Rules includes an income inclusion rule (IIR) and an undertaxed payment rule (UTPR). IIR imposes top-up tax on the parent entity of an MNE group in respect of the income of its constituent entity which is taxed at a rate below the global minimum tax rate. Under UTPR, any remaining top-up tax of the constituent entity of an MNE group with respect to its profits that fall outside the scope of IIR can be realized by way of denying deductions or making adjustments.
    2. https://www.sfc.hk/-/media/EN/files/COM/Reports-and-surveys/AWMAS2020_e.pdf
    3. Outline of the 14th Five-Year Plan for the National Economic and Social Development of the People’s Republic of China and the Long-Range Objectives Through the Year 2035

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. 

About this article

Authors
Agnes Chan, BBS

Senior Advisor, Chairman Office, EY Greater China

Contributor to public and business agenda. Leading business and tax advisor in Hong Kong. Named one of China’s Top 10 Outstanding Female Entrepreneurs in 2015.

Paul Ho

Partner, Financial Services Tax, Ernst & Young Tax Services Limited

Advisor to local and multinational financial services clients. Team builder. Advocate of Diversity and Inclusiveness. Likes hiking and cooking.

Related topics Tax