Hong Kong is a vibrant city that is renowned for its attractive low and competitive tax system, sound government finance and reliable provision of public service. In the wake of globalization, Hong Kong has proposed certain tax reforms that will expand its tax base to sustain a prosperous economy (Wacks 1999, p.396). These reforms are key in recovering from global economy losses in the past two years and creating crucial important investments.
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The Inland Revenue ordinance that is Hong Kong’s tax governing authority and it in charge of corporate and individual taxation matters. Inland Revenue ordinance was enacted in 1947 to impose income tax in Hong Kong (e-how Hong Kong 2006, p.3). Between 1940 and 1970 there were no tax reforms, but from 1970’s Hong Kong began growing at a rapid pace emerging as a city state and a significant financial centre and international trading point.
The government of Hong Kong as a result in the year 1997 established an attractive tax regime with low corporate and individual tax rates. The chief income taxes in Hong Kong are under three heads, salaries tax, profit tax and property tax (National library of Australia 1984, p.6).
A comprehensive overview tax system in Hong Kong according to Tax analyst firm U.S (2003) includes corporate profits tax rate is 16.5% (p.22). Individual tax rate on total income does not exceed 15% and the lower the income earner the lower the taxed charged (p.24). Workers are exempted from tax if their total income is below their total personal allowance. Only income and profits sourced in Hong Kong is taxable and residence status does not affect tax (p.25). Expenditure on capital assets is non-deductible, but an attractive allowance is granted for expenditure on plant and machinery. Lastly, there is no sales tax or value added tax, no tax on capital gain and no withholding taxes except for certain payments for non-residents (Tax analyst firm U.S 2003, p.26). The following tables illustrate the current tax rates in Hong Kong for corporate and individual tax.
Company’s tax rate in Hong Kong
|INCOME||RATE OF TAX (%)|
|capital gains tax||0|
|shareholder dividends tax||0|
|foreign-sourced income tax||0|
Individuals tax rate in Hong Kong
|INCOME (HONG KONG DOLLAR CURRENCY)||RATE OF TAX (%)|
|capital gain tax rate||0|
|income earned overseas tax rate||0|
|Dividends from a Hong Kong company tax rate||0|
Hong Kong currently relies on a limited tax base and non-tax income to generate revenue to support the city’s expenditure. Hong Kong is then proposing to reform its tax system to establish a steady revenue source to secure future growth (Ito and Krueger 1992, p.32). The main aim for proposed taxed reform is not to generate additional tax revenue but widen the tax base to enable Hong Kong rely on a dependable and growing revenue base to remain internationally competitive (Shamdasani 2010, p.4).
The current tax system in Hong Kong is characterized by low tax jurisdiction that has a narrow tax base, whose limited base is narrowing. It is also narrow in composition because it is heavily reliant on limited range of taxes. Hong Kong tax system remains the only developed tax jurisdiction that does not tax general consumption and also relies on non-tax revenue (Littlewood 2010, p.3). As opposed to organizations for economic cooperation and development (OECD) Hong Kong reliance on profit, tax is higher than the OECD economies. The pie chart below shows average tax revenue for Hong Kong as opposed to OECD in terms of percentages for total revenue.
According to Hong Kong institute of certified public accountants (2007) the IRO advisory committee found that Hong Kong’s current tax system suffers from five evident defects and these includes, lower revenue productivity during periods of economic downturn compared to broad based tax systems (p.23). Hong Kong’s taxed sectors are small, making it hard for Hong Kong to raise tax revenue to reflect the changes in economy and its narrowness exhausts economic distortions (p.24). It taxes income but not private consumption expenditure and lastly, it is slow to adjust to population demographics.
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Certain reforms were proposed to reform the current tax system by the Hong Kong government, this range of options were meant to broaden the tax base, the following were some of the proposals (Dorn 1998, p.371). The transforming of VAT , under this system fixed assets were to be classified as consumer goods and were to be subjected to VAT. But as a result, enterprises would not claim tax deduction for the purchase of fixed assets such as plant and machinery increasing the tax burden of enterprises which would not be a sound economic decision for economic restructuring.
The second proposed according to Dorn (p.1998) reform was adjusting consumption tax, this touched on people’s concept of luxury goods which is changing economic development. The move was meant to gradually lower or even remove consumption tax rate on commodities that had become mass consumer goods (p.372). The government was to impose high tax on new luxury goods and or big spending acts. The reform was to also impose consumption tax or raise it to protect the environment and ensure sustainable development on products that pollute the environment such as polythene and plastic bags.
The third approach was the unified tax reform that would see Hong Kong unifies its enterprise income tax (p.373). This move was to integrate the domestic market with the international market following China’s WTO accession. The treatment in tax in Hong Kong was to be extended to foreign enterprises so as to compete with international enterprises.
The fourth proposal was on reforming of local tax systems, this was to review the rational division of taxing in Hong Kong between the central government (Financial services and treasury bureau 2006, p.6). The centralized system of tax in China creates huge disparities with Hong Kong for example having the IRO legislate its taxation system. This was to monitor on the workability of a centralized plan for the taxing authority and of the local government in order to come up with an effective system (Dorn 1998, p. 373).
The fifth involved improving the systems of personal income tax and property tax. One of the main reasons for taxation is to control the gap between the rich and the poor to maintain social stability (Fulton et al 1998, p.123). This tax reform will seek to improve the taxation of personal income and encourage Hong Kong to identify key areas in property taxation. By narrowing the income gap in Hong Kong, efforts to improve property tax will be finally fruitful. This is because the low-income earners will also afford to purchase property in Hong Kong and own homes.
The sixth proposal was to replace charge with tax; this means that the various charges such as road transportation charges would be transformed to tax. If the charges are transformed to tax, then there is a possibility of acquiring better tax revenue as opposed to charges. The more the units, the higher the charge and vise verse (Dorn 1998, p.374).
Hong Kong also proposed to have the taxation policies for international activities reviewed to keep up with the fluctuating currency (Veen 2000, p.547). This meant that Hong Kong was to improve multinational taxation policies, upgrade the flow of international market systems, and lastly encourage direct investment from international companies. This was to see Hong Kong come up with economic incentives to attract international trade in service, financial institutions, investments and securities.
The last option was the addition of the goods and service tax to the taxation legislation. The GST is a multi stage indirect tax levied on local consumption (Veen 2000, p.655). The GST is also known as value added tax by parts of the world and it was to be charged on local consumption and is borne by end users. It was to be collected at two stages of the production and distribution by registered vendors who have to account for the tax value they have added to the goods and service (Fulton et al 1998, p.124). The goods and service tax by the vendor on its supply of goods and services is called the output tax and on the other hand the tax that the vendor paid to purchase the inputs is known as input tax.
The mechanism of GST was placed in that the vendor can net off its output tax liability against its input tax credit to arrive at the net GST payable if the figure is positive and net GST refundable if the figure is negative. The vendor is required to remit the net GST payable to the internal revenue department of Hong Kong (Chen and Vazquez-Martinez 2001, p.13). As for the net GST refundable, the vendor should refund the amount to the tax authority in accordance to prescribed rules.
The Hong Kong government after considering the various options proposed to broaden the tax reform, the government concluded that the good and service tax reform was the most preferred and relevant system (Guide me Hong Kong 2008, p.3). This was because the GST system was promising enough to secure the long-term sustainability of Hong Kong’s revenues base and improve its capacity to meet expenditure needs. The government also wished to retain the low tax system in Hong Kong a position envied by many countries.
The GST reform also had a few proposed packages that saw the offset and relief measures t address concerns by the community, over introduction of GST. Hong Kong tax base is very narrow by international standards, because it relies on a limited range of taxes and non-tax income revenue (Chen and Vazquez- Martinez 2001, p.13).
The GST was a highly favored options according to Guide me Hong Kong (2008) because GST would be able to produce stable and predictable revenues, because it would be based on consumption expenditure (p.4). This does not fluctuate to the same extent as income or assets value. GST will enable Hong Kong competitiveness and low-tax business environments, as a means of attracting foreign capital and talent. GST would be a broad based and levied at a low rate and still produce significant revenues. This tax reform would be fair because individual consumption determines the amount of tax paid (p.5). Meaning that the public only get to pay for goods consumed the fewer goods consumed, the less tax charged. Lastly, GST is capable of growing in line with consumption in the economy even with an ageing population. The GST tax system overall was favored because Hong Kong, the tax revenue will not need to generate additional tax revenue because GST is capable of generating enough revenue to meet Hong Kong’s expenditure (Macpherson and Smith 2003, p.10).
The Hong Kong government mains plan as noted by guide me Hong Kong (2008) is to have the first five years of revenue generated as a result of GST returned to the community as tax relief and compensation measures (p.6). The primary elements of the tax reform were to remain unchanged for the first five years to ensure stability. Meanwhile the government would seek to educate the public on new tax reforms and the implications (p.7). A lot of seminars have been held to ensure that the public understand that Hong Kong was taking new reforms to broaden the tax base to international standards. The public has also been brought to light on the rapid ageing of Hong Kong’s population and the effects of globalization challenges to Hong Kong’s economy and public finances (University of Illinois at Urbana-Champaign 2000, 16; Reynolds 2005, p.2).
The public feels that the current tax system is over-reliant on limited types of tax and a small number of taxpayers, the majority of tax revenue and non-tax revenue is closely related to the property market (Wacks 1999, p.397). This means that the property market was highly volatile to fluctuation and again Hong Kong was vulnerable to outside economic conditions and also to economic downturns. The rapid ageing rate worried the public due to diminished tax base (Swire 2010, p.6). Lastly, the public feels that the Hong Kong government needs to establish ways of reducing expenditure before increasing revenue (Ito and Krueger 1992, p.34; Veen 2000, p.655).
China’s 12th five-year plan
China promulgated the 12th five year plan in March 2011, which is meant to be the blueprint and action agenda for the economic and social development of Mainland (KPMG 2011, p.2). This plan was very significant to the Hong Kong government for the first time because it had incorporated a chapter on Hong Kong, discussing how Hong Kong was to consider modifying its tax regimes. This was to see the plan complete and consolidate its position as an international financial and trade centre.
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The Hong Kong chapter, as observed by KPMG (2011) emphasizes on three major areas; consolidating and enhancing Hong Kong’s competitive advantages through enhancing its position as an international financial, trade and shipping center (p.3). This also meant supporting Hong Kong’s development into an offshore renminbi centre and an international assets management. The second was to nature emerging industries and developing the six industries where Hong Kong would enjoy clear advantages. The six industries include cultural and creative, innovation and technology, environmental, testing and certification, education and medical. This will assist the six industries extend the fields of co-operation (p.4). The third area involves deepening economic co-operation between the mainland and Hong Kong. This would mean implementing of the closer economic partnership arrangement and confirming the Hong Kong Guangdong co-operation.
The 12th five-year plan recommended tax changes and modification in certain areas, which includes further expanding DTA’s, loss relief, and providing a level playing field for Islamic finances. It also proposed on tax incentives on asset management and research and development, tax deduction on intellectual property rights. There was also to be depreciation allowances for plant and machinery and Hong Kong was to determine principles that identify sources of profits (KPMG 2011, p.7). As regards to its regional counterparts Hong Kong cannot be said to have an expansive double taxation agreement. The following table highlights the number of double taxation agreements as compared to Hong Kong (KPMG 2011, p.7)
Hong Kong’s first step towards establishing itself as a hub for Islamic financing was through a new Islamic finance deal with Dubai (Shamdasani 2010, p.4). The Hong Kong monetary authority and the Dubai international financial centre authority signed a memorandum of understanding to boost cooperation in developing sharia-compliant financial products. This is very significant for the Hong Kong government especially in development of Islamic finance which will benefit Hong Kong as an international financial centre. As a result the Sukuk market has registered tremendous growth and has the potential of becoming Islamic financial centre (Shamdasani 2010, p. 5).
The Hong Kong government has the potential to grow to compete favorably with international markets because its current position is highly promising. Hong Kong has high fiscal reserves and with intention to introduce GST reforms to its tax system, the economy will attract foreign capital and expand its reserves. The undertaking to alias with the Islamic hub, Hong Kong has more to gain, because this hub is rich with oil and gas reserves that will see its cash reserves expand greatly.
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