Hong Kong Taxation Reform

From an Offshore Financial Center Perspective

Group 8
Interim Deliverable • Year 3 Surveying Studio • 11 November 2009

HK as Asia’s Offshore Financial Center • URL: http://hkofc.blogspot.com/ !

 SUBJECT: TAXATION REFORM IN HONG KONG! ! SURVEYING STUDIO III

PART I: Current Situation of Hong

Kong Taxation

Capital Gains Tax

Unlike other jurisdictions, no capital gains tax is imposed on any companies in Hong Kong SAR.
This provides a strong base for the financial development in terms of taxation benefits. It is no
doubt that for a o!shore financial centre the policy should retain in order to maintain the
competitiveness of the business environment.1

Stamp Duty Fee

Stamp duty is payable for any sales, transfer and lease of properties and the transaction of
marketable securities like stocks and derivatives. This is the major taxation to be focused on for
o!shore financial transactions, hence the trades of commodities and futures. No stamp duty will be
charged for non-residential properties.

We should note that, which will be discussed in the later parts, stamp duty fee is not very common
in other o!shore financial centers in other part of the world. To be competitive, a policy reformed
about the stamp duty should be made. Lam (2000) suggests that the stamp duty policy variations
mainly focused on the property market, which is the major industry in Hong Kong, compared to
Singapore.

From the general point of view of the public, the higher the stamp duty, the lower transaction
volume of the securities market will be. According to Umlauf (1993), transaction tax (i.e. the stamp
duty rate in Hong Kong) imposition will reduce the security market turnover. However, according
to Hu (1998), the changes of the transaction tax rate will only a!ect the stock prices in the market,
but not the volatility and turnover, if the capital market is highly regulated. The author therefore
suggested that any policy adjustment on stamp duty fee requires considerations on the migration
possibility in trading. Hence, the suggested future policy reform on stamp duty should focus on the
regulation itself, but not the stamp duty rate.2

1 Low-tax.net: www.lowtax.com
2Lam, N. M. K. (2000). "Government Intervention In The Economy: A Comparative Analysis of Singapore
and Hong Kong." Public Administration and Development 20: 397-421.

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Property Tax
All property owners shall not be subject to this tax unless he or she has received a consideration, for
example, a rental income. The property tax shall be computed on the net assessable value at the
standard rate. The property tax rate from the financial year 2008/09 onwards is 15% per year.3

From the report of property consultant, Jones Lang LaSalle, the common practice in Hong Kong
o"ce market is that the property tax is payable fully by the landlord but not equally share among
him and the tenants. Sales of grade A o"ce properties is also not the major transactions type of the
market in Hong Kong. Most of the grade A o"ce buildings in CBDs are occupied by major
landlords. Foreign investors who would like to set up their regional o"ces in Hong Kong will
probably rent the spaces they needed instead of purchase. In other words, the property tax system in
Hong Kong won’t a!ect the development of o!shore financial services much.

Profit Tax(Corporate tax/Income tax)

Profit tax is one of three separate heads imposed under tax system in Hong Kong, the other two are
salaries tax on income from pensions and employment, property tax on rental income. Profit tax
mainly focuses on profits of a trade, business or profession.4 The fundamental to the taxation of
profits in Hong Kong applies the territorial concept/rules. It means that only those profits which
arise in or are derived from Hong Kong are liable to profit tax in Hong Kong. (tax on Hong Kong
sourced income) The profit tax is currently at the rate of 16.5% of the 2008/09 year of assessment.

However, there are certain situations that profit tax is exempted in Hong Kong 5:

1. dividends received from a corporation which is subject to Hong Kong Profits Tax;

2. amounts already included in the assessable profits of other persons chargeable to Profits Tax;

3. Interest on Tax Reserve Certificates;

4. interest on, and any profit made in respect of a bond issued under the Loans Ordinance (Cap.
61) or the Loans (Government Bonds) Ordinance (Cap. 64), or in respect of an Exchange Fund
debt instrument or in respect of a Hong Kong dollar-denominated multilateral agency debt
instrument;

5. interest income and trading profits derived from long term debt instruments; and

6. sums received or accrued in respect of a specified investment scheme by or to the person as:

3 Inland Revenue Department: http://www.ird.gov.hk/eng/tax/ind_tra.htm

4 Survey Report of Jones Lang LaSalle, 2007
5 Source: Low-tax.net: www.lowtax.com
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• a person chargeable to Profits Tax in respect of a mutual fund, unit trust or similar investment
scheme that is authorized as a collective investment scheme under section 104 of the Securities
and Futures Ordinance (Cap. 571); or
• a person chargeable to Profits Tax in respect of a mutual fund, unit trust or similar investment
scheme where the Commissioner is satisfied that the mutual fund, unit trust or investment
scheme is a bona fide widely held investment scheme which complies with the requirements of a
supervisory authority within an acceptable regulatory regime.

Withholding Tax
Generally, there is no withholding tax in Hong Kong. But under certain circumstance that the
payment paid by a Hong Kong company to its foreign associate (subsidiary or holding company) is
deemed to be treated as Hong Kong source income, the company should withhold the tax for Hong
Kong taxation.

For instance, when a Hong Kong entity pays royalties for the use of intellectual property to its own
o!shore licensing a"liate, then tax is due of 10% of 17.5% = 1.75% and this must be withheld by the
Hong Kong paying company.6

Taxation for Funds & Trusts

Normally, funds and trusts are treated like other entities, which means they are subject to Hong
Kong profit tax (currently at the rate of 16.5% of the 2008/09 year of assessment) if their sourced
profits are attributable to a business carried in Hong Kong. However, there are certain statutory
exemptions from profit tax for such funds which are qualified by the government. Actually, there are
two specific exemptions available to funds which, subject to the relevant conditions being satisfied,
operate to exempt certain or all of the fund`s profits from tax in Hong Kong.

For authorized or regulated funds exemptions:

If a fund is:
• a mutual fund or unit trust authorized under the Securities and Futures Ordinance; or

• a mutual fund, unit trust, or similar collective investment vehicle which the Commissioner of
Inland Revenue is satisfied is bona fide, widely held, and complies with the requirements of a
supervisory authority within an acceptable regulatory regime.

Therefore, all profits of the funds will be exempted from profit tax to the extent that the profits arise
from investment activities which are in accordance with the fund`s constituent documents and the
requirements of the regulatory regime under which it operates.7

6 Source: The example is applied by LOWTAX.NET

7 KPMG International fund and fund management survey database for Hong Kong

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For offshore funds exemption:

It was introduced in March 2006 to apply to a broader category of o!shore funds. Generally, an
o!shore fund is exempted from Hong Kong profits tax if the fund is a non-resident person ( a
company, individual, partnership, or trust) and derives its profits from certain qualifying
transactions carried out through or arranged by specified persons. If profits of such o!shore funds
are not from certain qualifying transactions or from transactions incidental to these qualifying
transactions, the profits should still be subject to profit tax in Hong Kong.

To define non-resident person out of resident person is crucial to apply exemption provision.
According to KPMG Taxation of international executives Hong Kong, “the definition depends on
where the relevant entity exercises its central management and control. The Inland Revenue
Department has indicated that the central management and control requirement refers to the
highest level of control of the entity concerned rather than day-to-day management of the entity.”

Moreover, although other funds and trusts are not eligible to be exempted from profit tax in Hong
Kong, they are generally not subject to tax in respect of dividends, capital gain, certain interest
income, and o!shore sourced income.

Taxation for Holding Companies

Holding companies are often used within multinational groups to centralize the management of the
participations held by the group. It usually refers to a company which does not produce goods or
services itself, rather its only purpose is owning shares of other companies. Therefore, quite a few
jurisdictions around the globe provide taxation benefit to attract the setting up of holding
companies, like Luxembourg, Bermuda, etc. There is no some specific profit tax treatment for
holding companies in Hong Kong. They are generally treated as normal business with no
di!erence. If they conduct business and generate income with the region of Hong Kong, they
should be subject to profit tax. (currently at the rate of 16.5% of the 2008/09 year of assessment) 8.

8 KPMG International fund and fund management survey database for Hong Kong
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PART II: O!shore Financial Center

Explained
An O!shore Financial Center (OFC) can be broadly defined as a location where funds borrowed
from nonresidents and lent to other nonresidents through the intermediation of banks and other
financial institutions. The growth of OFCs has been prompted mainly by the needs and demands of
multinational business. To be specific, companies operating in various countries require:9

I. funding sources in di!erent currencies,

II. outlets for temporarily idle funds

III. access to di!erent kinds of credit facilities

IV. means for the transfer monies across international frontiers

As a result, taxation treatments is among the most important factors influencing the way
international business is transacted. This also explains the phenomenon that most OFCs are
characterized as “tax haven”.

Tax Haven Defined

This term is broadly used to describe di!erent OFCs around the globe. However, there is not yet
any exact definition of the term. Casually speaking, tax haven can be regarded as “a place where
foreigners may receive income or own assets without having to pay for it”.10

One of the most rapidly growing type of tax haven operation is that of shifting business profits from
high-tax jurisdictions to tax haven ones. The profit shifting transactions are usually carried out by
large conglomerates through tax haven subsidiaries, using sophisticated approaches to diminish the
tax base in high-tax countries while increasing it in tax haven places.

The other dominant type of activity carried out in tax haven is by the financial sector. The financial
sector usually comprises a large number of banks and trust companies, most of which are branches
and subsidiaries of foreign-owned financial institutions. The reason of their presence in OFCs can
be attributed as the following:

I. to shelter foreign passive investment income

II. to hold deposits for foreign investors

III. to provide administrative facilities for corporate subsidiaries

9 Henry C. Walich, Offshore Financial Centers, April 1979

10 Lan McCarthy, Offshore Banking Centers, Benefits and Costs
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IV. to proceed Euro-currency business through their “shell branches”

Tax haven advantages

Being tax havens could potentially bring various benefits to OFCs. One of the main advantages is
the possibility of achieving a higher employment level, which is particularly attractive to
jurisdictions with a narrow resource base like Hong Kong. Especially, the financial institutions that
are attracted to set up within OFCs could generate employment opportunities and additional
demand for services.

On the other hand, construction would be boosted, principally o"ce buildings. In addition, tourism
would be another sector that could be stimulated, as meetings of directors in the jurisdiction might
be a requirement for incorporation.

Finally, the tax haven sector is a course of revenue for the government. There will always be some
form of tax or fee for which foreign investors will be liable, no matter how the tax system will be like.
For Singapore banks, for example, profits from domestic sources are taxable while income from
foreign sources is exempt. Also, indirect taxes such as customs duties and sales taxes are fully
taxable in most OFCs.

Taxation advantages in OFCs

Low taxation is perhaps the primary reason attracting institutions. Specifically, the advantages
o!ered by OFCs can be categorized as income tax advantage, absence of estate, inheritance and gift
tax, bilateral tax treaties, and the existence of features in the tax systems of developed countries that
allow taxpayers to take advantage of the benefits o!ered of OFCs.

Taxes and levies on o!shore business are virtually nonexistent in OFCs, in “marked contrast” to the
situation in alternative locations. The taxation treaties in major OFCs around the globe can be
summarized as Table 1. Almost none of these OFCs impose minimum reserve requirement; None
of them enforces withholding taxes on internal income; And they impose very limited profit tax, if
any at all.

Jurisdiction Taxes & levies Annual license fee Min. reserve

requirement

Anguilla None EC$1,350 None

Bahamas None US$300-45,000 None

Bahrain None US$25,000 None

Cayman Islands None C$5,000-15,000 None

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Jurisdiction Taxes & levies Annual license fee Min. reserve

requirement

Hong Kong 10% withholding tax None None

on interest paid
(proposed 17%
offshore profit tax)

Jersey £300 per annum for None None

corporate tax
companies

Lebanon None None None

Luxembourg 40% profit tax None None

40% municipal
business tax
30% liquidity ratio

Netherlands Antilles 3-6% profit tax None None

New Hebrides None $A 1,000 None

Panama None None None

Philippines 5% profit tax (on US$20,000 None

offshore to offshore
transactions)
10% profit tax
(offshore to
onshore)

Seychelles None US$20,000 None

Singapore 10% profit tax (on S$50,000 None

offshore operations)

United Arab None None None

Emirates

Table 1 Taxation treaties in major OFCs around the globe 11

11 Mika Casnegra de Jantscher, Tax Havens Explained

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PART III: Proposal for Hong Kong’s

Taxation Reform
Double taxation Treaty
The Tax in Hong Kong is subject to territorial rules(or residence rules), which means only those
profits which arise in or are derived from Hong Kong are liable to tax in Hong Kong. This is
sometimes quite di!erent from the tax rules of other jurisdictions, for example, United States,
which levies its tax based on the nationality of American people. To avoid the conflicts of interest in
levying taxes with other jurisdictions, and also to lower the double tax burden of foreign investors in
Hong Kong thus improving the investment environment in Hong Kong, double tax agreement will
play an important role in such situations.

According to KPMG International fund and fund management survey database for Hong Kong,
Hong Kong has a comprehensive double tax agreement with Belgium, Thailand, and, more
recently, with Mainland China, Vietnam, and Luxembourg. The Hong Kong government is
presently in the process of negotiating a double tax agreement with Italy and the Netherlands.”

For Hong Kong to be a competitive Asian o!shore financial center, we suggest the HKSAR
government to speed up the negotiation process with other world famous financial jurisdictions in
achieving more double taxation treaties as early as possible. A complete and comprehensive double
taxation treatment system will attract investors from di!erent jurisdictions all over the world into
Hong Kong with little concern about taxation problem.

Exemption of holding company, funds and stamp duty

Nowadays, holding companies, funds and trusts are treated as normal business and similarly subject
to profit tax in Hong Kong. As it is always the case, other major o!shore financial centers in the
world are also the center of registration of holding companies and funds. If Hong Kong prefers to
take up these roles in future, it is better to consider a special and comprehensive taxation treatment
for holding companies and funds. We suggest HKSAR government to simply exempt the tax for
holding companies and funds in Hong Kong to give better incentives for foreign investors to
register their holding companies here and establish o!shore funds in Hong Kong as well. The loss
of these exemptions is relatively small, and it could be o!set by other tax increments from the
prosperity of Hong Kong as an o!shore financial center.

As discussed in part 1, stamp duty is the major taxation related to the transactions of commodities in
the Hong Kong Exchange market. According to the annual report 2007-08 of the Inland Revenue
Department, during the peak periods, i.e. the so-called economic crest like in 2008, where the

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transaction volume per day were huge, stamp duty would be the second major tax income source
(concluded for 25.7% of total tax incomes) of the HKSAR government. On the other hand, in a
complicated regulatory environment like Hong Kong 12, changing the stamp duty rate will greatly
a!ected the transaction volume as suggested by Umlauf (1993). Therefore, providing stamp duty fee
exemption would be the most appropriate measure to increase the investment incentive to the
foreign funds and trusts, rather than decreasing the stamp duty rate. The details of the fee
exemption should be discussed further in order to strike a balance between of the resulting benefits
and induced implications.

References
1. KPMG International fund and fund management survey database for Hong Kong

2. Inland Revenue Department Annual Reports: http://www.ird.gov.hk/eng/ppr/are.htm

3. Lam, N. M. K. (2000). "Government Intervention In The Economy: A Comparative Analysis

of Singapore and Hong Kong." Public Administration and Development 20: 397-421.

4. Hu, S.Y. (1998). “The e!ects of the stock transaction tax on the stock market – Experiences from
Asian markets.” Pacific-Basin Finance Journal 6(3-4): 347-364.

5. Umlauf, S.R. (1993). “Transaction taxes and stock market behavior: the Swedish experience.”
Journal of Financial Economics 33: 227–240.

6. Low-tax.net: www.lowtax.com

12Hong Kongʼs financial market is regulated by the Hong Kong Monetary Authority (HKMA), Securities and
Futures Commission (SFC), Hong Kong Insurance Authority (HKIA) and Hong Kong Association of Banks
(HKAB) with different sets of regulations.
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