Hong Kong’s low tax rate and simple tax regime has long been a cornerstone of the city’s success as an IFC. This situation is likely to continue: in this year’s Budget speech, Financial Secretary Paul Chan reiterated the government’s commitment to supporting the financial services sector, including by ensuring that a competitive tax regime is in place.
However, there has been significant external pressure on the Hong Kong tax system. The local application of the OECD’s BEPS 2.0 initiative, specifically Pillar 2, will see a 15% minimum corporate tax rate in Hong Kong in the next couple of years for the largest taxpayer groups. Under Hong Kong’s current regime, in accordance with the territorial system and with exemptions from tax for capital gains and incentives or concessionary treatments for certain other income, many of the biggest banks have a tax rate of below 15%; when Pillar 2 comes in, they will likely need to pay a top-up.
But even after BEPS is introduced, Hong Kong will continue to offer tax advantages compared to many other jurisdictions, and banking groups along with other large corporates will continue to want to do business here.
Talent and capital
Talent and capital are key attributes of Hong Kong’s place as an IFC, with tax an important enabler of both.
As a world-class city in terms of lifestyle as well as a global financial centre, Hong Kong attracts top-level banking specialists. These range from traders and relationship managers to specialised middle-office experts, while back-office functions are often managed from Hong Kong even if teams sit in other jurisdictions. Hong Kong’s relatively low personal tax rates and exclusions for investment income remain attractive factors for individuals in the financial services sector.
The question then arises, how much of the income generated by traders and relationship managers in Hong Kong should be retained here and how much shared with the rest of the organisation? A similar question applies for operations: how are the costs of operations teams based in Hong Kong but serving regional branches being shared across the group?
The quantum, nature and form of remuneration paid to these individuals then comes in to play, with the very same attributes that are important to corporates also important for their employees.
Another key attribute of Hong Kong as a financial hub is the large capital market. When major banks raise capital, much of it is done centrally then downstreamed to the banks’ operating subsidiaries. Banks need to identify the right time and place to raise funding, then figure out how to push the funding out to the group in the most tax effective and efficient manner. This includes ascertaining how much the subsidiary should be paying by way of funding costs for that capital that has been downstreamed.
Hong Kong’s specific tax rules for regulatory capital securities provide a robust framework for the tax implications for funding raised in Hong Kong or downstreamed to and through Hong Kong.
Transfer pricing regime
Another tax-related way that the government supports Hong Kong as an IFC is through its guidelines relating to transfer pricing. While having profits flow to Hong Kong is a good thing for banks based here -- and for the city more generally -- the government wants to make sure that we have robust guidelines to ensure that costs and income are in the right place and to strengthen the city’s position as a world-class financial centre.
Transfer pricing deals with how the income and costs in multinational businesses are divided up across the group appropriately. It is particularly important because Hong Kong is both a centre of excellence for senior bankers and a global or regional headquarters for a lot of banks and other multinational corporates, which generally provide support to affiliates in other jurisdictions. For example, traders in Hong Kong will support the generation of significant income and gains off a global platform. Equally, a bank’s head or regional office in Hong Kong will incur costs, much of which will be used to support the regional business.
In Hong Kong, transfer pricing guidelines were put in place in 2018. These not only give clear guidance to banks operating in Hong Kong, but also ensure that they have the supporting evidence and documentation to demonstrate to tax authorities in Hong Kong and in other jurisdictions that income and costs are being recorded properly and in the right place.
Banks should make it a priority to ensure that they are following the transfer pricing guidelines and that they are being proactive in terms of preparing the required documentations and collating evidence for record purposes.
The guidelines in Hong Kong do create a compliance burden for banks, as well as additional costs such as fees for service providers. This cost and compliance must also be borne in advance of any queries from the tax authorities.
But once they receive audit requests, banks will appreciate the benefits of the head office in Hong Kong having robust processes. Some other jurisdictions have very rigorous audit procedures, so it is especially useful to have the transfer pricing documentation prepared ahead of any questions from the tax authorities.
The guidelines also demonstrate that Hong Kong has a transparent tax environment and a framework in place to ensure that procedures are being followed, which is important to our global standing as an IFC.
Shifting tax landscape
As a result of global and local regulatory changes, Hong Kong’s tax rate is not quite so low and the regime is not quite as simple as it was in the past. OECD pressure means that refinements have been made to what had previously been a very straightforward Inland Revenue Ordinance, beside the increases to corporate tax rates that will come about under BEPS. The focus of the EU has also impacted the domestic tax landscape, albeit with corporate (as opposed to financial services) taxpayers more in their focus.
Another thing that has complicated matters is that Hong Kong has introduced certain incentives to encourage the development of the financial sector, in areas including corporate treasury centres, reinsurance, family offices, funds and other consolidations of wealth. Industry participants that want to take advantage of these incentives will need to ensure they are ready to tackle a certain amount of additional complexity and compliance requirements.
But while Hong Kong’s tax system has become more complex in recent years, it is still very straightforward by global standards as well as having a relatively low tax rate as compared to most other jurisdictions.
So despite the recent changes, as an IFC, our tax environment remains very attractive to global and regional corporates and financial institutions.
In terms of Hong Kong as an IFC, it is worth noting that there is also a tax lever in attracting people to come to the city to work. Compared to other world-class financial cities, Hong Kong’s income tax is relatively low, which will continue to be an attractive proposition for talent. Furthermore, Greater Bay Area cities have been introducing incentives to bring income tax in line with Hong Kong and to make it more attractive for Hong Kong-based talent to also work across the border.