Hong Kong is a densely populated 400-square-mile peninsula and collection of islands in south-eastern China, home to more than seven million people, and it certainly punches above its weight in international terms. In this feature we explore what makes Hong Kong into a thriving, world-leading business and financial centre.
A British colony until 1997, Hong Kong is now a Special Administrative Region of China.
Its constitution, the Basic Law, was adopted in 1990 and elucidates the guiding principle of “one country, two systems”: that the Chinese government would guarantee Hong Kong’s autonomy and leave its capitalist system unchanged until 2047.
Policy makers in Hong Kong have been free to pursue laissez-faire economic policies that have seen it consistently ranked the world’s third best financial centre, after London and New York, and Asia’s most important.
China has generally upheld the agreement, but there have recently been signs of change outside of economic matters, and Hongkongers’ desire to keep the status quo has resulted in protests this year.
Hong Kong has an open economy and as such is vulnerable to regional or global economic shocks. For this reason its economy has tended to see-saw in recent years.
Growth fell in the aftermath of the Asian financial crisis of the late 1990s, and the economy contracted by 2.7% in 2009. In between these two downturns however, the territory enjoyed growth rates of between 6% and 8% and rebounded sharply in 2010 when it grew by 6.8%.
From 2012 to 2017, the economy grew at a more modest pace, posting growth of between 2.5% and 3%. In the last two years GDP growth has begun to plateau.
A Financial, Business and Investment Hub
Low-value manufacturing used to be the mainstay of Hong Kong’s economy, but this industry has now largely decamped to neighboring Chinese provinces. The territory’s economy is now largely based on re-exporting and services, and financial services in particular.
Banking is a major constituent of Hong Kong’s substantial financial services industry. After Tokyo, Hong Kong is Asia’s second-largest banking hub in terms of external transaction volumes.
As of April 30, 2018, there were 175 licensed banks and 61 local representative offices of overseas banks present in Hong Kong. Total bank deposits have continued to increase steadily, standing at more than HKD13.6 trillion (USD1.74 trillion) at the end of July 2019.
Deposits in the Chinese currency – the yuan or renminbi (RMB) – rapidly increased in the first half of the decade as China sought to internationalize the currency. RMB deposits reached a peak of HKD1 trillion at the end of 2014, but have since fallen, totaling HKD616bn in August 2019.
Nevertheless, Hong Kong is by far the world’s largest clearing centre for the yuan, processing a 79% share of the world’s RMB payments in 2018.
Hong Kong is also recognized as the leading fund management centre in Asia, with the industry defined by its international and offshore characteristics. It has become a popular choice for hedge fund managers, especially since the Government granted an income tax exemption to offshore funds owned by non-resident entities administering a fund in Hong Kong.
Recently, the net asset value of Hong Kong’s hedge funds has decreased, but the territory remains home to 10 of Asia’s largest hedge funds.
Hong Kong has also established itself as the favored base for multinational companies looking to expand into Asia-Pacific markets. In 2018, the territory’s investment promotion agency, InvestHK, helped 436 overseas and mainland Chinese companies to set up or expand in Hong Kong, an all-time record and a year-on-year increase of 8.5%.
Mainland China continued to be the largest single investor into Hong Kong with a total of 101 projects completed, with many of them using Hong Kong as a springboard to go global. The US followed with 63 completed projects, followed by the UK (43), France (26), and Australia and Singapore (20 each).
Hong Kong continues to attract far more foreign direct investment (FDI) than most industrialized economies. According to the United Nations Conference on Trade and Development’s (UNCTAD) World Investment Report 2019, Hong Kong was ranked third in terms of FDI in 2018, behind only the US and mainland China, with an inflow of USD116bn.
So far, the protests this year have not dampened investment flows through Hong Kong into China. According to Chinese government figures, from January to August 2019, China received USD63bn in foreign direct investment via Hong Kong, representing 70% of the all inflows.
Hong Kong and China’s Closer Economic Partnership
Foreign companies are also flocking to Hong Kong to take advantage of its Closer Economic Partnership Arrangement (CEPA) with China, a free trade deal that has substantially liberalized rules on the bilateral trade in goods and services. CEPA was further expanded in June 2016 and again in June 2017.
Hong Kong has established itself as the foremost stock market for Chinese firms seeking to list abroad. In August 2019 there were 2,392 companies listed on HKEx markets, up 206 from the April 2018 figure. Just over half of these were mainland Chinese enterprises, making up 69% of market capitalization, and 76% of annual equity turnover value.
So far this year, the performance of Hong Kong’s Stock Exchange has been somewhat mixed though generally positive. The market capitalization of HKEx’s securities in August 2019 was HKD30 trillion (USD3.8 trillion), representing a decrease of 6.8% on August 2018. However, the average daily turnover of stock futures doubled to 4,221 contracts, that of gold futures rose by 60%, and turnover for debt securities rose by 50%.
The Hong Kong Stock Exchange was the world’s top IPO fundraising market for 2018. The first-place ranking was further bolstered with new listing rules, adopted on April 30, 2018, that allow certain pre-startup tech companies with weighted voting rights structures to list on HKEx.
“Offshore” But Onshore
Unlike most onshore jurisdictions, tax in Hong Kong is levied on a “territorial” basis, which means that tax is due on locally sourced income only. What’s more, a number of taxes that are levied in other jurisdictions are less extensive in Hong Kong; for example, there is no VAT regime, no annual net worth taxes and no accumulated earnings taxes on companies that retain earnings rather than distribute them.
While corporate income tax (known as profits tax), at 16.5%, is higher than in most offshore jurisdictions, it is still substantially lower than in most OECD jurisdictions.
Hong Kong does not levy a separate capital gains tax on companies or individuals. However, speculative profits may be subject to tax under the profits tax regime where those activities constitute a business’s main business activities. The Inland Revenue Department (IRD) of Hong Kong would be responsible for making such a determination.
This differs on an international level where corporations often pay a flat rate of capital gains tax on any gains made upon disposal.
In Hong Kong, stamp duty is levied on the sale of immovable property, leases, and the transfer of Hong Kong stock.
A stamp duty rate of 0.1% applies on both the purchase and sale of quoted shares.
The rate on the lease of immovable property varies between 0.25% and 1% depending on the contractual term of the lease.
The maximum stamp duty rate on non-residential property sales is 8.5% of the property value.
A stamp duty applicable to instruments of residential property executed on or after November 5, 2016, applies at a flat rate of 15% of the consideration or value of the property, whichever is higher.
Lower rates ranging from 1.5% to 4.25% apply to permanent Hong Kong residents who did not own a home prior to the acquisition and acted in their own name.
With effect from November 20, 2010, any residential property acquired on or after November 20, 2010, either by an individual or a company (regardless of where it is incorporated), and resold within 24 months or 36 months will be subject to a Special Stamp Duty (SSD), at a rate of between 10 and 20%.
Withholding tax (WHT) is deducted at source in respect of certain payments made to companies or individuals.
In Hong Kong, withholding tax is not levied on dividend or interest payments made to companies or individuals. However, royalty payments made to a non-resident entity are generally subject to withholding tax on 30% of the payment at the profits tax rate.
Certain royalty payments are taxed on 100% of the payment at the profits tax rate, such as certain royalties paid to a related party. Royalty payments made to an individual are generally subject withholding tax on 30% of the payment at the rate of 15%. For tax purposes, a non-resident company is generally one whose central management and control is exercised from outside of Hong Kong.
Personal taxation is also low by international comparison. Income tax, known in Hong Kong as salaries tax, is paid at either a flat rate of 15%, or on a progressive scale between 2% and 17%, whichever results in the lower tax liability.
Individuals are subject to salaries tax on annual employment income and Hong Kong pensions, less permitted deductions.
For the past several years, a 75% reduction in profits tax and salaries tax has been made available to taxpayers, subject to a ceiling that has varied each year.
The 2019/20 Hong Kong Budget proposed a ceiling of HKD20,000 for the 2018/19 tax year, and in August 2019, the Hong Kong Financial Secretary proposed increasing the 75% reduction to 100%, whilst maintaining the proposed HKD20,000 ceiling.
Until June 2001, the territory had no comprehensive double taxation agreements in place. Since under the “territorial principle” only Hong Kong source income is taxable, the double taxation of income does not usually occur, thereby obviating the need for double taxation treaties. However, under article 151 of the Basic Law the territory can negotiate its own double taxation treaties independently of China using the citation Hong Kong, China, and the Government is now entering an increasing number of tax treaties of various types.
Legislation from March 2010 allows Hong Kong to enter into comprehensive DTAs, incorporating the OECD international standard on the exchange of information. In 2013, it also put in place a legal framework for entering into standalone tax information exchange agreements with other jurisdictions.
Legislation for Hong Kong to adhere to the new international standard for automatic exchange of financial account information in tax matters, the Common Reporting Standard (CRS), was gazetted on January 8, 2016.
Hong Kong will only automatically exchange taxpayer information with jurisdictions with which it has an agreement for such. The Inland Revenue (Amendment No. 2) Ordinance 2019 increased the number of reportable jurisdictions from 75 to 126.
The Ordinance also removed a number of entities from the list of non-reportable institutions. These include Mandatory Provident Scheme Funds, registered Occupational Retirement Schemes, credit unions, pooling agreements, and approved pooled investment funds. Such institutions are now required to undertake due diligence and reporting requirements.
The first reports under the CRS will be due by May 31, 2021, in respect of the 2020 year.
Base Erosion and Profit Shifting
Recently, governments around the world have been seeking to prevent opportunities for tax base erosion and profit shifting, where corporate taxpayers move profits from a high-tax territory to a low-tax territory, to reduce their tax exposure, or exploit differences in two or more territories’ tax systems to achieve double non-taxation.
To tackle this, the base erosion and profit shifting (BEPS) Action Plan provides 15 actions to prevent the avoidance of tax. Over 130 jurisdictions are committed to implementing these actions as part of the BEPS Inclusive Framework (IF), of which Hong Kong is a member.
Hong Kong had basic transfer pricing documentation requirements in place before the BEPS Action Plan. However, in 2018 Hong Kong expanded its requirements in order to strengthen its rules and to meet the BEPS Minimum Standard in this area. As a result, companies in Hong Kong are now generally required to prepare a master file, local file, and country-by-country (CbC) report in respect of transactions with related parties.
While Hong Kong’s light-touch economic and regulatory approach has ensured it has grown in stature, it is its continued position as the gateway for investment into and out of China that will underpin its future growth. So long as China upholds the “one country, two systems” principle that has thus far been key to its success, Hong Kong’s leading financial centre will go from strength to strength.