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

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.

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.

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.

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.