Profits Tax Review
Response to the Consultation Document
Hong Kong Coalition of Service Industries
September 1997
Profit tax rate
- While Hong Kong may still have a competitive edge over some other places, this advantage
is being eroded as it has increasingly become a high-cost economy. To maintain its
competitive edge within the constraints of high costs, Hong Kong must continue to offer
investors a low taxation environment governed by simple tax rules. The most effective and
simplest way to do this would be by reducing profits tax to the same level as salaries
tax. A single percentage point reduction would result in a loss of revenue of HK$1.8
billion in 1998/89, which is only a small percentage of total government revenue and would
in no way affect profits tax as the "stable and productive revenue source"
referred to in the Consultation Document. One possible way of achieving this reduction is
by cutting profits tax by one-half of a per cent each year over the next three years until
it is reduced to 15%. This would have the advantage of making a substantial impact which
would be echoed with each successive budget.
- From a slightly different angle. we note a view that any change in the tax rate should
be handled with great care given Hong Kong's very narrow tax base. The current profits tax
rate of 16.5% is already low by international standards. While a reduction would be
welcomed generally it would have to be justified by substantial gains to the community.
- In conclusion, the HKCSI believes that a reduction of the profit tax would enhance Hong
Kong's competitivenss to the benefit of the business sector and the community in general.
We therefore support a gradual reduction of the corporate profits tax from 16.5% to 15%.
Certainty
- Certainty requires that the tax system is simple, transparent and administered evenly.
In this regard we believe there is much room for improvement. The law on the territorial
source concept is vague and the Inland Revenue Department is sometimes perceived as being
over-aggressive.
- For certainty to be achieved a clear definition of the territorial source concept is
required. That it is a matter of fact does not imply it defies definition. It is fair and
reasonable that businesses should have a clear and unambiguous understanding of what is
and what is not subject to profits tax. Clearer definition would also streamline
administration of the tax system by reducing disputes induced by Inland Revenue Department
over definition or redefinition of the source rules.
- We would therefore welcome further clarity in the interpretation of case law as well as
in the guidance notes and their application. Practice notes and guidelines should be
clear, comprehensive and consistently applied by Inland Revenue Department. They should be
updated regularly and be seen to be an equitable interpretation of case law.
Deductions
- We do not support deduction of more than cost. We agree with the consultation document
that this will complicate the system and incur additional time and money on all sides thus
perpetuating the waste of effort.
- Hong Kong should introduce a system of group relief whereby tax losses incurred by one
company within a group should be available for offset against assessable profits generated
by another company within the same group. This is, we believe, a widely accepted practice
in other tax jurisdictions.
Depreciation allowance
- We believe current regulations on depreciation for plant and machinery should
be rationalised. For instance, although 72% depreciation is allowed in the first year for
plant and machinery, a reducing allowance for the remaining 28% applies over subsequent
years. Thus an enormous amount of unnecessary time and cost is spent by all parties and
Inland Revenue Department dealing with a comparatively small proportion left to depreciate
after year one. We believe therefore that the government should allow 100% write offs in
the first year for these functions. Furthermore, it would simplify the tax system
considerably.
Rebuilding allowance
- Hong Kong is now predominantly a service-oriented economy. Depreciation allowances on
commercial buildings are only 2% p.a. and do not reflect the probable economic life of
office buildings. Allowances on industrial buildings are much more generous. There are
strong arguments for introducing an initial allowance on commercial and residential
buildings and increasing the 2% annual allowance so as to encourage developers to maintain
a steady supply of quality office space and housing. It is encouraging that the
Consultation Document (para. 15) suggests that the Finance Bureau are already thinking
along these lines.
- We therefore recommend that the flat rate for annual depreciation allowance for all
buildings be standardised to 4% applying equally to commercial and industrial buildings.
- As to refurbishment we suggest that the write-off currently applying to hotels should be
applicable also to other commercial buildings, including both offices and shopping
centres. Already owners of these premises are faced with regular up-grading to keep pace
with changes in technology and with end-user aspirations. Such refurbishment expenditure
should be written off over a period, ideally five years as in the case of hotels, but
certainly no more than 10 years when a building begins to look tired and many of the
working parts require up-grading.
- In the case of the residential sector, to achieve government's housing objectives, the
pace and quantum of residential development would have to be stepped up. On the other hand
the developer margins are becoming much tighter as the developers use up their land banks
acquired at historical prices and are faced with making most of their land purchases in
the open market. We would therefore suggest that government consider offering additional
incentives in the form of an initial 10% allowance on construction cost and an increase in
annual depreciation allowance for residential buildings held for long term investment.
Tax incentives
- Tax incentives inevitably introduce complications. The present tax system is effective
in its simplicity and introducing tax incentives will erode the virtue of our system. As a
matter of principle, therefore, we do not support tax incentives.
Double taxation
- Government should consider introducing changes to the current tax system to mitigate the
adverse impact of double taxation on Hong Kong companies. A number of countries impose
withholding taxes on income such as interest, royalties, professional fees and management
charges. When such income is earned by a Hong Kong company, it is not uncommon that
foreign withholding taxes are levied on the gross income and the same income is also
subject to tax in Hong Kong based on the source principle. This means that the Hong Kong
company is doubly taxed and in some cases the combined tax rate may be in excess of 50%.
Currently, limited relief on foreign withholding tax is given in the form of a deduction
for the taxes paid but only for certain types of income.
- We therefore suggest that government consider introducing a unilateral tax credit for
foreign withholding tax on income which is also subject to tax in Hong Kong.
- We have reservations on extending double taxation arrangements to other sectors
comprehensively. This might expose the financial services industry particularly to
disclosure of information which could undermine the industry in Hong Kong.
Tax evasion and avoidance
- Whilst we agree that government must ensure that taxes due are paid, the Consultative
Document (para 22) seems to suggest an attitude of mistrust between Inland Revenue
Department and the taxpayer. We believe it would be beneficial to both the taxpayer and
Inland Revenue Department if the latter were to be more proactive and transparent in
resolving disputes and to devote more resources to taxpayer service and education.
- A corollary is that the use of field audit teams should not be a threat. Field audits
should be conducted fairly in a non-confrontational manner and without resort to heavy
handed practices.
(ends)
If you have any question, free to email us at csi@hkcsi.org.hk
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