Hong Kong’s run of good luck is running out. One obvious sign is the increasing interference of Beijing in its domestic affairs, most recently using tame Chief Executive C.Y. Leung and a clique of yes-men to interfere in a senior academic appointment at the University of Hong Kong.
But beyond that, there is a convergence of unwelcome news. One of the broader dangers is the diminishing value of the territory’s role as a tax shelter and money-laundering center. The threat comes from two directions. The first is the mainland, which has hitherto been indulgent over the use of Hong Kong by mainland firms – not least major state enterprises – to generate profits which in reality arise on the mainland or elsewhere where tax rates are significantly higher.
In its crackdown on corruption and money-laundering in Macau, Beijing has shown no great concern for its impact the economics of the gambling and entertainment enclave. Hong Kong, just at the other side of the mouth of the Pearl River, may be next. Beijing may well feel that Hong Kong is even less deserving of sympathy because of its autonomous attitudes. As it tries to boost the yuan as an international currency and SDR component, greater control on money flows through Hong Kong may be put in place.
Transfer Pricing, Hong Kong’s Cash Cow
The bigger danger, however, may lie in the territory’s dependence on the tax revenue it accrues from transfer pricing via Hong Kong-based entities. Despite its low level, corporate tax is by far the biggest direct tax source for the Hong Kong government and accounts for 27 percent of total revenue and one third of recurrent revenue. How much of that is genuinely generated in Hong Kong can only be guessed at but trade data reveal that re-invoicing in Hong Kong without value-added amounts to 15 percent of re-export turnover.
This could now be under threat not only from the mainland but from the Organization for Economic Cooperation and Development, the 34-member group of major developed countries including the US, EU and Japan. Political as well as budget pressures in these countries have led to an outcry against tax avoidance on a mega scale by the likes of Apple and Google, and many more, artificially to route profits through places where they have little or no business, ranging from Ireland to the Cayman islands, with low or non-existent taxes on profits.
Last week, OECD ministers meeting in Peru for the World Bank annual meeting concluded an agreement on profit tax recognition which seeks to address the issue. Even if only partly successful it will hurt offshore profit-booking centers. China indicated its support for the move.
Hong Kong is far from being a leading player in the avoidance business as its taxes are not negligible and the city generates a huge amount of genuine trans-border trade in goods and services. Nonetheless it is under increasing scrutiny with some tax authorities in Europe reportedly now treating Hong Kong as part of China for tax purposes.