China’s Taxman May Axe HK Economy

Hong Kong’s economy, already looking a little wobbly, could suffer a major blow if China is serious about cutting down on tax-dodging. With capital flowing out and debt problems mounting, Beijing has both economic and political reasons to clamp down on the use of the territory for re-invoicing of trade transactions. This not only is an easy way of moving money out of the country but bolsters Hong Kong tax receipts at the expense of those of the mainland.

This year Hong Kong expects profits taxes to yield HK$138 billion, or 27 percent of total revenue. How much of that is genuinely derived from Hong Kong business and how much from re-invoicing to avoid tax in low-tax Hong Kong or beat the higher rates in China and most other countries is not clear. But Hong Kong’s re-export trade at HK$3,558 billion in 2015 appears far higher on paper than in reality, and much of the (declining) business of its container port is simply the trans-shipping of containers packed elsewhere. The re-export margin is estimated at 16 percent which would yield HK$590 billion in gross profit arising in Hong Kong.

Hong Kong revenues from this source could take a big hit just when other major sources – land sales and stamp duties on share and property transactions – also take a hit from declining property prices and modest stock market activity.

Multinationals in the sights

China announced on May 11 that it is looking into ways of making multinational companies reveal more about their pricing policies and locations of their profits in order to prevent leakage of tax. This has sent a shiver down the spine of multinationals doing big business in China who are already fearful of the government’s increasingly nationalistic stances towards foreign companies. But Beijing may be taking aim at mainland companies too.

Catching them may be more difficult but it probably has enough leverage with the Hong Kong administration via its puppet chief executive C.Y. Leung to get cooperation from the HK Treasury and the HK Monetary Authority to track down large-scale laundering and tax evasion through invoicing scams. As it is, the HKMA only goes after small fry and the old ladies used as intermediaries to keep up a pretence of stopping illicit flows. But that may have to change, hurting Hong Kong as badly as the crackdown on the mainland has ravaged Macau’s gambling and laundering industry, At the least, mainlanders may devise new ways of avoidance and re-invoicing – which would also avoid Hong Kong.

China can certainly claim that it is intending to do no more than developed countries also now promising to attack profits tax avoidance through low- and no-tax offshore centers. It also fits with government promises in the wake of the Panama disclosures to crack down on offshore companies being used for actual or potential illicit purposes, be they money laundering, evasion of exchange controls or tax avoidance. The latest Panama leaks by the International Consortium of Investigative Journalists deal with thousands of corporations instead of individuals. There may be ominous news lurking in the papers for mainland companies and their multinational counterparts.

Panama Papers hide trouble

China and Hong Kong between them account for about one quarter of the owners of the firms named in the Panama papers. Given President Xi’s attack on corruption, the papers add to China’s need to be seen to be doing something against capital flight and tax evasion. Those who have already got their money out – which doubtless includes most of the families of the party leadership and heads of major state enterprises – may have little to fear. But the flows will probably dwindle – and with them the revenue streams of the Hong Kong government and the territories lawyers and private bankers.

In the past, China was so awash with money coming in that it could afford to let some flow the other way. But times have changed, as has the political climate, with Hong Kong looking increasingly ungrateful for Beijing’s largesse. That is likely to spell trouble for a city that has so far escaped a good deal of trouble.