FISCAL POLICY – Expenditures Amid A Pessimistic Outlook

Hong Kong’s Financial Secretary John C Tsang has recently delivered his ninth annual Budget on government spending for the coming year – in a fashion considered nearly identical to those of the previous eight years. With the continuation of a government fiscal policy deemed conservative, there are few surprises despite a range of short-term, one-off relief measures intended to alleviate pressure in a volatile global economy. Let’s hear what three renowned professional services firms – PwC, Deloitte, and EY – have to say about the 2016-17 Hong Kong Budget

By Kenny Lau


PwC: Breadth, Not Depth

In the 2016-17 Hong Kong Budget, Financial Secretary John Tsang “has not departed from his prudent fiscal management philosophy,” PwC believes. In other words, it is a continuation of a fiscally conservative approach in government spending as in the past eight years, despite offering billions of dollars in “sweeteners” on a wide range of short-term one-off relief measures. He has also cautioned explicitly the possibility of more economic and political volatility in the year ahead.

In addition to a forecast of a 2015-16 provisional budget surplus of HK$30 billion – or HK$75 billion if the Housing Reserve of HK$45 billion is included, Tsang has proposed a number of measures “to cultivate new businesses, technologies and talent” as part of a collective effort to “shore up Hong Kong’s competitiveness.”

Most relevant to the individual employee is the increase in basic allowance (deductions) from HK$120,000 to HK$132,000 and from HK$240,000 to HK$264,000, for single and married persons, respectively. The increase fell short of PwC’s recommendations and is more of an adjustment to the skyrocketing level of inflation people of Hong Kong have had to endure in the past few years.

One-off items

All of the one-time measures, such as the refund of salaries tax and waiver of rates as well as the revision of allowances for people supporting dependent parents or grandparents, are of “recurring” themes – measures Tsang hopes will “alleviate the financial pressure [and] spur domestic economic growth.” The idea is also applied through waiving business registration and other license-related fees and extending the application period for SMEs interested in the Financing Guarantee Scheme.

What’s encouraging, PwC notes, is Tsang’s moves to “embrace the adoption of technological breakthroughs in financial services and to cultivate start-ups and R&D in this area.” That is aligned to results of PwC’s 19th Annual Global CEO Survey, in which 77 percent of respondents believed technological advances are a top trend poised to “transform wider stakeholder expectations of businesses within their sectors over the next five years.”

While the development of technology in financial services, startups, and SMEs may help to “reinvigorate services and redefine offerings in a rapidly evolving environment,” they may not be “sufficient to stimulate sustainable advances and stabilize the economy,” according to PwC. “Reducing the profits tax rate from 16.5 to 10 percent for qualifying high-tech companies and [providing] additional tax relief and incentives to encourage growth” may prove to be more effective.

Long-term items

The allocation of some surplus into the Future Fund (in addition to the HK$220 billion from the Land Fund) reflects an anticipation of a government structural deficit down the road, and it is “a responsible and prudent step in planning and financing the city’s future,” PwC points out. “The HK$45 billion top-up into the Housing Reserve will strengthen the financial health of the Housing Authority [in support of an increasing] supply of public housing.”

Setting aside HK$200 billion to expand and upgrade healthcare facilities in a 10-year hospital development plan amid an aging population is “commendable,” but it is largely on the hardware. Investment in the software – attracting, training and retaining healthcare workers for the public healthcare system – is equally, if not more, important.

The “prudent approach” to government spending is “perhaps understandable,” given an economic outlook far less optimistic than in previous years, PwC believes. What’s important is “whether his proposals will be fully implemented in a timely manner to the intended effect.” Lastly, a comprehensive review of the Inland Revenue Ordinance as a first step towards a modernized tax legislation is “long overdue.”

Deloitte: No ‘Exciting’ Relief Measures

While the 2016-17 Budget is a commitment to long-term growth with measures to nurture innovation, identify new markets and foster talent development, there is a lack of exciting short-term relief measures to help alleviate pressure on the individual and corporate levels, according to Deloitte’s analysis.

On the positive side: The focus on innovation and new markets through rapid development of information technology can “energize” under what Financial Secretary John Tsang calls the “New Economic Order,” says Yvonne Law, Partner, Deloitte China. “The government is aware of the importance of Fintech in shaping the future of Hong Kong, and there are programs and measures to promote research and the development of start-ups and creative industries.”

Hong Kong is also aware of the increasing need to remain relevant in the global market, and the government intends to “leverage Hong Kong’s long standing competitive advantages of having one of the most efficient and transparent regulatory regimes” through the proposed measures announced in the Budget in a way which is “also in tandem with the deepening of reforms in China.”

The three-runway system, support for the work of Asian Infrastructure Investment Bank as well as trade and investment agreements are “initiatives to find new markets.”

On the not-so-positive side: The proposed short-term relief measures are “unexciting,” despite that fact that “nearly two million taxpayers will benefit from the increase in basic allowance and married person’s allowance,” notes Davy Yun, Tax Partner, Deloitte China. “With ample fiscal reserves, the government could be more aggressive in relief measures, especially for the business community.”

One important key, Yun points out, is the lack of proposed “action to address the problem of a narrow tax base” even as the government has taken significant steps in preparing for the future with a “foresight to invest our fiscal reserves for Hong Kong’s long-term [needs] through the Future Fund.”

For the people

While the increases in deductible allowances are largely beneficial to the middle class, the government could have considered introducing tax allowances for working couples through further deductions for expenses relating to children’s education and salary to domestic helpers, Deloitte highlights in a commentary. The budget could also have introduced deductions for “medical insurance premium” for taxpayers and their dependents.

Deloitte also considers Hong Kong’s role as an international trading center to be an equally critical pillar industry, an area which could use – and deserves – more support from the government by putting forward tax incentives for foreign-owned companies engaged in the trading business in the city. This is simply to take advantage of Hong Kong’s geographical location as a global trading center in Asia already equipped with a network of well-developed infrastructure.

An amount totaling HK$800 million intended for elderly residential care services with 3,000 vouchers under a three-year pilot scheme will provide some assistance to the elderly. The one-month extra allowance to recipients of social welfare benefits, including those of the CSSA, Old Age Allowance, Old Age Living Allowance and Disability Allowance, also reflects a focus on the needy.

The larger question, however, is about an aging population – an issue for which “the government will need a more comprehensive plan to tackle” in the long run, says Alfred Chan, Tax Director, Deloitte China. “We are pleased that the government has held consultations on setting up a universal retirement scheme, and we hope the government is able to find a solution that balances the need for retirement care while allaying the [fiscal] pressure on long-term expenditure.”

Broader issues

The Budget essentially contains a plan of “long-term directions” and “immediate measures for various industries to [build on] Hong Kong’s advantages and gear up for an economic downturn. Immediate reliefs include waivers of the business registration fee and of license fees for the tourism and catering industries. The government has also announced it will examine the use of tax concessions to promote the aircraft leasing business.

The Profits Tax rate remains the same for 2016/17 – 16.5 percent generally and 15 percent for incorporated businesses. But a one-time tax rebate of 75 percent of Profits Tax payable for 2015/16 has been proposed, up to a ceiling of HK$20,000. A further reduction in the rate could help Hong Kong maintain its competitive edge over the long term at the cost of a short-term reduction in tax revenue, Deloitte suggests, even though Hong Kong’s low Profits Tax rate is considered quite competitive in attracting foreign investment.

The Budget is comprehensive for individuals, with a broad coverage of relief measures catering to “the underprivileged, the working class and middle income earners” in ways similar to measures of previous years, Deloitte notes. “From a business perspective, although a strategy has been set out to explore new markets and nurture innovation for sustainable economic growth, short-term relief measures for businesses are fewer than expected.”

EY: Diversification in Midst of Paradigm Shifts

The economic challenges facing Hong Kong are a result of “breakthroughs in IT which have had an impact on both traditional and emerging industries…and have led to a more open market ecosystem, [causing] ground-breaking paradigm shifts that have impacted existing market players,” according to EY’s interpretation of the 2016-17 Budget. The need for economic diversification, hence, has never been more crucial.

Financial Secretary John Tsang, EY notes, has “opted for a more creative game plan,” with a much larger focus on innovation, new markets and talent development, while dropping “the usual monologue concerning the four [legacy] pillars of Hong Kong’s economy.” The concern, however, is that “Hong Kong has no track record in certain of the areas Mr Tsang [has] proposed to develop.”

“Sweeteners”

The handout of “sweeteners” has become “somewhat of an annual rite” that is “coming under ever-increasing scrutiny, with other fee waivers and tax concessions labeled as having “done little to reduce the gap between Hong Kong’s rich and poor and to address concerns over Hong Kong’s aging population or its narrow tax base.” And many argue the increase in expenditures on education, social welfare and healthcare services “are not of sufficient magnitude.”

Nonetheless, “given that Hong Kong may be entering a challenging era of slow economic growth this year, the proposed one-off relief measures would help alleviate the tax burdens of individuals and enterprises, and help those within the social security net to better face the challenges ahead,” says Agnes Chan, Managing Partner for Hong Kong and Macau, EY.

The 10-percent increase in tax deductible allowances for single and married persons as well as single parents – which were last revised in the 2011/12 year of assessment – is indicative of inflation over the years, notes Grace Tang, Partner, Tax and Business Advisory Services at EY, adding that the proposed 75-percent reduction for the 2015/16 final tax, capped at HK$20,000, is a targeted approach primarily intended to benefit middle lower income earners.

“We welcome the proposed increase in dependent parents/grandparents allowance and the increased deduction ceiling for elderly residential care expenses,” Tang says.

“However, whilst an additional allowance of an equivalent amount is currently granted to taxpayers who live with their dependents, there are often situations that prevent taxpayers from doing so.”

“We hope the government will consider adopting our proposal that taxpayers would be granted the full amount of the additional allowances, regardless of whether they reside with their dependents, so long as the remaining qualifying conditions are met,” she adds.

Other initiatives

On IP rights, Tsang will expand the scope of tax deduction from the existing five categories to include rights of integrated circuit designs and other related items, but can also consider such tax deductions for certain license rights and indefeasible rights of use typically acquired in the telecommunication industry. But Hong Kong needs to examine whether the current requirement of legal ownership of IP rights as a pre-condition for granting any tax deduction should remain.

The proposal of granting tax deductions for interest paid by a Hong Kong corporate treasury company (CTC) to its overseas affiliates and of levying a 50-percent concessionary tax rate on certain profits may not turn out to be as striking as expected because it can be “difficult to calculate how much overseas tax paid in a current year or a subsequent year is attributable to the interest or sum concerned.”

In turn, a simple “subject to tax” requirement may be an alternative in the promotion of Hong Kong as a corporate treasury center, EY notes. “Given that Singapore grants similar tax incentives more flexibly, [we] may need to consider the suggestion that a concessionary tax rate be granted so long as the relevant activities undertaken by a CTC satisfy the qualifying conditions defined in the legislation.”

To promote the local asset management industry, Hong Kong is contemplating with the idea of allowing the structure of “open-ended fund companies” (OFCs) – which is “a collective investment scheme structured in corporate form with limited liability and variable share capital.”

Because exemption from profits tax will only be granted when an “unauthorized” OFC is a “non-Hong Kong resident…a new separate profit tax exemption regime for resident OFCs” in Hong Kong is therefore considered beneficial.

Despite a forecast of deficits in two years’ time (with fiscal reserves of some HK$860 billion dropping to HK$830 billion by early 2020), there should be no cause to be overly concerned, EY believes. “If Hong Kong is successful in diversifying its economy, our fiscal reserves may not fall and our government may also be able to increase its recurrent expenditure program to better serve the needs of Hong Kong’s aging population.”

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s