Hong Kong: Giving away the milk, never sold the cow.

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Hong Kong has only been saved from financial blacklisting in the recent past by Chinese intervention. The OECD gripes that Hong Kong is lagging in introducing legal measures to make it easier for its members to access bank accounts in Hong Kong. All that is about to change with the new amendments to the Inland Revenue Ordinance. What is a legislator to think?

Is Hong Kong sleepwalking itself out of a future deal with the world’s biggest economy? Or is it facing the inevitable?

The Hong Kong government has got religion when it comes to Comprehensive Double Taxation Agreements. This past Wednesday, LegCo moved the ball forward on 3 agreements – with Canada, Austria and Jersey – with little fanfare. Guernsey inked a deal on April 23 and April 1 saw treaties from 6 Asian and European companies come into effect. Hong Kong now has CDTAs coming into effect, being negotiated or being gazetted monthly. But some of its biggest trading partners may never be interested if Hong Kong gives away the best card in its hand over the next few months.

Alphabet Soup – EoI, TEIA and CDTAs

Comprehensive Double Taxation Agreements (CDTA) ensure that, simply put, income and profits in one jurisdiction are not taxed again in the partner jurisdiction. This encourages more natural trade flows and investment and ensures that funds generated in one jurisdiction are repatriated when appropriate, rather than being stashed away to avoid onerous penalties. Taxes on inbound cash have resulted in odd situations, such as Apple borrowing billions to return cash to shareholders even though it has massive cash reserves abroad. Apple keeps the money abroad to avoid US taxes on inbound income, hindering investment in America and returns to shareholders.

CDTAs require another legal agreement between countries before they come into effect. These are Exchange of Information Agreements (EoI). In addition to allowing authorities to verify tax claims made under CDTAs, they have other uses. They can be used to track fraud, illegal behaviour and tax cheats under-declaring assets or income in their home jurisdictions. Their uses have expanded from their original tax-only purpose. Many countries employ a tax philosophy alien to Hong Kong – that your global revenue and profits should all be taxed by the country in which you live (i.e. have primary residence for tax purposes).

America is almost unique in that also taxes its citizens living abroad. It is very interested in all its’ citizens incomes, including those in Hong Kong. It is rare among Hong Kong’s major trading partners to have not completed or entered negotiations on a CDTA (along with other top 15 trading partners Germany and Australia). Canada, France, China, Japan and 25 others have concluded negotiations. India, Korea, Macau, Saudi Arabia, the UAE and many more have negotiations under way. Singapore and Taiwan are holdouts from the top 15, but for special reasons, likely competitive and political, respectively.

Most countries engage in bilateral EoI’s with the intention of concluding CDTAs. However, in recent times, cash-strapped governments – primarily in the OECD – have become more interested in the EoI only. As their deficits grow and tax revenues plummet, they have become more aggressive in expanding their tax reach and chasing those evading taxes. They may consider a CDTA a drawback if it inspires their firms to relocate HQ or other operations in a lower-tax partner jurisdiction like say, Hong Kong. Caltex is one of the most famous examples of an American icon relocating to Singapore in 1999. Hong Kong has very different motivations. It has little interest in EOIs as it makes no claim on income generated offshore. It is very interested in CDTAs that may result in operations and legal entities coming to Hong Kong, generating jobs in its financial and managerial sector.

Some key partners would want Hong Kong to enact a TIEA – Tax Information Exchange Agreement with The Global Forum on Transparency and Exchange of Information for Tax Purposes . It is, in effect, unilaterally imposing an EoI on oneself usable by all Forum members- without the commitment of a CDTA from a counterparty. For revenue hungry countries chasing funds around the world, it makes sense to be ‘in the club’. For Hong Kong, it is all pain and no gain. How is Hong Kong reacting?

Rolling Over?

It seems the government’s primary interest right now is to avoid a blacklisting from Global Forum and create a legal structure whereby Hong Kong will offer up information without a CDTA in place. The Global Forum will be conducting a review of member compliance (including Hong Kong) later this year. The government seems desperate to get a good report.

From the Gazetting announcement of April 12, it refers to the ‘global backdrop’ and its importance to concluding future deals:

“Only through doing so can Hong Kong be able to continue with its efforts in negotiating CDTAs with existing as well as potential partners, whilst providing in place a legal framework for TIEAs for Hong Kong to meet its international obligations.”

The government makes assurances about protecting privacy from unjustified requests from prying governments. Its ability to stand by this commitment will be of interest to the millions of Hong Kong residents that hold foreign passports, although many of those key countries already have EoIs with Hong Kong in place (Canada, UK). Most aren’t concerned about Hong Kong residents, just assets their residents may have in Hong Kong.

The Hong Kong General Chamber’s CEO Shirley Yuen raised concerns about privacy and the vagueness of threatened sanctions from Global Forum members in their submission of last year, noting Hong Kong’s already strong record in working with global authorities in criminal matters.

But has it given up a useful tool to maintain its supremacy as a centre for regional HQ’s? Given its stated commitment to securing DTAs with major economic partners, will partners be interested once they have a de facto EoI, through the TIEA, without requiring a commitment to a CDTA?

The Hong Kong Institute of Certified Public Accountants questioned whether “by providing the legal framework for entering into TIEAs with other jurisdictions, Hong Kong’s ability to conclude further CDTAs will be hindered and whether even existing CDTAs may in future be terminated or not updated over time.”

In other words, why buy (or maintain) the cow, when you already have all the milk? In 2012, the HKICPA was explicit: “Hong Kong should not be forced into a situation where it is obliged to provide EoI without anything in return. We consider that Hong Kong’s existing priority, of agreeing to EoI only in the context of a CDTA, strikes a reasonable balance between providing EoI to a partner jurisdiction on the one hand, and obtaining benefits for Hong Kong taxpayers…”

If blacklisting, still of undefined consequences, proves too much, they recommended TIEA-light, so those seeking access to Hong Kong still have some, albeit weakened, motivation to negotiate a CDTA.

Among Hong Kong’s top trading partners, the USA, Germany and Australia have neither started negotiating or concluded CDTAs with Hong Kong. Will they in the future?

The American Chamber of Commerce in Hong Kong has pushed the issue repeatedly in their annual ‘DoorKnocker” visits to Washington DC, thus far without success. The Australian business community here has likewise met with little success on this front.

Whither LegCo?

The government gazetted the bill on April 12 and first and second reading passed on April 24 and it was off to Bills Committee from there. Just this past Wednesday, Kenneth Leung (FAccountancy) spoke to HT about this 4 page bill. He had just been nominated Chair of the Bills Committee that morning.

He explained that many of the concerns expressed in previous consultations were still held by some of the members. They related to issues surrounding privacy. He felt the IRD had been fairly meticulous about making serious demands of countries requesting information and was responsible in handling requests. He was not aware of any major complaints with any of the cases previously handled.

So who is driving this anyways?

To this issue of giving up the only thing Hong Kong had to hold back – information – he seemed to think it was a bit of a non-issue. The hold-outs among Hong Kong’s major partners wouldn’t be signing on for a CDTA any time soon – if ever. They just don’t seem interested.

In fact, Hong Kong needs to become compliant with FATCA – the Americans’ Foreign Account Tax Compliance Act. With it, the Americans have effectively strong-armed the world into offering up financial information on the pain of being blocked from transacting with American linked financial institutions. Which includes pretty much everyone using USD. Given that Hong Kong has no choice (save exiting the global financial system), it might as well enact the legislation to be compliant in time for the 2014 deadline.

If almost all the OECD countries have agreements in Hong Kong, and the Americans are forcing compliance, does that leave Germany and Australia cast as those pushing the OECD to pressure Hong Kong?. Threatening grey-listing and black-listing and branding as a ‘tax haven’?

Not really. Apparently the OECD are a bureaucracy unto themselves, quite independent of their national governments. As Mr. Leung put it, “OECD top management want everyone to be members of the club.” The national governments generally respect Hong Kong’s compliance and regulatory environment. It’s seems to be a case of out of control peer pressure.

The High Road

On the issue of CDTAs and the TIEA then, it seems Hong Kong has one road to take – the high road. If national governments support the OECD which, on their behalf, conducts a campaign of shaming with non-compliance (even when mostly compliant), and, like the US, enforces regulatory compliance and places administrative burden on Hong Kong, then Hong Kong has a moral case.

Legislators can choose to make a statement and defy the OECD and United States. The OECD sanctions, aside from, as one economist put it ‘fingerwagging’ – seem vague and of undeterminable impact. Finger wagging would be a certainty and legislators would have to live with that responsibility. However, almost all the OECD members happily have EoI agreements and even CDTAs and all is well.

FATCA, however, has real teeth. Defiance will have real consequences. It is an American problem that has been made our problem. If Hong Kong must have this then, our legislators and government should take every opportunity to remind their counterparts in CDTA holdouts that we are compliant and now they are the holdouts. Rather than Hong Kong being the sole Global Forum jurisdiction that is holding out, America, Germany and Australia are the DTA hold-outs against fully compliant Hong Kong. The high road may not stand against realpolitik, but sometimes, it is the only road one has.