The current political situation in Hong Kong has been at the top of the global news cycle for the better part of two years. In 2019 the news was dominated by pro-democracy political protests. In 2020 reporting on Hong Kong focused on the Central Government’s imposition of the National Security Law, the strong enforcement provisions of which resulted in the abrupt silencing of these political protests. Reactions to the National Security Law from around the world included condemnation from global leaders and US sanctions of certain Hong Kong and China government officials involved in the National Security Law promulgation[1]. The US went further still with the removal of Hong Kong’s separate status from China under certain provisions of US law[2]. More recently, this month, Hong Kong is again at the top of the global news cycle as a result of revisions to Hong Kong’s electoral system by the Central Government in Beijing, which revisions have been widely viewed as the formal end of Hong Kong’s democratic experiment under the “One Country, Two Systems” governance model.[3]
Along with these developments in Hong Kong over the past two years has been media reports consisting primarily of anecdotes of multinational companies moving significant staff out of Hong Kong or relocating their regional headquarters out of Hong Kong entirely. As a natural reaction to this news, well-known multinational companies have been debating internally or imminently planning similar moves. Notwithstanding the political and legal developments in Hong Kong, it is important to re-focus attention on the commercial and strategic reasons why multinational corporations chose Hong Kong as their principal hub for China business operations or even broader Asia Pacific business operations. Hong Kong’s draw for these global companies has been based largely on five key characteristics.
These core attributes have not been granted to Hong Kong by an act of either the National People’s Congress in Beijing or the US Congress in Washington. Consequently, Hong Kong’s favourable business attributes have not been affected by the National Security Law or changes to the Hong Kong electoral system nor by a US decision regarding its treatment of Hong Kong under US law.
1. Attractive corporate tax rates assessed on a territorial source of profits basis
Global accounting firm PwC conducted a survey in conjunction with the World Bank in which Hong Kong was determined to be the most business-friendly tax system in Asia and the second most business-friendly tax system in world amongst 190 tax jurisdictions[4]. Under Hong Kong’s low and simple tax system corporate profits are taxed at just 8.25 per cent on the first HK$2 million (US$255,000), after which the prevailing rate of 16.5 per cent applies. Salaries tax is capped at 15 per cent. There is no inheritance tax, no withholding taxes, no capital gains tax and no GST or VAT in Hong Kong.
Moreover, Hong Kong’s territorial basis for assessing tax has always been a fundamental benefit for multinationals operating in Hong Kong. This territorial system results in only those profits which arise in or are derived from Hong Kong are liable to profits tax in Hong Kong. This enables global corporations to leverage Hong Kong as a headquarters for China and Asia Pacific business in a tax efficient manner. While the question territorial source has been litigated several times over the years[5], the transparency available into these previous decisions of the Hong Kong Internal Revenue Department and judicial precedents on the resolution of such disputes enables multinationals to appropriately plan and structure their operations with the level of predictability and certainty necessary for large global corporations.
Finally, it is important to note that these tax benefits are entirely outside the scope of China’s legislative and enforcement changes over Hong Kong. There may be some who speculate that disputing IRD determinations could soon become politically unwise in a way similar to disputing decisions of the State Administration of Taxation decisions may be viewed in Mainland China. There may even be attractive logic in this speculation as Hong Kong is governed more directly by the Central Government in Beijing. Nevertheless, no such actions have been taken and no threats of such actions have been made by Beijing.
2. Market access to, and well-developed logistics infrastructure with, the World’s second largest economy
Mainland China and Hong Kong entered into a broad framework agreement in 2015, the Closer Economic Partnership Agreement (CEPA)[6]. In 2017, China and Hong Kong signed the Investment Agreement under CEPA, which extends investment access for Hong Kong investors into several sectors, including manufacturing, mining and investment, CEPA covered only services sectors[7].
The Investment Agreement grants preferential investment access to non-service sectors using a ‘negative list’ approach, under which it is presumed that a sector is open for investment by Hong Kong investors if it does not fall within one of the 26 categories listed in the negative list (e.g., the manufacture of transportation carriers, exploitation of natural gas and radioactive mineral resources). Under the Investment Agreement, Hong Kong businesses can also expect better investment protections in the form of uniform procedures to approve investments within a reasonable timeframe and the implementation of a dispute resolution mechanism under article 20 of the Investment Agreement[8].
In addition to the market access provisions and investor protections under CEPA, Hong Kong also benefits from preferential tax rates with China. Withholding taxes on interest, dividends and royalties are generally 10% when paid outside of China. Such payments made to qualified Hong Kong entities benefit from lower rates from 5% on dividends and certain royalties to 7% on interest payments[9]. These treaty benefits bestowed upon qualified Hong Kong entities underscore the enormous volume of trade that continues between Hong Kong and Mainland China.
According to the Census and Statistics Department of Hong Kong, the SAR remains China’s third largest trading partner behind only the United States and Japan[10]. More than 77% of this trade is made via road transportation over land border crossings[11]. In fact, further trade and economic integration between Hong Kong and Mainland China is central to China’s ambitious Greater Bay Area plan[12]. Under this plan, the movement of people and merchandise will be facilitated amongst the cities of Southern China including Hong Kong, Macau, Zhuhai, Shenzhen and Guangzhou. Between these cities are the world’s busiest container and airports as well as increasing land border crossings.
Unique investor protections, access to the Mainland market, preferential tax rates, and seamless logics infrastructure between Hong Kong China will maintain Hong Kong’s leading role for multinational corporations seeking to enter the world’s second largest economy.
3. Sophisticated global banking and financing capacity
Hong Kong is the largest global offshore RMB foreign exchange market, with an average daily turnover in excess of the second and third largest offshore RMB markets—London and Singapore—combined[13]. Further to the market access and investor benefits discussed above, China’s ministry of Commerce in 2020 released statistics showing that Hong Kong was responsible for more than half of the foreign investment in China over the past ten years[14]. In 2018, Hong Kong accounted for nearly two thirds of all foreign direct investment into China[15].
Hong Kong’s banks remain amongst the most sophisticated and trusted banks in the world. With advanced and innovative fintech regulatory facilitation, one of the world’s leading capital and debt markets, and a trusted legal and judicial structure supporting these attributes, Hong Kong is not likely to lose its role as a leading financial hub for international investors into China or across the Asia Pacific region more broadly.
4. Improved predictability and transparency for commercial disputes and regulatory controversies such as tax disputes with the Internal Revenue Department; and last but certainly not least
Hong Kong’s English common law system remains among the most significant reasons why multinational corporations have chosen Hong Kong as their hub for China or broader Asia Pacific business operations. There are growing concerns over whether China’s more direct authority over Hong Kong generally or the National Security Law specifically will impact upon Hong Kong’s common law system. However, Hong Kong’s common law system—particularly for commercial disputes and regulatory controversy—is alive and well.
As recently as 2019, the World Economic Forum affirmed Hong Kong’s judicial independence rankings, which is a ranking of courts that are not subject to improper influence from the other branches of government or from private or partisan interests. WEF ranked Hong Kong first in Asia and thirteenth overall globally, for judicial independence[16]. Many may point to recent political arrests in Hong Kong under the National Security Law as evidence of the erosion of this independence even since 2019. However, in his first public speech and press conference after his appointment, Chief Justice Andrew Cheung stated that “It [his] mission to do [his] utmost to uphold the independence and impartiality of the Hong Kong judiciary.[17]”
There are recent case examples that demonstrate Hong Kong’s ongoing commitment to judicial independence. Specifically in the commercial controversy space and potential disputes with Chinese State-Owned Enterprises, the Hong Kong courts have shown that sovereign immunity will not apply to Chinese SOEs[18]. Consequently, SOEs can be sued in the Hong Kong courts, and enforcement and execution can be made against their assets. This should provide comfort to international investors doing business with Chinese SOEs and further distinguishes Hong Kong from Mainland China in adjudicating commercial disputes.
In addition to the courts in Hong Kong, its arbitral bodies including the Hong Kong International Arbitration Centre (HKIAC) and International Chamber of Arbitration are amongst the most trusted in the world. Indeed, Hong Kong has an advantage for arbitrations involving mainland China. The Arrangement Concerning Mutual Assistance in Aid of Arbitral Proceedings by the Court of Mainland and of the Hong Kong Special Administrative Region came into effect on 1 October 2019[19]. Hong Kong is the only jurisdiction from which Chinese courts can grant interim measures in an arbitration.
For all of these reasons, Hong Kong mature, well-established common law system and trusted arbitral institutions, especially as it relates to potential disputes involving Mainland China parties and interests, remain superior to the alternatives.
5. The human capital available in Hong Kong which remains amongst the best educated, highest quality workforces in Asia if not globally.
Last, but certainly not least, is the important role that Hong Kong’s workforce plays in how multinational corporations decide the locations for their regional and global headquarters operations. In this regard, Hong Kong’s leading role is unlikely to change. In fact, Hong Kong ranked fourth in the World Bank’s new Human Capital Index, which ranks countries on how well prepared their children are for the future[20]. The index suggests that the higher the investment in education and health, the more productive and higher earning a workforce will be.
Hong Kong ranks similarly in the World Economic Forum’s annual guide to competitive economies around the world[21]. Hong Kong regularly ranks amongst the most competitive economies in the world, based largely upon its human capital advantage.
There have been many reports of young professionals and students in Hong Kong contemplating leaving Hong Kong in light of recent political upheavals. However, news reporting and anecdotes notwithstanding, Hong Kong is likely to retain this competitive advantage as the factors that contribute to tis measurement remain unchanged. Hong Kong’s well educated, multi-lingual population will continue to be a draw for global corporations and international investors for the foreseeable future.
Conclusion
Hong Kong has been through a significant amount of turmoil over the past two years. Nevertheless, it is worth remembering that Hong Kong has survived much turmoil in the past. These five key factors, amongst countless others, will see Hong Kong’s role as a leading hub for China and Asia Pacific business operations to continue. Much has also been said about the treatment or status of Hong Kong under US law. In this regard it is important to note that none of the significant factors that have made Hong Kong the leading business hub it is today has anything to do with US law. In fact, it is entirely dependent upon Hong Kong’s own legal and regulatory infrastructure and its proximity to and relationship with the world’s second largest economy that have been its key competitive advantages. Moreover, none of these factors depend directly on Mainland Chinese law. These factors are not in dispute and have not be upended by the recent turmoil. Hong Kong remains a preferred regional hub and is expected to continue to fill that role for the foreseeable future.
[1] Security Law Comes into Effect, June 30, 2021 (available at https://www.news.gov.hk/eng/2020/06/20200630/20200630_230351_787.html )
[2] President Trump’s Executive Order on Hong Kong Normalization, E.O. 13936 of Jul 14, 2020 (85 FR 43413, July 17, 2020).
[3] Decision of the National People’s Congress on Improving the Electoral System of the Hong Kong Special Administrative Region, March 11, 2021 (text available at http://www.xinhuanet.com/politics/2021-03/11/c_1127199305.htm )
[4] PwC Report: Paying Taxes in 2020 (available at https://www.pwc.com/gx/en/services/tax/publications/paying-taxes-2020/overall-ranking-and-data-tables.html?WT.mc_id=CT13-PL1300-DM2-TR2-LS1-ND30-TTA4-CN_payingtaxes-2019-ranking-data-table-button%20 ).
[5] See, Consco Trading Co Ltd v Comm. Of Internal Revenue, CFA 2004; Comm. of Inland Revenue v Li & Fung (Trading) Limited, HCIA 3/2010; Kim Eng Securities (Hong Kong) Limited v Comm. Internal Revenue, CFA 2014;
[6] Consolidated Text of Closer Economic Partnership Agreement between the Hong Kong Special Administrative Region and the People’s Republic of China (available at https://www.tid.gov.hk/english/cepa/files/main_e.pdf).
[7] Id.
[8] Mainland China and Hong Kong Closer Economic Partnership Investment Agreement (main text available at https://www.tid.gov.hk/english/cepa/legaltext/files/cepa14_main.pdf).
[9] Summary available at https://taxsummaries.pwc.com/peoples-republic-of-china/corporate/withholding-taxes (updated January 5, 2021)
[10] Hong Kong Monthly Digest of Statistics June 2020 at Para. 1.2 (available at https://www.statistics.gov.hk/pub/B72006FC2020XXXXB0100.pdf).
[11] Id. at Para. 2.2.
[12] See the Outline Development Plan for the Guangdong-Hong Kong-Macao Greater Bay Area (available at https://www.bayarea.gov.hk/filemanager/en/share/pdf/Outline_Development_Plan.pdf)
[13] See HKMA Report, Hong Kong: Global RMB Hub available at https://www.hkma.gov.hk/media/eng/doc/key-functions/monetary-stability/rmb-business-in-hong-kong/hkma-rmb-booklet.pdf
[14] See National Assimilation of Foreign Investment Report from the Ministry of Commerce of the People’s Republic of China, available at http://english.mofcom.gov.cn/article/statistic/foreigninvestment/201812/20181202815485.shtml
[15] Id.
[16] World Economic Forum Judicial Independence Scope Card 2018 available at https://reports.weforum.org/pdf/gci-2017-2018-scorecard/WEF_GCI_2017_2018_Scorecard_EOSQ144.pdf
[17] See https://www.cnn.com/2021/01/12/asia/hong-kong-judiciary-china-intl-hnk/index.html
[18] See, TNB Fuel Services SDN BHD v. China National Coal Group Corp (2017).
[19] Arrangement Concerning Mutual Assistance in Aid of Arbitral Proceedings by the Court of Mainland and of the Hong Kong Special Administrative Region available at https://www.doj.gov.hk/en/mainland_and_macao/pdf/arbitration_interim_e.pdf
[20] See, https://www.worldbank.org/en/publication/human-capital#Index
[21] World Economic Forum Global Competitive Report 2020 available at http://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2020.pdf