HK budget: first step on a bumpy road to GST

2003/2004 Budget Highlights

Economic Indicators

• 2.3% increase in GDP in 2002/2003. A 3% increase in GDP is forecast for 2003/2004. Medium term growth forecast is also estimated to be 3%.
• A consolidated budget deficit of HK$70 billion forecasted for 2002/2003 as compared with a deficit of HK$45.2 billion announced this time last year for the same period.
• Deflation for 2002/2003 of 3%, with 1.5% forecasted deflation for 2003/2004.
• A consolidated budget surplus of HK$8.4 billion forecasted for 2007/2008. At the end of 2007/2008, the Government is projected to have fiscal reserves of around HK$202 billion, equivalent to 10 months of total Government expenditure.

Profits Tax

• Corporate Profits Tax rate increased to 17.5% in 2003/2004. Rate increased to 15.5% and 16% for unincorporated businesses in 2003/2004 and 2004/2005 respectively.
• Profits tax concessions for qualified debt instruments to be enhanced. Offshore funds to be exempted from profits tax.

Salaries Tax

• Restore the marginal Salaries Tax bands and marginal tax rates to 1997/1998 levels, namely bands of HK$30,000 and rates of 2%, 8%, 14% and 20%. The standard rate is to be increased to 16%.
• Restore the basic and married person's allowances to 1997/1998 levels, namely HK$100,000 and HK$200,000 respectively.
• The above measures will be phased in equally over two years.
• Increase allowance for third to ninth child to HK$30,000.
• Tax exemption for holiday warrant and passage to be removed.

Government Duties and Charges

• No increases in tobacco duties, duties on alcoholic liquor, fuel duties or hotel accommodation tax.
• No changes to Stamp Duty or Estate Duty rates or bands.
• No changes in Rates.
• Changes to Government fees and charges to be announced at a later date after consultation with the Policy Bureaux.
• Duty concession for ultra low sulphur diesel to be extended for another year.

Others

• Air Passenger Departure Tax to be increased from HK$80 to HK$120. Boundary Facilities Improvement Tax for departures by land to be introduced, but timetable not defined.
• Exemption from Motor Vehicle First Registration Tax for accessories and distributor's warranties to be abolished. Tax bands and widths to be adjusted, and a marginal rate tax system to be introduced.
• Property Tax increased by 1% point to 16% over two years.
• Tax deductible limit for charitable donations increased from 10% to 25% of assessable profits or income.
• Betting Duty increased from 19% to 20%.
• Football Betting Tax to be introduced at a rate of 50% of gross profits.
• Acceptance that a Goods and Service Tax to broaden the tax base and secure a stable source of public revenue is necessary in the long term.
• HK$112 billion to be raised from sale or securitisation of Government assets.
• Restoration of civil service salaries to 1997 levels in cash terms in two phases over two years. Reduce civil service numbers by 10% by 2006/2007, launch second round of Voluntary Retirement scheme, and freeze recruitment.
• Reduction in social security payments by 10%.

On 5 March 2003, Financial Secretary, Mr Antony Leung, delivered his second budget speech. Unlike his maiden speech, his second speech was full of measures which he hopes will address Hong Kong's structural deficit problem.

Perhaps the most significant feature of Mr Leung's speech was that it seems that the Government now accepts that a Goods and Services Tax ("GST") has to be introduced in the long term in order to broaden Hong Kong's tax base and secure a stable source of public revenue. As no definite timetable for this has been provided, some may ask what "long term" means. Another question is what, if any, sweetener can or will be offered to cushion the introduction of such a tax. Others who have ventured down this path before Hong Kong have done this. In a few years we may therefore find some, or all, of the revenue raising measures which Mr Leung unveiled being reversed to compensate for the introduction of a GST.

In the meantime, Mr Leung reaffirmed the Government's three-pronged solution to tackling the deficit problem: reducing expenditure, raising taxes, and boosting economic activity.

So far as reducing expenditure was concerned, no specific new measures beyond the reduction in social security payments, civil servants pay, and civil servant numbers revealed prior to Mr Leung's speech were announced.

Whilst Mr Leung indicated that the Government was not totally against the idea of issuing bonds to fund Government expenditure, he explained that such a step would not solve Hong Kong's deficit problem. Whilst we agree with this, there are other benefits which may merit it. Although acknowledging that issuing bonds to fund investment in capital infrastructure projects was acceptable, he has chosen instead to finance such projects in part using the proceeds from the sale or securitisation of Government assets over the next five years. The unanswered question is what specific assets can or will the Government sell to raise the HK$112 billion of revenue targeted by Mr Leung?

A raft of revenue raising measures were announced. In total, these are expected to raise additional revenue of HK$14 billion a year once fully implemented. Mr Leung warned that further measures to raise an additional HK$6 billion of revenue could be necessary over the next three years. He however gave no indication on what these additional measures might be.

The Salaries Tax measures announced by Mr Leung will raise an additional HK$6.8 billion of revenue. However, it is important to note that the vast majority of this burden will fall upon the same 200,000 of taxpayers who currently pay almost 80% of the Government's total salaries tax collections. The abolition of the tax exemption for holiday warrant and passage will also be an additional burden for many of these taxpayers. Whilst the reduction in personal allowances will bring an additional 90,000 or so taxpayers into the tax net, the tax collected from these individuals will be insignificant.

On the Profits Tax side, the increase in the rate for corporate taxpayers to 17.5% was more than we had expected. Mr Leung has assured us that Hong Kong's competitive edge will not be affected by the increase. We hope that he is correct, but some in the community may question this given the general trend globally to reduce corporate tax rates. Further, the narrowing differential between the tax rates in Singapore and Hong Kong may also be a concern.

In addition to the commitment to introduce a GST in the long term, Mr Leung's speech contained a number of other surprises. These included the increase in the taxable proportion of certain "royalty" payments made by Hong Kong businesses. This will result in an increase from 1.6% to 5.25% in the rate of tax applicable to such payments. However, by international standards, this is still low.

A welcome measure was the confirmation of the Government's intention to exempt offshore funds from Profits Tax.

Overall, we believe that in this his second budget Mr Leung has attempted to address Hong Kong's deficit problem. He has been bolder and more courageous than he was in his first budget. Whether he will be successful in his endeavours remains to be seen, especially given the uncertain global economic climate today. Further, if the forecasted growth in the Hong Kong economy over the next five years does not materialise, further pain may unfortunately be ahead.

Marcellus Wong	Guy Ellis	Rod Houng-Lee