Asian Tax Review: Poetic Injustice in The Pearl River Delta

By Laurence E. Lipsher

Let’s get one thing straight before we delve into taxes: There really is no poetic injustice around here other than my occasional attempts at haikus, blues riffs, or poetry. I’m not good at it — I openly admit that — but, hey, I can get away with it more often than not for the simple reason that I need something to motivate me into writing a biweekly (mostly) tax-oriented article. And this sort of craziness hopefully keeps you, the reader, interested because you are unable to anticipate what I’ll come up with next. And so, without further ado:

Took a day off in Guangzhou,
Weather’s nice and clear . . .
Thought there’d be some traffic because of the
Guangzhou Trade Fair.
But there were plenty of taxis in search of a fare,
Because, alas, there ain’t no one there.

It’s all about the economy — or lack thereof. The 106th semiannual Guangzhou Trade Fair ran from October 15 through November 4. If you believe what you read in the newspapers, this fair was supposed to be substantially busier than the last one, which took place in April. The city of Guangzhou, where the country’s most ambitious beggars and women of the night gather during the last half of every October and April, has been filling both the local and national press with statistics showing at the very start of the fair a ‘‘prominent’’ increase in orders from last April, when trade values slumped 17 percent. At least that’s what Xinhuanet stated in an October 16 press release, which hit both the China Daily and People’s Daily that day. Only 17 percent? I think it was worse than that.

The event, which started in 1957, has been a good barometer of demand for Chinese exports, and local radio news reports touted heavy traffic at the fair and increased order volume. And yet:

• During my time at the fair, I had absolutely no problems finding a taxi, and every cab driver I spoke with said the same thing: ‘‘Where are the crowds?
• A restaurant I went to the first weekend, which brought out its special fair menu and charged a 10 percent price increase, returned to its regular menu by the second weekend.
• You’d never know there was a trade fair in town by walking the lobbies of the two most prominent hotels in Guangzhou — which I did as my own barometer of the local economy. While I wouldn’t go so far as to say that either lobby looked like a morgue, they were quiet and devoid of visitors.
Just as I gauge the Hong Kong economy by the size of the Saturday want-ad section of the South China Morning Post (which has been truly miniscule for well over the past nine months), I make my own assessment of the economic situation here, rather than pay serious heed to what I read in the papers.

Year on year, according to government statistics, exports dropped 23.4 percent in August and 15.2 percent in September. Imports also declined, decreasing another 3.5 percent in September after a 17 percent drop in August. The government is seriously trying to boost its exports by raising export tax rebates and expanding export credit insurance, but if there are no importers, how can you export?

On a positive note, though, the Guangzhou Municipal Civil Affairs Department announced on October 15 that effective October 1, it increased the lowest living guarantee to rural residents of the city from CNY 220 per month to CNY 271 per month. Even without a cost of living increase, that little bit extra just might have a trickle-up effect in getting people to spend more.

Macao gambling IPOs: They’re successful—and how!
Visa restrictions lifted; will there be hordes of gamblers now?
Damn! Restrictions imposed again yesterday—one visit every two months—so how can one play?
That gambling stock I own—watching it drop ain’t no fun,
Same sort of indigestion as eating a rotten barbecue pork bun!

After lifting travel restrictions to Macao, Guangdong province just one short week later announced on October 10 that it will again tighten its visa policy for residents traveling to the former Portuguese enclave. (For prior coverage, see Tax Notes Int’l, Nov. 2, 2009, p. 373, Doc 2009-23196, or 2009 WTD 209-16.) Non-tour-group travelers to Macao now can apply for visas once every two months. The South China Morning Post stated that industry watchers believed that this move was likely due to mainland concerns about the overheating of Macao’s gambling economy.

I disagree. I believe it was in response to the flood of funds coming into Hong Kong, a sizable portion of which are going into Hong Kong stock market plays. Steve Wynn’s successful initial public offering (the resort Wynn Macau) and the likelihood of another Macao IPO (from the Las Vegas Sands group) has put a lot of pressure on the economy in Hong Kong, where speculative capital continues to come in from the mainland. That recently forced the Hong Kong Monetary Authority to pump an additional HK $47 billion into the economy on top of the HK $338 billion that they put into ‘‘monetary play’’ over the past half year.

Under the individual visitation scheme, mainland visitors to Macao fell 34 percent during the first eight months of 2009 to 3.2 million people. Yet group visitation (considered more ‘‘controllable’’) rose 13.9 percent to 3.8 million gamblers.

Welcome to Hong Kong; we’re glad to let you all in.
You want to start working? Sure, it’s easy to begin.
Yet if you earn some money, pay your tax and don’t pout.
Don’t try to evade it or you’ll never get out!

Bill Heywood, a plumbing and piping contractor, came to Hong Kong in 1996 and worked on a number of projects. He set up his own company in 2000 and ran it until his departure to Egypt in late 2003. Heywood ‘‘forgot’’ to settle his final taxes with the Inland Revenue Department (IRD), saying he didn’t realize that one must conclude tax obligations before final departure. Ha! I don’t believe him. After the first year of taxing you, Hong Kong also imposes a provisional tax for the next year to reduce the tax obligations of those trying to cheat the system.

The IRD estimates that more than HK $140 million of taxes due have been lost because of residents who leave and do not return. Last year alone, HK $13 million was written off as uncollectible. In Heywood’s case, though, his unsettled bill of HK $50,782 has come back to haunt him big time. Heywood came to Hong Kong on vacation earlier this year, but he wasn’t allowed to leave until he coughed up his obligation. He didn’t have it, so he had to remain in Hong Kong until it was paid off.

To rub salt in this humiliating wound, when Heywood applied for a work permit to get a job to pay off his debt, it was denied. The Immigration Department will no longer issue work permits to expatriates if the jobs they seek can be filled by local residents. Heywood is still in Hong Kong — on monthly visiting visas costing him HK $160 each time.

Yet it’s not just departing expats who have problems with the IRD. The Federation of Hong Kong Industries claims that hundreds of Hong Kong-based firms are being hit with unfair taxes because of the change from contract-processing operations in the Pearl River Delta to import-processing operations. These operations are quite similar. Both use imported raw materials to process, assemble, or produce goods for export from China to the rest of the world, but import processing allows them access to the P.R.C. consumer market as well.

The problem lies in the fact that under the income tax arrangement with the mainland, 50 percent of the profit is subject to tax in Hong Kong, while 100 percent of the profit is subject to tax under importprocessing contracts. To make matters worse, while import processing does not allow tax-free incentives for depreciation of imported machinery, this incentive exists under the contract processing scheme.

With the export market going through a rather sudden disappearing act, many a Hong Kong-based factory owner gladly switched to import processing from their former method to gain access to the Chinese market. They had to be aware of the tax consequences. Their accountants must have told them. But who listens to the accountant when they are hanging on to their business by the thinnest of strings? The firms that successfully stayed in existence now have to contend with a tax situation they knew about but never thought they would face. Alas, the IRD policy is going to be difficult to change because it is based on the tax arrangement with China. Many of those who have survived the depression will not be able to survive the IRD.

The DTAA—that’s Hong Kong’s round hole,
Yet the TIEA is the IRS’s square peg.
Exchange of information? That’s everyone’s stated goal—
Only the IRS won’t get it, even if they beg.

The Hong Kong government on June 26 introduced to the Legislative Council Inland Revenue Bill (Amendment) (No. 3) 2009. The bill would permit Hong Kong to adopt the OECD’s 2004 version of information exchange and allow for information sharing between tax treaty partners. According to the proposal, the amendments would extend the IRD’s informationseeking power so that it can obtain information on ‘‘any matter that may affect any liability, responsibility or obligation of any person, under the laws of a territory outside Hong Kong, concerning any tax of that territory,’’ provided there is a double taxation avoidance agreement (DTAA) between Hong Kong and that government.

Hong Kong has tax treaties with China, Belgium, Luxembourg, Thailand, and Vietnam, and is negotiating tax treaties with Austria, the Czech Republic, Italy, Kuwait, the Netherlands, and Spain. There are no treaties, nor are there any negotiations planned with, the U.K., the U.S., Australia, India, or Japan.

The Hong Kong government has placed safeguards within its proposal to protect an individual’s right to privacy and confidentiality regarding any information exchanged. These safeguards include the following:

• Information exchange would be conducted only on specific cases, based on formal, legitimate requests. Neither automatic nor wholesale exchange of information would be permitted.

• Only tax information covered by the DTAA would be exchanged.

• The relevant authority of the requesting government must first satisfy the IRD that the information requested is necessary and ‘‘foreseeably relevant’’ for carrying out the DTAA or for administering or enforcing its local tax laws to safeguard against ‘‘fishing expeditions.’’ (The quotes are from the proposal.) I have an idea, though, that fishing expeditions are being — or will be — carried out at Citibank and HSBC in Hong Kong by the IRS, as both banks have separate agreements in effect because of their U.S. banking operations. Yet the IRS might have problems seeking information from either the local Hong Kong banks or other international banks with operations in Hong Kong. Somehow I think the IRS might find it hard to extract information from an entity like the National Bank of Pakistan’s Hong Kong office.

• The requesting party must treat the information provided as secret information under its domestic laws.

• The requesting party must not share the information provided with any third party (including a third jurisdiction or another government department within its own jurisdiction), regardless of domestic information disclosure laws. Thus, the U.S. would be precluded from using Belgium as its ‘‘back-door connection’’ (my term) for getting information out of Hong Kong.

• The requesting party must use the information provided only for the purpose specified in the request.

• Hong Kong is not required to supply information that the requesting party itself could not obtain under its own laws. Thus, banking information, presumably from HSBC or Citibank, would not be provided by Hong Kong if a DTAA were in effect, as the U.S. already has procedures to do that directly.

The proposed legislation is most likely to pass before the end of the year. Following are some of the individual safeguards:

• The IRD would have to notify the individual for whom information has been requested of the information the IRD proposes to give to the requesting country.

• The individual would be permitted to verify the accuracy of the information with the IRD before the IRD releases the data.

• The requesting government would have to confirm that it has pursued all means available in its own country first before obtaining this information.

• The requesting government would have to state the reasons why it believes that the information requested is held in Hong Kong or is in the possession or control of that individual in Hong Kong.

• The requesting government would be required to provide specific background information of the case to the IRD, including the specific tax purposes for which the information is being sought.

All this tells me that nothing has really changed. As far as banking is concerned, Hong Kong is still much stricter than, for instance, the U.S., because you have to show up in Hong Kong to prove who you are before being allowed to open up a bank account. You don’t have to do this in the United States. In fact, Delaware, Nevada, and Wyoming are the best banking tax havens in the world if you want to start banking. As far as corporate data is concerned, it is easy for anyone to search corporate records in Hong Kong to find out information — far easier than most places in the world.

Keep in mind, though, that Hong Kong’s prime ‘‘customer’’ is China and that the Hong Kong safeguards in place are welcome by China — by the government, its businesses, and its citizenry. Hong Kong is not about to change its status. For that matter, neither is Singapore (which I’ll cover in an upcoming article). Those square pegs will never fit into the round holes — be they in Asia or anywhere else.