Bloomberg Businessweek recently ranked Hong Kong first and Singapore second among 18 regional jurisdictions covered in its “International Business — Asia Pacific 2010” report. Access to adjoining markets, ease of business setup, and obviously favorable tax regimes account for the ranking. Heck, with low tax rates, taxation based on territoriality of income, ease of doing your own tax return – online – and government enactments preventing fishing expeditions from becoming part of tax information exchange agreements, Hong Kong and Singapore are tax havens in the nicest sense of the term. And you’d better believe that neither will change that focus without the other jurisdiction changing as well.
Singapore’s corporation tax rate is 17 percent. That’s only half a percentage point above Hong Kong’s corporate tax rate. While Hong Kong is only now adhering to the OECD’s TIEA requirements, Singapore boasts the greatest number double tax avoidance agreements I know of – 63 – and the number is growing. There is no more treaty savvy a jurisdiction than Singapore. It is poised to become the future investment gateway to India because it is more transparent and credible than Mauritius. Hong Kong and India are in the process of writing a tax treaty. It will be interesting to see what develops, as proximity does make a difference. It is possible to fly from China to Hong Kong, sign documents that must be signed in person, and return to China in one day. No matter what the situation may be, you cannot do that with Singapore, and that is an important factor for consideration. Who knows? Perhaps a Hong Kong entity held by a Singaporean parent corporation might be a worthwhile option for the future.
One begins to appreciate Singapore with age. In my youth, before the disillusionment with jurisdictions large and small and systems in which money is the mother’s milk of politics, I hated the lack of freedom in Singapore. But it ain’t so now. There is an honesty in government that shines as a singularly distinct beacon in a region where corruption is the norm. I like Singapore and I really like what it is doing.
So you want to spur capital expenditures and foster productivity and innovation? How about a 250 percent tax deduction, with up to a maximum of SGD 300,000 in each of the following activities:
– acquisition or leasing of automation equipment;
– registration and acquisition of intellectual property rights;
– research & development;
– training programs; and
– design activities.
In addition to this being part of the current-year tax regime in Singapore, eligible businesses can convert SGD 300,000 of their innovation credit to a direct cash grant of SGD 21,000. There is a five-year sunset clause. Hopefully, the world economic uncertainties will be over by then and this program will not be needed in the future. But for the present, what better incentive can a small business have than a huge write-off ?
And then there’s the property tax. China is experimenting with property taxes – it will be the wave of the future in China. Hong Kong, owned by a few developer family oligarchs, gives rather weak explanations about being helpless to do anything regarding taxation without interfering with Hong Kong’s free market. Hong Kong real estate is bought and sold not to live in but as a commodity for day trading.
Singapore is attempting to end that trend by shifting its flat rate property tax system for all owner-occupied residential properties to a progressive property tax rate based on annual valuation of property. The shift will keep Singapore, in the long term, from having to rely on its GST if broadening the tax collection base is required.
What about Singapore and the U.S. signing a tax treaty? Don’t bet on it. Hong Kong doesn’t have one with the U.S., and Singapore will not put itself in a disadvantageous situation in competition for the financial markets versus Hong Kong. I see neither double tax avoidance agreements nor TIEAs with the U.S. on either Singapore’s or Hong Kong’s agenda.
The progressive property tax appears to be catching on in Asia. On December 12 the Dow Jones newswire quoted Jia Kang, director of the Fiscal Science Institute of the Ministry of Finance, as saying that a U.S.- style property tax is imminent as part of a complete overhaul of the real estate tax system. In the central and eastern regions of China, property taxes will become the major source of income for local governments, eventually replacing the land sales tax — especially for governments that run out of land to sell. As a long-term revenue stream, this is the model to adapt in urban China. As a curb against a property price bubble, however, it won’t work. More is needed. As a vehicle of government bureaucratic expansion, implementation of a progressive property tax throughout the country would mean a whole lot of government hiring to go along with a fundamental new system.
China currently collects two — possibly three — types of residential property taxes. First is a sort of capital gains tax from the sale of property held under five years. The second is a tax on rental income. The latter is a weak spot in the Chinese tax system because much is not reported. Let’s face it, no matter where the jurisdiction, many pure cash transactions never make it into the tax system. Then again, with such a low rate of return from rentals, many owners choose to sit on a vacant apartment for years, waiting to turn the property at a handsome profit.
The former is also a weak spot because the actual sales contract seemingly never is that on which taxes are paid. The third type? There is some form of tax based on purchase price, but it is deemed of minor importance within the tax system.
As a result, regardless of curtailing bank loan availability, limiting the amount of dwellings a person or his family can own, and imposing a property tax on sales of less than two years or less than five years – a tax that in essence, the buyer is still paying, not the seller on whom it was intended – prices rose again, for October 2010. Yet if it is any consolation, that increase was only 8.6 percent for the month, down from 9.1 percent the previous month.
J.W. Wang, in the December 2010 edition of the monthly magazine of the Hong Kong Institute of CPAs, stated that governments will have to determine whether annual appraisals of property are necessary and who will pay for the cost — the government or property owners having to obtain private appraisals. Training and keeping a qualified staff throughout the country is a major project. Policing both that system and a system of private appraisers is no small matter.
How will the local offices of the State Administration of Taxation handle collecting the tax? True, the property tax is an idea that needs implementation, but how do you do it and how long will it take?
It’s going to take less time than people think. To maintain stability, the government has to “produce” for the tax it extracts. I’ve been touting this for a long time and I believe it more than ever: The SAT bureaucracy is soon going to expand in size, hiring new employees to cover all the aspects of assessing, administering, enforcing, and maintaining the integrity of the tax system.
PR Trouble at the SAT
There is a public relations problem that the SAT is encountering, vis-a-vis the collection of two taxes: the city maintenance and construction tax and the education support tax from foreign entities in China. Some foreign entities and Western bloggers are up in arms, claiming unmitigated doom. The central government stood by doing nothing and lost the spin on this one because no one recognizes that these taxes are merely surcharges to either the current business tax or the VAT — and that doesn’t amount to much.
A December 9 op-ed in the China Daily by Yang Zhiyong called this the “great equalizer” in deed but not much in revenue production because these are only surcharges. And yet the Seattle-based China Law Blog has a December 19 posting calling this a “very bad thing.”
Let’s use me in a hypothetical example to see the economic impact of these new taxes. First, the educational surcharge is a flat 3 percent. For the maintenance and construction tax, in cities the rate can be as high as 7 percent. This goes down to 5 percent in counties and townships and can be as low as 1 percent in other areas. I’m a city guy, so let’s take that 7 percent surcharge and add it to the 3 percent educational surcharge — that’s 10 percent. Have I lost you?
Let’s say that my business, a service industry, generates CNY 1 million a year in gross income subject to a 5 percent business tax. That’s CNY 50,000 business tax. A 10 percent surcharge on that is CNY 5,000. During inflation, that’s a nuisance I can grumble about but it ain’t the end of the world. And yes, there would be more of a tax bite if a full-fledged VAT is the basis for the surcharge, but to a foreign enterprise making money in China, this is a livable tax increase.
The China Law Blog also mentioned something I have been stating for the longest time: If you are in business in China and your operations are not making a profit after a reasonable period of time – and especially if your operations have consistently been showing a loss beyond a reasonable time frame — then not only can you soon expect an audit, but the government will impute a healthy profit as your alternative, taxing and penalizing you for your lack of sincerity.
As this is my first column for 2011 I am going to fearlessly forecast what I think will happen with China taxation over the next year.
The 12th Five-Year Plan will finally be announced in early 2011. Based on all that I’ve read out of China, Hong Kong, and Taiwan – where The China Post has been particularly good for resource material — I think there is going to be an across-the-board reduction in ranges into which China’s progressive income tax system falls, effectively producing a tax reduction for middle-income earners.
The Ministry of Finance places middle income in China between CNY 8,000 and CNY 20,000. This group of taxpayers has been paying 22 percent of individual income tax collected.
Expansion of the tax bureaucracy, as discussed earlier in this essay, will extend enforcement of higher income tax evaders. That and reform of the VAT/ business tax, the reform of a property tax (and possible expansion of a capital gains tax if property trading is not held in check), and corporate tax audit expansion will enable the tax system to reduce middle-income tax payments and, if inflation doesn’t continue to screw things up, there will be additional money to spend in what will hopefully be a consumer-based economy.
It was just about a year ago that Circular 698 was issued by the State Administration of Taxation. Taxation authorities challenged indirect transfers of equity interests in Chinese companies held by offshore holding companies that lacked commercial substance and were essentially passthrough entities. In short, this knocked the bottom out of the most favored offshore jurisdictions with either zero or near zero capital gains taxes. While it’s uncertain how this will be enforced, it does portend a growing body of new tax laws and regulations based on cases that will develop, challenging this law, as loopholes are found. And yes, loopholes are indigenous to taxation, no matter where the tax!
Guoshuihan  No. 323, issued in July 2010, set the wheels in motion for numerous transfer pricing audits. As long as Chinese companies are exporting, there will be transfer pricing issues and there will be tax audits taking place. After all, since transgressions in transfer pricing are between offshore owners, why not increase the due diligence requirements to reduce transgressors and along the way increase business taxation revenues, thereby taking further pressure off of revenue necessity from middle-income taxpayers? It’s all so very symbiotic.
The gauntlet has been thrown down to the Indian offshoring industry to develop in China, lest the Chinese do it themselves because of Caishui No. 65, jointly issued by MOF and SAT, which eased qualification standards while expanding both the scope and locations where technology advanced service enterprises (TASEs) qualify for a 15 percent enterprise income tax rate for outsourcing business activities, as well as an additional 8 percent double expense deduction on payroll salaries for staff education and training expenses. This is a two-year tax incentive that expires December 31, 2013. To qualify, the Chinese company (which can be owned by an Indian offshoring expert through either a Mauritius, Singapore, or Hong Kong holding company) must meet these requirements:
– More than 50 percent of TASE employees must have a college degree (thereby assisting the 30 percent of last year’s university graduates in China who are still unemployed).
– At least half of the annual revenue of the TASE must be within a stipulated advance technology service activities list. I do not have a copy of that list handy, but I recall that it is fuzzy enough that almost any service would qualify.
– More than 50 percent of the TASE income must come from specific outsourcing operations.
– The 21 cities where you can qualify (a whole lot more than economic development zones) are: Beijing, Changsha, Chengdu, Chongqing, Dalian, Daqing, Guangzhou, Harbin, Hangzhou, Hefei, Jinan, Nanchang, Nanjing, Shanghai, Shenzhen, Suzhou, Tianjin, Wuhan, Wuxi, Xiamen, and Xian.
If I were a decade younger, not as burnt out after 44 years of doing tax returns, I’d seriously consider outsourcing in China for U.S. tax return data entry. But this is now and I’d rather write about tax returns than do them.