PROPOSED GST IN HONG KONG: TIME TO PAY THE PIPER?

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 003170

SIPDIS

SIPDIS

STATE FOR EAP/CM AND EB
TREASURY FOR OASIA GKEOPKE
STATE PASS USTR
USDOC FOR 4420
NSC FOR DWILDER/KTONG

E.O. 12958: DECL: 08/07/2016
TAGS: ECON EFIN PGOV HK CH
SUBJECT: PROPOSED GST IN HONG KONG: TIME TO PAY THE PIPER?

Classified By: Acting E/P Chief Jeff Zaiser. Reasons B,D


1. (C) Summary and Comment: On July 18, the Hong Kong
Government's (HKG) Financial Services and the Treasury Bureau
(FSTB) launched a nine month public consultation on a
proposal for a new Goods and Services Tax (GST). Although
the proposal has gained some support from economists
concerned about the HKG's future ability to meet increasing
expenditure needs with its current narrow tax base, most of
the Hong Kong public and Hong Kong political parties have
voiced strong opposition to the proposed tax. The usually
pro-government Liberal Party held an unexpectedly large
anti-GST rally on Sunday, August 6, indicating the high
degree of antipathy towards the new proposal. The Democratic
Party also announced its intention to hold an anti-GST rally
on August 20. Given the broad public opposition, there is
little chance that the new tax proposal will be implemented,
and many of our contacts believe the proposal is "designed to
fail," possibly in order to allow the Government to claim
that it has listened to the will of the people. End Summary
and Comment.

What is the GST?
--------------


2. (U) The GST as currently proposed by the HKG is a
multi-stage indirect value-added tax (VAT) aimed at all forms
of domestic consumption, including imports and the sale and
rental of commercial properties. Although the tax is
ultimately charged against consumers, it differs from a
simple sales tax in that the GST is collected at each stage
of the production and distribution chain by registered
vendors against the value added on goods and services. Under
the GST framework, each registered vendor charges GST on its
sales (output tax) and can also reclaim credits for the tax
paid on its purchases (input tax). The HKG decided to focus
on a GST instead of other types of taxes based upon its
2001-2002 report, "Final Report of the Advisory Committee on
New Broad-Based Taxes." In this report, the HKG concluded
that the GST was the least economically damaging tax that it
could use to broaden its tax base. See paragraph 10 for a
summary of the main aspects of the current GST proposal.

HKG: We Need More Stable Revenue
--------------


3. (C) According to Financial Secretary Henry Tang, the
primary reason for introduction of the GST is that Hong
Kong's narrow tax base leaves the Government's revenue flow
extremely vulnerable to sudden shifts in the economy. (Note:
Most of the HKG's tax income currently comes from property
and corporate taxes.) On August 4, Principal Assistant
Secretary for Financial Services and the Treasury Vincent

SIPDIS
Tang pointed out to Econoff that Hong Kong's narrow tax base
had led to massive budget deficits during the most severe
part of the economic downturn in 2001 and 2002. Although the
HKG currently enjoys a significant overall surplus, Tang
cautioned that provision of services for Hong Kong's aging
population will result in an increasing financial burden. To
meet that need, Tang believes the new tax should be
introduced now, during an economic boom; if the HKG tried to
introduce the GST during an economic recession, Tang said the
proposal would be "dead before it started."


4. (C) The HKG estimates that the GST will generate 27.9
billion HKD (approximately USD 348 million) per year in net
revenue, of which approximately 7.2 billion would be used to
compensate low income families. Another 300 million HKD
would be allocated to GST relief measures for businesses and
charities, bringing the overall increase in Government
revenue from the GST at about 20.4 billion HKD in the first
year. Despite these positive figures, Vincent Tang
acknowledged that the HKG still faces a difficult uphill
battle in the court of public opinion. He argued, though,
that the GST as proposed would only have a short term impact
upon the economy for two reasons. First, the five percent
GST would be balanced by reductions in the corporate profit
tax and the salary tax. Second, the GST proposal provides
for many relief measures and is designed to have a high
threshold, five million HKD in business turnover, for
mandatory participation in the scheme - a threshold which
would allow 90% of all small and medium enterprises (SMEs) to
opt out of the scheme. Tang emphasized, however, that the
HKG would "never consider" imposing the new tax against the

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will of the people of Hong Kong, citing the nine-month public
consultation period as evidence of the HKG's determination to
tread carefully.

The Case for GST
--------------


5. (C) On August 1, Hong Kong University of Science and
Technology Business School Dean and Hong Kong Consumer
Council Chairman K.C. Chan told us that Henry Tang has wanted
to introduce the GST concept for "quite some time." He said
the HKG has actually been under pressure from many prominent
economists and advisors, including himself, to broaden its
tax base for many years. Because Henry Tang does not
actually expect the GST proposal to pass at this time, Chan
said he is willing to propose the GST now to mollify
advocates of the GST, while avoiding the "political poison"
of being the one to actually usher in a new tax. Chan
deplored the automatic negative response by the public and
the political parties, arguing that the actual negative
impact of a new GST would be negligible. He argued that a
five percent tax increase would not affect business
investment or tourist arrivals in Hong Kong; instead, he
believed business investment would continue as long as Hong
Kong's underlying economic situation did not change
drastically, and tourists would continue to be drawn by Hong
Kong's other attractions.


6. (C) On August 2, Hong Kong General Chamber of Commerce
Chief Economist David O'Rear told us that although he
supported the idea of broadening Hong Kong's tax base, the
real issue was forcing the HKG to rein in surging government
expenditures, which eventually would force the Government to
introduce new taxes to generate income. He observed that
during the previous recession, the HKG had been forced to
spend one-third of its financial reserves to cover budget
deficits. If there had to be a new tax, O'Rear believed the
GST would inflict less damage on the economy than any of the
other options. He dismissed accusations that the GST would
be a regressive tax aimed at shifting the tax burden to the
poor, pointing out that compensation to low income families
included in the GST proposal would result in a "profit" for
most of them. O'Rear also claimed that other possible
negative economic impacts generated by a new GST would be
easily overcome by the new economic activity generated by the
proposed concurrent cuts in Hong Kong's corporate profit and
salary taxes.

The Case Against GST
--------------


7. (C) On August 3, Vice Chair Shirley Chan of the Hong Kong
Retail Management Association, which represents 500 retail
companies employing approximately two-thirds of the total
retail workforce in Hong Kong, explained her opposition to
the new tax. Aside from the potential damage to Hong Kong's
unique "brand image" as a tax-free shoppers paradise, the
fact that the proposed GST would complicate Hong Kong's
simple and attractive tax system would drive away many
prospective investors in Hong Kong. Chan also pointed out
that many retail shops would incur a significantly heavier
tax burden, even while they were forced to hire more
personnel to handle the additional administrative procedures
involved in collecting and refunding (to tourists) the GST.
Chan also doubted that the HKG would have the political will
to actually slash the corporate profit tax, as most
corporations were satisfied with the current corporate tax
rate. Finally, Chan said her greatest concern was that Hong
Kong would follow the trend of all other countries that have
introduced GSTs and succumb to the temptation to repeatedly
raise the tax rate.


8. (C) Most of the major political parties in Hong Kong,
including the generally pro-government Democratic Alliance
for the Betterment and Progress of Hong Kong (DAB) and the
Liberal Party, have publicly opposed the GST proposal. On
August 3, Liberal Party wholesale and retail sector
representative Vincent Fang Kang, who is Chairman of the
newly-formed Coalition Against Sales Tax, told Econoff that
despite the narrowness of the tax base, the current tax
system has worked well for many years. Many years of
budgetary surpluses have given the HKG financial reserves of
approximately one trillion HKD (approximately USD 125
billion),and he therefore saw no need to expand the tax base

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"any time soon." He also observed that most countries using
a GST, such as the United Kingdom, still continue to run
budget deficits despite their high VAT rates. He also
suggested that the extra paperwork costs and bureaucratic
hassles of a new GST would encourage businesses to relocate
to China or Macau, effectively "killing" Hong Kong's
competitiveness as a hub for logistical services.

Anti-GST Rally
--------------


9. (C) On August 6, Fang and the Liberal Party organized a
rally to demonstrate the public's opposition to the new GST.
They claimed that up to 6,000 people from more than 70 trade
organizations participated, although the police estimated the
crowd at approximately 3,000. Liberal Party vice-chairperson
Miriam Lau said the large turnout was unexpected and that the
Liberal Party would continue to campaign against the GST in
coming months. The Democratic Party stated that it would
launch a city-wide signature campaign against the GST on
August 13 and would organize its own anti-GST rally on August

20.

Summary of GST Proposals
--------------


10. (U) Summary of GST Proposals:

- The GST rate should be a low and uniform rate.

- The registration threshold for businesses will be an annual
turnover of HKD 5 million, thus excluding most small and
medium enterprises.

- The tax base will be road based (what does this mean?) and
provide for few exemptions, thus keeping down the costs of
compliance for businesses.

- There will be no special treatment for food, health,
education, or e-business, to minimize complexity.

- Export goods and international supplies will be
"zero-rated," in other words functionally exempt from the GST
to maintain Hong Kong's competitiveness as an international
trading and logistics hub.

- The HKG will implement a Tourist Refund Scheme (TRS) to
refund GST to tourists who spend at least HKD $1,500.

- Financial services will be mostly exempt from the GST.

- Commercial property sales and rentals will be covered by
the GST but residential sales and rentals will be exempt.

- A Deferred GST Payment Scheme (DGPS) and Qualifying
Exporters Scheme (QES) will be set up to mitigate upfront GST
costs on traders at the time of importation.

- Non-profit organizations and charities will be able to
register for the GST so they can reclaim input tax on GST
charged against them for purchases they make but will not be
compelled to register for the scheme.

- The HKG will be regarded as a "taxable person" to enable it
to reclaim input tax; HKG commercial and non-regulatory
activities would also be taxable to maintain a level playing
field between the HKG and the private sector.

- Transitional rules will be drawn up to mitigate the
immediate economic impact of GST upon its implementation.
Sakaue