August 2020

FSDC Paper No.46

Hong Kong Catching Up – Modernising Hong Kong’s Tax Loss Relief

Content

Executive Summary

I. Background and Context

II. Hong Kong’s Tax Regime

III. Regulatory Regime Influences How Financial Services Organisations Operate

IV. Innovation and Research & Development

V. Guangdong-Hong Kong-Macao Greater Bay Area (GBA)

VI. Common Approaches to Group Tax Losses

VII. Singapore’s Approach

VIII. Financial Services Industry’s Need for a Group Loss Relief Regime

IX. Recommendation of the Group Tax Loss Relief Framework for Hong Kong

X. Conclusion

Appendix A – Survey Results

Appendix B – Tax Loss Relief Mechanisms in Developed Economies as of April 2020

Appendix C – Singapore’s Group Tax Loss Regime

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Executive Summary

Currently, Hong Kong is the only leading international financial centre without some form of group tax loss relief or tax consolidation regime, and continues to remain an outlier when it comes to its inaction in this area. In uncertain times like this, Hong Kong should reconsider its tax policy and ensure that it is globally competitive and modern, reflecting commercial realities and levelling the playing field for its taxpayers.

Businesses are typically conducted through a number of separate legal entities due to regulatory reasons, or to ring-fence commercial and operating risks. This is especially so for the financial services industry. It is heavily regulated, and such regulations direct the operation of certain activities in separate legal entities. Hong Kong’s lack of group tax loss relief arrangements causes a mismatch with the commercial reality, and increases the operating costs of financial services groups undertaking responsible risk management practices. The industry sees this as a major impediment to Hong Kong’s future growth and prosperity as a modern global financial services hub.

The economy of Hong Kong has faced challenges that adversely impact the overall business environment and economy. Introducing group tax loss relief can effectively encourage corporations to continue to invest during these difficult times, and will be a welcoming gesture from the Government to further support the business community in Hong Kong.

The Financial Services Development Council (FSDC) issued a paper in September 2017 on a proposal for the introduction of group tax loss relief in Hong Kong. The FSDC has recently revisited this proposal and its recommendations. This paper builds on the 2017 paper, taking into consideration the comments previously raised by relevant stakeholders. The objective of this paper is to introduce a group tax loss relief regime that would allow for unutilised tax losses of one group company or branch to be transferred to, and be set off against, the taxable profits of another company or branch within the same corporate group. The proposed regime is designed to be relatively straightforward and simple to administer, which should require minimal amendments to existing laws and manageable administration and compliance cost. The changes we recommend are likely to result in tax revenue reduction in short term, but will result in longer term benefits to the financial services industry and, consequently, tax revenue. If it is thought necessary to limit short term tax revenue reduction, transitional mitigation measures (such as limitations on transferable losses) could be considered.

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Companies and Hong Kong branches within a 75% group (including Hong Kong branches of 75% group companies) should be able to offset tax losses via a tax loss grouping/ transfer system;

The companies and branches within the group need to have the same accounting period;

For the tax losses to be grouped and offset, the tax losses must be incurred after the implementation of the group tax loss relief regime and at the time the companies/ branches are in the same group;

Where the loss company/ branch is subject to tax at a lower rate than the profit company/ branch, the tax losses transferred would be adjusted to reflect the tax benefit of those tax losses to the loss company/ branch (i.e. the adjustment approach);

Losses could be carried back for one year, within the loss company/ branch, to offset the assessable profits of the immediate preceding year;

Specific anti-abuse measures may need to be implemented to counteract tax-avoidance arrangements effected to take advantage of group tax losses that were incurred prior to the implementation of group tax loss relief (i.e. anti-avoidance rules);

Where a company/ branch within a group does not elect to transfer the tax losses for offsetting purposes, or has excess tax losses, the losses would be retained by the company/ branch and treated in the same manner under the ordinary tax loss rules (i.e. tax loss carry forward);

The company/ branch would continue to account for taxable profits and deductible losses in the ordinary manner, i.e. there would be no tax consolidation.

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The FSDC recommends the following key features for Hong Kong’s group tax loss relief framework:

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This paper is prepared to consider fiscal policies that could improve the competitiveness of Hong Kong's position as an international financial services hub. The drafting of this paper began in early 2019, since then, there have been several internal and external factors that have had a significant adverse impact on the overall business environment in Hong Kong. These factors include the recent global outbreak of the COVID-19, the ongoing trade dispute between China and the United States, and the social disruption in Hong Kong that began in mid-2019. Together, these events have negatively impacted business productivity, confidence and the overall morale in Hong Kong.

The decline in Hong Kong's economic growth and business activity are illustrated across many sectors of the economy. Gross domestic product for 2019 was down 1.2% from the preceding year, which is the first annual decrease since 2009. This has largely been driven by a decline in exports and the adverse effect on tourism numbers and retail sales. Hong Kong's economy has not been this weak since the outbreak of SARS in 2003. With the recent outbreak of COVID-19 and other challenges ahead, the economic outlook for 2020 will be severely impacted.

One of the conclusions reached in this paper is that in order to ensure Hong Kong retains its standing as a place of business for multinational corporations, it must maintain a competitive and progressive approach when considering tax and financial policies for corporate groups. Group tax loss relief is an important policy in this regard in most other developed economies. This is further accentuated in times of an economic downturn when corporates rely on the grouping of losses and profits to manage their cash tax payments. Corporate group tax loss relief can therefore be an effective tool to encourage corporations to continue to invest in business regardless of the economic environment in which they are operating.

Hong Kong's lack of group tax loss relief, compared to all other international financial centres, puts it at a distinct disadvantage when multinational corporations are considering where to establish new business operations and where to invest capital in existing ventures worldwide. Indeed, the current Hong Kong tax regime discourages investment in riskier business endeavours where tax losses from unsuccessful businesses investment cannot be netted against profit within a corporate group if they are conducted in separate legal entities.

Preamble

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Concerns have been raised that the introduction of group tax loss relief would have an adverse impact on government revenue collections given the reliance on profits tax as a source of government tax revenues. This is largely a result of Hong Kong having a very narrow tax base and an over reliance on a relatively small number of corporates contributing a majority of the profits tax collected. For example, in 2017/ 18, it is estimated that the large corporations operating in Hong Kong contributed the vast majority of the profits tax revenue in that year. The concern is that such revenue collection from large corporations would be impacted by group tax loss relief.

We do not share these concerns, as we believe that any shortfall in revenue will be temporary and more than made up by future revenues. However, to the extent that these concerns are valid, there are various ways to limit such potential shortfalls which will be discussed in Section I of this paper.

Further global tax developments, driven largely by the OECD’s ‘BEPS 2.0’ initiative, could also have an impact on the competitiveness of many of the businesses operating in Hong Kong. For example, some of the changes under consideration include a global minimum tax rate, which could severely impact the competitiveness of corporate groups in Hong Kong in the absence of group tax loss relief. This paper concludes that Hong Kong needs to introduce group tax loss relief in order to ensure that it remains globally competitive as an international financial centre.

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I. Background and Context

At present, Hong Kong’s tax regime does not allow transfer of tax losses between group companies and branches operating in Hong Kong. Such tax losses are quarantined to the legal entity where the tax losses are incurred. While the tax rules do allow tax losses at legal entity to be carried forward indefinitely until such losses are fully utilised, there is no relief to a group of companies that has losses and profits in different legal entities.

Hong Kong is the only leading international financial centre (IFC) without some form of group tax loss relief or tax consolidation regime. This is an area that the financial services sector and the business community in general have been proposing to the Hong Kong SAR Government with the aim of ensuring that our taxation system is both modern and progressive, and reflects the ways in which businesses, both big and small, operate in Hong Kong.

Financial services is one of the pillar industries in Hong Kong, directly representing approximately 20% of the city’s GDP in 2018 and is an important and significant component to Hong Kong’s economic prosperity and growth. Indeed, Hong Kong is recognised as one of the world’s leading global financial centres. It is widely recognised as Asia’s foremost financial services hub, and one of the top centres globally - along with London and New York.

Although Hong Kong is a leading global IFC, it remains the only leading IFC that does not have any form of group tax loss relief or tax consolidation regime. The two other global financial services hubs, London and New York, both operate under a tax regime that allows groups to combine profits and losses for tax purposes so that the group’s tax position reflects the overall net profit or loss of the group. The fact that Hong Kong does not permit some form of tax consolidation or group tax loss relief is seen by the industry as an impediment to Hong Kong’s future growth and prosperity as a modern global financial services hub.

The importance of Hong Kong as an IFC has been emphasised in the Outline Development Plan for the Guangdong – Hong Kong – Macao Greater Bay Area (GBA), released on 18 February 2019.1 In the Outline Development Plan, Hong Kong’s role and importance as a financial centre, an offshore RMB hub and a source of private equity capital for the GBA, is front and centre. Following the 21st Plenary of Hong Kong/ Guangdong Co-operation Joint Conference on 16 May 2019, detailed cooperation measures were stipulated in the Work Plan of the Framework Agreement on Hong Kong/ Guangdong Co-operation2, which again reiterated Hong Kong’s unique role in the GBA.

The importance of financial services in Hong Kong

The State Council of the People’s Republic of China, ‘Outline Development Plan for the Guangdong-Hong Kong-Macao Greater Bay Area (translated)’, 18 February 2019.The Government of the Hong Kong SAR and People’s Government of Guangdong Province, “Work Plan of the Framework Agreement on Hong Kong/Guangdong Co-operation (translated)” 16 May 2019.

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Despite the fact that the GBA initiative is expected to contribute positively to the Hong Kong economy in future years, it is important to consider factors impacting the Hong Kong market from both internal and external perspectives. For the last six months of 2019 and in the first quarter of 2020, Hong Kong has been experiencing social and economic instability and slowing productivity. This has had a widespread effect on the morale of Hong Kong people and has negatively impacted business confidence within the market. Hong Kong businesses are currently facing unprecedented economic hardships, and there could still be room for policy changes to address this economic downturn. From a business continuity perspective, now could be the ideal time to introduce a group tax loss relief policy, both as a relief measure and a gesture to show support to the business community, especially for SMEs.

The introduction of a group tax loss relief regime was a repeated topic in Hong Kong many times before and was the subject of an earlier FSDC paper,3 but has never been more needed than it currently is. This can be evidenced through the various new Government initiatives pertaining to the financial services sector in Hong Kong, which are all designed to ensure that Hong Kong remains competitive internationally. As competition arises due to advances and developments in FinTech, as well as competition from other recognised financial services centres within Asia and indeed globally, conducive changes to the business environment is much needed.

In this regard, the mechanics of a jurisdiction’s tax regime plays an important part in its competitiveness for multinational corporations (MNCs) evaluating where to establish business operations, including financial institutions. This is not simply a reference to the headline corporate tax rate or whether an incentive or concession is offered to attract business, but rather, whether the overall taxation system fosters and encourages businesses continue to operate, invest and innovate in the most effective manner. Many competing jurisdictions now offer tax rates similar to that of Hong Kong. As such, Hong Kong’s historically low rate no longer creates a natural competitive advantage. Hong Kong needs to ensure that its overall tax regime caters to the needs of businesses operating domestically.

Financial Services Development Council, “A Proposal for the Introduction of Group Tax Loss Relief in Hong Kong”, September 2017.3

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II. Hong Kong’s Tax Regime

Hong Kong operates a territorial system of taxation whereby only profits sourced in Hong Kong from a trade, profession or business carried on in Hong Kong are generally subject to profits tax.4

The Hong Kong tax regime does not allow for any form of tax consolidation or group tax loss relief for a group of companies under common control. Subject to anti-avoidance rules, taxpayers can carry forward tax losses indefinitely until such losses are fully utilised, but they cannot be shared within the group.5

The idea of transferring losses from one taxpayer to another is not totally foreign in the Hong Kong tax context. The Hong Kong tax rules permit a very limited form of loss transfer between a partnership and a partner in that partnership. The rules allow a partner to offset its share of a partnership loss against the partner’s other profits, vice versa.6 However, this rule does not extend to profits and losses between companies under common control.

Despite an overwhelming desire by the financial services sector and the business community for some form of group tax loss relief in Hong Kong, the principal reasons previously given for not implementing such a regime have been essentially twofold:

The push for group tax loss relief measures in Hong Kong started 50 years ago, but to no avail as of today. The Financial Secretary of the Hong Kong SAR Government indicated in his 2006-07 Budget that he had no intention to introduce any tax loss carry back or group tax loss relief in Hong Kong as he was concerned that such arrangements would place enormous pressure on tax revenue during periods of economic downturn.7 He also highlighted the potential abuse of the group tax loss relief measures for tax evasion.8 The Government’s position had been reiterated in the following years and these reasons were provided in response to the FSDC’s Group Tax Loss Relief Paper published in September 2017.9

For Hong Kong to maintain its position as a leading IFC, it is appropriate to reconsider its policy on tax loss relief and introduce some form of group loss relief. The fact that Hong Kong has a low corporate (profits) tax rate is no longer sufficient on its own to justify having no group loss relief. Many countries now have corporate tax rates that are comparable to that of Hong Kong’s rate.

Hong Kong continues to remain an outlier when it comes to its inaction on group tax loss relief. Hong Kong is only one of very few jurisdictions among developed markets that do not have some form of group loss relief measures, and it is the only leading IFC that does not allow for tax losses transfers within the same group of companies. In contrast to the approach in Hong Kong, nearly all developed markets have been able to adopt some form of group tax loss relief or tax consolidation.

Firstly, the perceived complexity in its administration; and

Secondly, concerns over the volatility in revenue collections.

Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China, Article 108, “The Hong Kong taxation system is enshrined in Article 108 of the Basic Law, whereby the HKSAR Government strives to maintain a low rate taxation system consistent with the HKSAR’s tax policy of prior years.” Inland Revenue Ordinance (Cap. 112) (“IRO”), s.19Cibid, s.22AHKSAR Government, Budget Speech 2006-07 (22 February 2006, Hong Kong), para 79ibid.Note 3.

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Many organisations in the financial services industry typically conduct business through a number of separate legal entities. Reasons for this phenomenon are many, but particularly for the financial services industry, the main contributing reasons relate to the need for regulatory compliance and ring-fencing of commercial and operating risks between different businesses.

The financial services industry is heavily regulated across banking, insurance and asset management segments, and the need to operate certain business activities in separate legal entities is often dictated by regulatory requirements. These include the regulatory rules both in the financial services group’s headquarters, as well as other in-market regulatory rules where the group operates in.

The FSDC conducted a survey among members of the various financial services industry associations (see Appendix A). The survey indicated that a majority of respondents of the financial services businesses operating in Hong Kong operate through several operating entities. More than 80% of the respondents responded that they operate in Hong Kong through more than one legal entity.

Different types of financial services or products offered by financial institutions are subject to different regulatory regimes and regulators. In Hong Kong, the Hong Kong Monetary Authority (HKMA) licenses and regulates banks, the Securities and Futures Commission of Hong Kong (SFC) license and regulate intermediaries carrying on securities, futures and asset management businesses, and the Insurance Authority licenses and regulates insurance companies and insurance intermediaries.

While many banks are also registered with the SFC to carry out securities, futures or asset management related businesses, it is more common to see banks operating the larger part of their securities, futures, or asset management businesses through separate SFC licensed subsidiaries. One reason for this is that the HKMA serves as the front-line regulator for banks, including the securities business of the banks and the banking industry, whereas the SFC has a much closer view of the securities and futures markets. Hence, many financial institutions typically arrange their securities and futures businesses in separate entities regulated solely by the SFC. The position is similar in the context of insurance, where insurance companies establish separate subsidiaries to undertake their securities or asset management businesses.

III. Regulatory Regime Influences How Financial Services Organisations Operate

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This paper is prepared to consider fiscal policies that could improve the competitiveness of Hong Kong's position as an international financial services hub. The drafting of this paper began in early 2019, since then, there have been several internal and external factors that have had a significant adverse impact on the overall business environment in Hong Kong. These factors include the recent global outbreak of the COVID-19, the ongoing trade dispute between China and the United States, and the social disruption in Hong Kong that began in mid-2019. Together, these events have negatively impacted business productivity, confidence and the overall morale in Hong Kong.

The decline in Hong Kong's economic growth and business activity are illustrated across many sectors of the economy. Gross domestic product for 2019 was down 1.2% from the preceding year, which is the first annual decrease since 2009. This has largely been driven by a decline in exports and the adverse effect on tourism numbers and retail sales. Hong Kong's economy has not been this weak since the outbreak of SARS in 2003. With the recent outbreak of COVID-19 and other challenges ahead, the economic outlook for 2020 will be severely impacted.

One of the conclusions reached in this paper is that in order to ensure Hong Kong retains its standing as a place of business for multinational corporations, it must maintain a competitive and progressive approach when considering tax and financial policies for corporate groups. Group tax loss relief is an important policy in this regard in most other developed economies. This is further accentuated in times of an economic downturn when corporates rely on the grouping of losses and profits to manage their cash tax payments. Corporate group tax loss relief can therefore be an effective tool to encourage corporations to continue to invest in business regardless of the economic environment in which they are operating.

Hong Kong's lack of group tax loss relief, compared to all other international financial centres, puts it at a distinct disadvantage when multinational corporations are considering where to establish new business operations and where to invest capital in existing ventures worldwide. Indeed, the current Hong Kong tax regime discourages investment in riskier business endeavours where tax losses from unsuccessful businesses investment cannot be netted against profit within a corporate group if they are conducted in separate legal entities.

In addition, the different regulatory regimes also impose different capital adequacy requirements. This often makes it necessary for financial services groups to establish separate legal entities from a capital management perspective.

From a risk management perspective, such arrangements are sensible as different businesses represent different levels of risk for financial groups. For example, a retail business has a very different risk profile than a business that only serves professional investors. A financial group would seek to ring-fence its exposure to lower margin/ higher-risk business providing complex products/ services from its higher margin/lower-risk business that provides plain vanilla products/ services. New businesses, for example, adopting FinTech strategies would also ordinarily be ring-fenced from traditional business. Internal controls and compliance requirements, including the level and sophistication of systems, controls and processes such as record keeping, may also differ according to business and/or product and service offerings, explaining why financial services groups establish separate legal entities in managing and operating their businesses.

Additionally, many traditional international financial services groups are headquartered in the US, UK or continental Europe. The local laws and regulations applied to these groups on a prudent basis may also drive the use of multiple subsidiaries in Hong Kong. For example, separate local subsidiaries may be used to limit or minimise the extraterritorial impact of US or EU banking or securities laws – sometimes referred to as "regulatory spillover”. There may, or may not, be an element of regulatory arbitrage at play. Nonetheless, these factors drive the business structuring decisions in Hong Kong (and globally).

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IV. Innovation and Research & Development

The Government has a renewed focus in the area of innovation and technology, encouraging businesses in Hong Kong to leverage its global financial services expertise to create a powerful force on innovation globally. To encourage innovation in Hong Kong, the Government has introduced incentives in the area of research and development (R&D).10 The incentives provided are divided into Type A and Type B expenditures which allow for different R&D deductions. Type A expenditure includes payments to a designated research institutions and research activity with relates to the relevant taxpayer’s trade, profession or business, which qualifies for a deduction of 100%. On the other hand, Type B expenditure includes activities which directly involve an employee engaged in the R&D activity and items that are used for the R&D activity, and qualifies for a ‘super’ deduction of 300% for the first HK$2 million and then a 200% deduction on any remaining amount.11

The financial services industry is an area where the pace of innovation and technological change is developing speedily. There is a need for banks, insurers and asset managers to continue to innovate and develop new technologies so as to remain competitive. Such development may be in the area of new payments systems, block chain technology or new virtual banking networks, etc.

Many groups will choose to segregate innovative endeavours, be it for general R&D or FinTech specific purposes, in separate entities. This is usually because it is commercially sensible to isolate risks of a new business venture from the rest of an organisation. However, the tax consequences of this segregation are that the losses sustained from the innovation are not utilised, and the ultimate owner of the group is therefore penalised for the sensible commercial expenditure. Similarly, the tax deductions offered for some relevant activities cannot be utilised efficiently. Group tax loss relief allows for entities making a loss from innovation spending by related ventures to offset the profits of other companies within the group, thereby reducing taxable profit. The commercial incentives created by such arrangements would encourage organisations to be more allured to investing in innovative activities, knowing that they would not disadvantage the whole group. The money saved from the offsetting of losses against gains can, in turn, be reinjected into the group for further investment, thereby fuelling growth of the Hong Kong economy.

Inland Revenue (Amendment) (No. 7) Ordinance 2018.KPMG, Enhanced tax deductions for R&D activities in Hong Kong, KPMG Hong Kong Tax Alert, May 2018.

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Concerns have been raised that the introduction of group tax loss relief would have an adverse impact on government revenue collections given the reliance on profits tax as a source of government tax revenues. This is largely a result of Hong Kong having a very narrow tax base and an over reliance on a relatively small number of corporates contributing a majority of the profits tax collected. For example, in 2017/ 18, it is estimated that the large corporations operating in Hong Kong contributed the vast majority of the profits tax revenue in that year. The concern is that such revenue collection from large corporations would be impacted by group tax loss relief.

We do not share these concerns, as we believe that any shortfall in revenue will be temporary and more than made up by future revenues. However, to the extent that these concerns are valid, there are various ways to limit such potential shortfalls which will be discussed in Section I of this paper.

Further global tax developments, driven largely by the OECD’s ‘BEPS 2.0’ initiative, could also have an impact on the competitiveness of many of the businesses operating in Hong Kong. For example, some of the changes under consideration include a global minimum tax rate, which could severely impact the competitiveness of corporate groups in Hong Kong in the absence of group tax loss relief. This paper concludes that Hong Kong needs to introduce group tax loss relief in order to ensure that it remains globally competitive as an international financial centre.

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V. Guangdong-Hong Kong-Macao Greater Bay Area (GBA)

With economic growth of the GBA expected to double12 within the next decade, the region is anticipated to generate significant demand for banking, insurance and asset management products and services13. Hong Kong is set to leverage its expertise as an IFC in the roll-out of the GBA implementation plan. This provides Hong Kong’s financial services industry with significant opportunities arising from the GBA, which aims to, through riding on the competitive advantages of Hong Kong, Macau and the nine cities in Guangdong, create a globally competitive business region.

Hong Kong serves as a conduit for financing investment and trade activities within the GBA, for both MNCs looking to expand further in the region, as well as for Chinese corporates looking to go offshore. The reason for this is that Hong Kong boasts a vibrant capital market and one of the most developed asset management and insurance markets in Asia and the globe. Hong Kong is also the largest offshore RMB business hub.

Opportunities for the financial services industry within the GBA do not only limit to the traditional banking sector. Hong Kong is also an established private wealth and asset management centre that is well-placed to be the GBA hub to provide such services to the growing number of middle class and high net worth individuals in the region. The depth of the financial markets in Hong Kong provides access to investment instruments required for portfolio diversification to this group of individuals whose investment options are currently limited. Likewise, the Hong Kong insurance sector can contribute to corporates and individuals in the GBA through their expertise in risk management and broad products spectrum.

KPMG/ AustCham Hong Kong, Connecting Opportunities in the Greater Bay Area, 2018, p26. ibid, p2.

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VI. Common Approaches to Group Tax Losses

The FSDC paper released in September 2017 outlined some common approaches to group tax loss relief.14 Nearly all developed economies allow some form of group tax loss relief measures to taxpayers, whether by way of a transfer of tax losses between group companies or through tax consolidation. Hong Kong now stands as the only leading international financial centre and one of very few developed economies globally without a group tax loss relief arrangement.

A summary of the developed economies that have adopted some form of group tax loss relief is outlined in Appendix B, including other major IFCs, namely the US, the UK and Singapore15. These countries group or transfer losses either by way of group consolidation, group tax loss transfer or consortium relief. As a proposed treatment for Hong Kong, the FSDC recommends Hong Kong to consider the form of group tax loss transfer. Group consolidation and consortium relief methods are generally considered relatively more complex to implement and administer, whereas group tax loss transfer is generally viewed as simple from an implementation point of view.

As a point of reference, the UK and Singapore16 adopt group tax loss transfer regime. A group tax loss transfer regime allows unutilised tax losses of one group company to be transferred to and set off against the taxable profits of another company within the same corporate group. Typically, a tax loss transfer regime would require (1) only amendments to existing laws (rather than a new body of law), (2) more flexible joining requirements (by percentage of direct or indirect ownership) and (3) less administration and compliance costs than, say, the group consolidation or consortium relief arrangement. Accordingly, a tax loss transfer regime is likely to fit better into Hong Kong's current tax system as compared to the other forms of group consolidation.17

Note 3.Refer to Appendix C for details regarding how group tax loss relief works in Singapore.ibid.Note 3, p9.

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VII. Singapore’s Approach

Singapore first introduced group tax loss relief measures in 2003, while, in many other aspects, the Singapore tax regime is similar to that in Hong Kong.18 Singapore did this as it recognised the importance of allowing group tax loss relief to support corporate groups in promoting investment and entrepreneurial risk taking. Singapore first introduced a tax loss transfer regime for the year of assessment 2003, and then subsequently, a tax loss carry-back system from the year of assessment 2006. Singapore implemented the group tax loss relief with relative ease, requiring only minimal adjustments to its existing taxation legislation.19

It is apparent from the Singapore experience20 that the Singaporean government neither encountered significant fluctuations in revenue collections following the introduction of the rules nor additional levels of complexity in the administration. Singapore had considered the potential loss of revenue in evaluating the tax loss carry back regime when it was introduced in 2006, but they were able to get comfortable with this aspect as well.21

More importantly, Singapore took the view that allowing the transfer of tax losses amongst group companies should not lead to a higher degree of uncertainty in revenue collections. This was on the basis that an ultimate loss in revenue would only arise if a business did not recover from current year losses and subsequently failed. The working hypothesis was that businesses are managed to make profits, and not losses. The grouping of tax losses would therefore help strengthen a group’s cash flow, and it should help businesses to overcome those cyclical downturns in business.22

An outline of Singapore’s approach to group tax loss relief and comments are set out in Appendix C.

Refer to Appendix C for details regarding how group tax loss relief works in Singapore.Economic Review Committee: Sub-Committee on Policies related to Taxation, the CPF System, Wages and Land, Restructuring the Tax System for Growth and Job Creation, REDAS, 2002, para 25.Refer to Appendix C for details regarding how group tax loss relief works in Singapore.ibid.Note 7, para 54.

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Hong Kong’s tax system must evolve and modernise not only to maintain its competitiveness with leading IFCs, but also to support the economic growth and development of Hong Kong businesses. Hong Kong’s profits tax rate is no longer considered competitive on its own compared to many other countries. The global trend has been for jurisdictions to lower their corporate tax rates to such an extent that many other markets now have corporate tax rates similar to that in Hong Kong. Introducing group tax loss relief measures in Hong Kong would be one way to ensure Hong Kong’s tax regime remains attractive to financial services businesses operating in Hong Kong. This is especially relevant given the social and economic challenges that Hong Kong is facing.

The international community’s response to the recent situation in Hong Kong has posed challenges to the Hong Kong market. Not only have travel bans to Hong Kong been put into place, but many events, including events specific to the financial services industry, have been cancelled as a result of the instability in Hong Kong. This is a critical time for Hong Kong to adopt progressive and practical fiscal policies that mirror international trends.

Group tax loss relief acknowledges the underlying commercial reality that group companies are made up of ‘single’ economic units that are ultimately managed by the same group of persons. This is especially the case in the financial services sector. The lack of group tax loss treatments may be conceived as discriminating against corporate taxpayers that operate their respective businesses through separate legal entities in Hong Kong, compared to those operating multiple businesses through a single legal entity, whereby the former would not be able to offset losses from one business against profits from the other. From a tax policy perspective, there should be no distinction between the taxation of either type of business organisation, particularly in the financial services sector when there are clear commercial reasons for such business decisions, as regulatory requirements or rules often direct how the business should be undertaken.

VIII. Financial Services Industry’s Need for a Group Loss Relief Regime

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Financial services providers operate businesses in separate legal entities instead of through a single legal entity for the reasons highlighted in this paper:

Clearly, there are genuine commercial drivers that influence the legal structure of a business and of particular importance is the need to quarantine risk that may arise from entrepreneurial activities and non-compliance with regulatory requirements. Ultimately, Hong Kong’s lack of group tax loss relief treatment is increasing the operating costs of financial services groups undertaking responsible risk management practices, which is not a desirable outcome from a policy perspective. In contrast to Hong Kong, key IFCs such as the UK and the US, as well as Singapore, all have various forms of group tax loss relief mechanisms in place. To maintain Hong Kong’s competitiveness among its peers, Hong Kong cannot afford to be an outlier by having a tax system that may not be perceived as supportive of the financial services industry.

To quarantine/ ring-fence commercial risks across different businesses and to mitigate the contagion of risk for new innovation and investing into research and development;

To facilitate the divestment of businesses by separating them into separate legal entities and to provide a platform for future investors where required;

To implement a legal structure for the various business operating units in view of implementing management, operational and investment evaluation frameworks and to comply and be more efficient with capital adequacy rules; and

To comply with regulatory restrictions, i.e. certain business activities are not allowed to be undertaken by the same legal entity and are required to be separated.

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Hong Kong should consider introducing a group tax loss transfer regime that would allow for unutilised tax losses of one group company or branch to be transferred to and be set off against the taxable profits of another company or branch within the same corporate group.

The ability to make use of group tax losses within a corporate group should be also limited to entities within a corporate group that have a 75% or more common ownership. This is in line with the tax systems in both the United Kingdom23 and Singapore24, which allow for group tax loss relief to apply across entities with at least 75% common ownership.25 We take note of the fact that the current stamp duty intra-group relief regime in Hong Kong is applicable to companies where there is at least 90%26 common ownership. However, to be in line with global best practice, we would propose a 75%27 common ownership threshold to be considered for the group tax loss relief arrangement.

Such rules should cover (1) losses amongst companies and Hong Kong branches only in respect of losses that arose from when they were within the same corporate group, and (2) the companies or branches share the same accounting period.

Further, we would recommend allowing carry back losses against the company’s previous assessable profits for one year, which is also in line with global best practice. It is important to consider a loss carry-back option to ensure Hong Kong can stay competitive in the global market. This would also address concerns that have been raised from recent accounting standard changes.

The introduction of section 18G-L28 into the Inland Revenue Ordinance to implement International Financial Reporting Standard 9 (IFRS 9) brings a degree of volatility as it calls for the widespread use of fair value accounting of unrealised gains. The effect of IFRS 9 in Hong Kong is that entities may have to pay tax on unrealised gains in one year of assessment only to have those gains turn to a loss in the following year that cannot be carried back. The implementation of IFRS 9 presents the prospect that tax losses could be indefinitely kept within an entity. This creates a level of commercial inequality that can be partially mitigated by group tax loss relief and tax loss carried back measures. It is important to note that IFRS 9 is an international accounting standard which many other jurisdictions have enacted alongside group tax loss relief and tax loss carried back. Financial services businesses in our competitor jurisdictions will not suffer the same problem as a result of IFRS 9 as Hong Kong taxpayers.

The ability to bundle tax losses across group companies should not be regarded as any type of tax avoidance or tax advantage as there are sufficient safeguards to ensure that the correct amount of tax is paid. For example, the anti-avoidance provisions in the current tax law and the mandatory disclosure of related party transactions in profits tax returns are all effective safeguards against tax avoidance.

IX. Recommendation of the Group Tax Loss Relief Framework for Hong Kong

Ernst & Young, “UK reforms group tax loss rules”, Tax Alert 2016Refer to Appendix C for details regarding how group tax loss relief works in Singapore.Note 23.ibid.ibid. IRO, s18G-s18L.

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24

25

26

27

28

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The group tax loss relief rules would need to cater for instances where tax losses are incurred by a company that qualifies for taxation at a rate lower than the standard 16.5% corporate tax rate. This could arise in respect of, inter alia:

The FSDC is cognisant of the concerns on the perceived complexity in the administration of group tax loss relief, and the volatility in revenue collection, and addresses these concerns below. The FSDC contends that the administration of a group tax loss transfer regime should be relatively straightforward and simple to administer in contrast to other forms of similar measures, such as group consolidation. Typically, group tax loss transfer provisions would require minimal amendments to existing laws (as opposed to a new body of law), and less administration and compliance cost. Consequently, we maintain that a group tax loss transfer regime should be the preferred approach for policymakers to consider.

There are various ways to limit the short term reduction of any potential loss of revenue. Options include setting a cap on the amount of losses that could be transferred between entities in the same group, limiting the number of entities that can fall within the group loss relief, (e.g. one entity can transfer to a limited number of other entities within the group). Alternatively, or additionally, restrictions could also be placed on the number of years that carry back losses are allowed. These options can be considered in combination with a phased approach, if appropriate.

Corporate treasury centre rules, where an 8.25% profits tax rate to qualifying profits from certain corporate treasury centre activities;

Aircraft leasing rules that will apply an 8.25% profits tax rate to qualifying profits from certain aircraft leasing activity;29 and

The two-tier corporate tax system which imposes profits tax at 8.25% on the first HK$ 2 million of profits and 16.5% thereafter.30

a.

b.

c.

IRO Sch 8B, s2(a)(i).IRO Sch 8B, s2(a)(ii).

29

30

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In summary, key features for group tax loss relief measures should include:

Companies and Hong Kong branches within a 75% group (including Hong Kong branches of group companies) should be able to offset tax losses via a tax loss grouping/ transfer system;

The companies and branches within the 75% group need to have the same accounting year;

For the tax losses to be grouped and offset, the tax losses must be incurred after the implementation of the group tax loss relief regime and at the time the companies/ branches are in the same group;

Where the loss company/ branch is subject to tax at a lower rate than the profit company/ branch, the tax losses transferred would be adjusted to reflect the tax benefit of those tax losses to the loss company/ branch (i.e. the adjustment approach);

Losses could be carried back for one year, within the loss company/ branch, to offset the assessable profits of the immediate preceding year;

Specific anti-abuse measures may need to be implemented to counteract tax-avoidance arrangements effected to take advantage of group tax losses that were incurred prior to the implementation of group tax loss relief (i.e. anti-avoidance rules);

Where a company/ branch within a group does not elect to transfer the tax losses for offsetting purposes, or has excess tax losses, the losses would be retained by the company/ branch and treated in the same manner under the ordinary tax loss rules (i.e., tax loss carry forward); and

The company/ branch would continue to account for taxable profits and deductible losses in the ordinary manner, i.e. there would be no tax consolidation.

a.

b.

c.

d.

e.

f.

g.

h.

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X. Conclusion

Hong Kong remains the only leading international financial centre without some form of group tax loss relief or tax consolidation. Currently, Hong Kong’s taxation system does not allow for the transfer of tax losses between group companies and branches operating in Hong Kong. There is therefore no relief available to a group of companies that have losses and profits in different legal entities.

The absence of group tax loss relief measures continues to put financial services groups operating in Hong Kong in a disadvantaged position when compared to those operating in other financial services hubs.

The financial services sector has been advocating the need for a level playing field for Hong Kong taxpayers that reflects commercial realities. Some form of group tax loss relief would ensure that the taxation system in Hong Kong is modern and competitive to attract foreign investment to the sector. Considering the keen competition of international peers, Hong Kong can no longer afford to rely on its source based system and relatively low corporate and individual tax rates alone to attract investment into the financial services sector. The tax regime needs to cater the need of how modern financial services groups operate. This invariably involves operating through many separate legal entities, which is often dictated by the local and home country regulatory requirements and the need to ring-fence the risks associated from new investment and business ventures.

As such, given the increasingly globally competitive environment for capital and investment and the recent economic hardship, now more than ever, we believe that it is time for Hong Kong to consider introducing group tax loss relief measures and a loss carry-back regime to cement Hong Kong’s position as a modern international financial services, technology and trading hub.

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Appendix A – Survey Results

With the help of various financial services industry associations, FSDC conducted a survey31 to ascertain if the proposed Group Tax Loss Relief measures would have an impact on their businesses. The survey was conducted across various financial services firms, with the majority (around 95%) being from the banking and insurance sectors. The survey results show that:

Over 80% of the firms surveyed are regional or global based (as opposed to Hong Kong based with domestic operations); Over 80% of the firms surveyed operate in Hong Kong through more than one subsidiary (which are separate legal entities); Over half of the firms surveyed (56%) operate through a Hong Kong branch; The majority of firms surveyed (70%) consider group relief losses may or will provide an additional incentive for their business to set up a separate Hong Kong based subsidiary to conduct R&D activities even if it is loss making; and

All firms surveyed support the introduction of the "group tax loss relief" to the Hong Kong tax system.

1)

2)

3)

4)

5)

These were the Capital Markets Tax Committee of Asia, the Hong Kong Federation of Insurers, the Hong Kong Association of Banks, the Hong Kong Investment Funds Association, and the Chinese Banking Association of Hong Kong.

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Appendix B – Tax Loss Relief Mechanisms in Developed Economies as of April 2020The following summary table provides an overview of the tax loss relief mechanisms adopted by different developed economies.

Note: This summary table has not included temporary tax measures for COVID-19 introduced by various economies.

Economies

Austria

Australia

Canada

Cyprus

Denmark

Finland

France

Germany

Ireland

Italy

Japan

Luxembourg

Malaysia

Netherlands

New Zealand

Norway

Portugal

Singapore

Spain

Sweden

United Kingdom

United States

Tax loss carry back

Not available

Not available

3 years

Not available

Not available

Not available

1 year

1 year

1 year

Not available

1 year

Not available

Not available

1 year

Not available

2 years36

Not available

1 year37

Not available

Not available

1 year

Not available38

Group relief

Group consolidation

Group consolidation

Not available

Loss transfer

Group consolidation

Loss transfer32

Group consolidation

Group consolidation

Loss transfer, consortium relief33

Group consolidation

Group consolidation34

Group consolidation

Loss transfer

Group consolidation

Dual system35

Loss transfer

Group consolidation

Loss transfer

Group consolidation

Loss transfer

Loss transfer, consortium relief

Group consolidation

The loss transfer regimes operated in Finland, Norway and Sweden are commonly known as group contribution regime. It allows profits (instead of losses) to be transferred within a corporate group.Consortium relief is an extension of group tax loss transfer regime that allows tax losses to be transferred between the consortium entity and its consortium members.Restrictions apply based on the size of the entities/ group.New Zealand offers both group consolidation and loss transfer mechanisms to taxpayers on an elective basis.Applicable in the year of ceasing business only.This is subject to a cap of SGD 100,000.The ability to carry back losses was abolished in 2017 by the Tax Cuts and Jobs Act of 2017.

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33

34

35

36

37

38

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Appendix C – Singapore’s Group Tax Loss Regime

In order to utilise the group loss relief benefit, the companies must be Singapore incorporated entities with the same financial year end39 that maintain a 75% ordinary shareholding threshold where at least 75% is held directly or indirectly by an associated entity.40 The companies applying for group relief will need to submit a GR form A and GR form B when they file their tax returns. These forms detail which companies within the corporate group will claim the tax losses and the amount that will be transferred.41 Group tax loss in Singapore is predominately governed by section 37C of the Income Tax Act.42

Upon introducing the rules in Singapore, the then Deputy Prime Minister of Singapore provided the following explanation for the group tax loss relief regime in his Budget Statement 2002:

In the Budget Statement 2005, the Prime Minister of Singapore further explained the reasons for introducing the loss carry back regime as follows:

“The ERC Sub-Committee has recommended allowing group relief to help reduce the cost of doing business in Singapore. Group relief recognises group companies as a single economic entity by allowing the unutilised losses and capital allowances from one company to offset the profits of a related company in the same group. This is already the case in most developed countries, including the US and the United Kingdom (UK).

The introduction of group relief will lower the tax burden on companies, and encourage more risk-taking and enterprise. It will also help companies during recessions or the early years of new ventures, when they are likely to make losses. Companies which set up subsidiaries for risky ventures will be able to enjoy the limited liability benefit of separate subsidiaries, and still offset those subsidiaries' losses against their own profits.”43

“Small businesses are the backbone of many economies. They support the MNCs and larger local companies as part of an integrated production network and provide jobs for a large part of the population. They are also often key sources of innovation and buzz. We too must ensure that our SMEs thrive and grow in our competitive economic landscape..., we will provide tax relief for small businesses to help them cope with cash flow problems, especially in a cyclical downturn. Our corporate tax system already allows companies to carry forward business losses to offset future tax liabilities. In other words, if you lose money this year, you can carry the loss forward and you can offset it against profit you make next year. So next year, you can reduce the tax you have to pay...”44

Economic Expansion Incentives (Relief from Income Tax) Act (Cap. 86), SingaporeInland Revenue Authority of Singapore, “Transferring Loss Items Under Group Relief” Inland Revenue Authority of Singapore, “Applying for Group Relief”Income Tax Act (ordinance 39), Singapore, Revised Edition 2014. The Ministry of Finance of the Singapore Government, Budget Statement 2002: A Budget for a Different World (3 May 2002), paras 4.9 and 4.11.The Ministry of Finance of the Singapore Government, Budget Statement 2005: Creating Opportunity, Building Community (18 February 2005), paras 2.34 and 2.36.

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40

41

42

43

44

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The FSDC was established in 2013 by the Hong Kong Special Administrative Region Government as a high-level, cross-sectoral advisory body to engage the industry in formulating proposals to promote the further development of the financial services industry of Hong Kong and to map out the strategic direction for the development.

The FSDC has been incorporated as a company limited by guarantee with effect from September 2018 to allow it to better discharge its functions through research, market promotion and human capital development with more flexibility.

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Email: enquiry@fsdc.org.hkTel: (852) 2493 1313 Website: www.fsdc.org.hk

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